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Summary
Convergence, the annual user conference for Microsoft Dynamics, showed that Microsoft’s enterprise resource planning (ERP) software business continues to evolve from four distinct units – acquired in a series of mergers - into a cohesive whole. We think Dynamics still has a long way to go, but Microsoft has made significant progress over the past three years in enhancing, marketing and selling the products. Software for midsize companies poses different product design challenges than ERP for large corporations – challenges that affect implementation and maintenance as well as sales and marketing. Great Plains Software had a leading market share before Microsoft acquired the company because it did a better job than most in addressing this. Microsoft entered the midsize ERP market for two reasons: It presented an attractive business opportunity, and it could pull through incremental sales of Microsoft’s server and other products. In theory, a fully integrated technology “stack” has advantages for midsize organizations. But Microsoft still must turn theory into reality.

Assessment
This year’s Dynamics conference took place against a positive backdrop. After years of mediocre growth, revenue increased 19 percent in both the September and December 2006 quarters. Attendance, about 8,500 by Microsoft’s count, was double last year’s. In our view, the Dynamics business continues to make progress in its long-term transition from four distinct software companies into a single business unit that offers a line of integrated business management applications for midsize companies worldwide. After years of post-merger digestion, the product enhancements Dynamics has made over the past two years have been a significant factor in the recent sales acceleration.

Over the past three years the Dynamics group has addressed lingering post-merger issues and improved user interaction with the software in small but important ways. We believe the recent product improvements have finally given customers a reason to buy the software. Those who appreciate deep integration with Microsoft’s Office and various server products will find more of that than ever. (On the other hand, those who find the constant cross-selling in every demonstration annoying will have to live with it.) The Dynamics group’s four products continue to progress toward a single platform, but with so many ERP vendors, including Oracle and Infor, managing multiple acquisitions, integration is not a pressing issue. The recent wave of industry consolidation has taught vendors, including Microsoft Dynamics, that it is smarter to provide one’s installed base with a steady stream of product enhancements than to force a migration.

The company gradually is addressing a number of significant business model issues that have been up the air. It is clarifying the purposes and markets of the four brands. Microsoft has positioned the old Great Plains as an accounting package for North American services business, while Solomon, another accounting package, is aimed at specific verticals, such as project-oriented businesses, mainly in North America. Navision is the European brand, and Axapta, a worldwide manufacturing and supply chain application, is currently the growth engine of this business. We believe the channel issue – who is going to sell what to whom – will resolve itself as the various resellers and integration partners go their separate routes.

One of the most interesting demonstrations at Convergence showed companies how the Dynamics software – in this case, Axapta – can respond rapidly to a supply chain hiccup. The “wow” factor in the demo was a slick interface that enables users to see the underlying flow of materials through the process. They can visually manipulate how they want to allocate the now-constrained supplies and see the impacts on key customers, revenues and profit margins. However, Microsoft Dynamics is not offering the interface yet. It apparently has other advanced usability tricks up its sleeve as well, but we don’t expect these to be released soon.

Performance management and business intelligence (BI) also were in evidence throughout the conference. We think the decision to bring FRx, a stand-alone entity that Great Plains had acquired,  into the Office business unit indicates a two-tier approach to this market; Microsoft is targeting PerformancePoint at larger midsize companies and FRx at the rest. The crowds around the FRx Forecaster demonstration suggest a latent demand for an alternative to spreadsheet-based budgeting.

Market Impact
Over the past several years, Microsoft Dynamics has solidified its position in the market for ERP software for midsize companies. In our judgment, integration of the ubiquitous Office applications and the company’s server products (such as SQL Server, BizTalk and SharePoint) with the Dynamics product line provides both advantages and disadvantages. On the plus side, Microsoft can bundle integrated software stacks with sophisticated capabilities for different markets and sales channels. On the other hand, we think Microsoft must do more to make implementation and maintenance easier. It also needs to cut the total cost of ownership to bring the software within reach of more midsize companies. Because Microsoft’s development process appears unwieldy, companies such as Epicor, Exact and Sage Group have a good opportunity to remain competitive.

Recommendation
ERP software has come a long way, particularly for midsize companies. The current generation of enterprise software for those companies has capabilities available only to large corporations 10 years ago. Companies that are looking to replace their ERP should first consider not only what aspects of the software they have today they need to replace but also how they can manage their businesses better through software that enables more effective processes. To do otherwise will be to miss an opportunity to achieve higher returns from this important investment. Microsoft Dynamics offers companies many choices, and we advise those looking at new ERP software to evaluate the offerings.