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Oracle's California scandal problem
Oracle is famous for aggressive sales tactics. But an embarrassing scandal could change its ways.
May 14, 2002: 11:01 AM EDT
By Eric Hellweg, CNN/Money Contributing Columnist

NEW YORK (CNN/Money) - There's scandal brewing in California, and it's shining an unwelcome spotlight on Oracle's sales practices.

Here's the basic story: Last year, the state of California quietly signed a $95 million contract to purchase Oracle (ORCL: up $0.23 to $8.70, Research, Estimates) software for state employees. The deal was never put up for competitive bidding, and a subsequent report by state auditors found that it would waste $41 million in California taxpayer dollars.

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To top it off, after the deal closed, Oracle made a $25,000 contribution to the campaign of California governor Gray Davis. Since news of the deal came to light, two state officials have been forced to resign, Davis was forced to return Oracle's $25,000 donation, and, according to some reports, the FBI has launched an investigation. Negotiations are also under way to cancel the software contract altogether.

As it happens, however, shady contract deals are new to neither Oracle nor the software industry. Back in 1993, Oracle became the target of a Securities and Exchange Commission lawsuit accusing the company of billing customers for work that was never done. (Oracle eventually settled out of court.) Meanwhile, the software industry at large is famous -- infamous? -- for pushing through questionable deals at the end of each quarter so revenue from those sales can be counted toward that accounting period.

Two factors make Oracle's California scandal noteworthy. First, it has become a political issue -- this is an election year after all, and Oracle's ill-timed donation to the Davis campaign has become a ripe topic for the governor's adversaries. Second, for investors, the more pressing danger is that the current stink could change the way customers interact with software companies such as Oracle, as well as how those companies account for their revenue.

Since this is a technology and investment column, I won't get into the political ramifications of the story, other than to say that Davis must be privately thankful that the "smoking gun" memos detailing Enron's complicity in the California power crisis have received so much national attention, leaving only state and local papers to cover the Oracle mess.

But for large companies that buy a lot of software, this couldn't be a hotter story. Since time immemorial -- or at least since corporations began investing in enterprise software packages -- large customers have been at the mercy of software vendors. Software sellers have been able to dictate the terms of their payment structures, but most of these are out of whack with generally accepted accounting principles (GAAP), says Ted Schadler, group director of research at Forrester Research of Cambridge, Mass.

"The software industry has avoided GAAP forever," Schadler says. "They make you pay up-front, but customers really want to pay as they go." This practice makes it impossible to accurately weigh a seller's costs against its revenues -- one of the bedrock principles of good accounting. In addition to being pushed to close sales at the end of a fiscal quarter, corporate customers -- much like the state of California -- are often pressured by the vendors to sign big deals up-front or forfeit time-sensitive discounts. "It's time for the software industry to grow up," Schadler argues.

Schadler has developed a "maturity scale" that he uses to calculate the sales tactics of various software companies. Mature firms assist their customers with due diligence, are straightforward about additional costs, and are realistic about implementation time frames. Immature companies are recklessly aggressive and will do anything to get the sale before a competitor does, even if it means deceiving a potential customer.

Where does Oracle sit on this scale? "It's maturing," Schadler says with a diplomatic chuckle. "It's being forced to mature."

Of course, many Fortune 500 companies have aggressive sales cultures. But even within the cutthroat world of Silicon Valley, Oracle is famous for being particularly aggressive. Now, however, with all the negative publicity surrounding the California contract, many think the company will need to revise its tactics to ensure future growth.

Jim Mendelson, a managing director of enterprise software at Soundview in Greenwich, Conn., reiterated his firm's "strong buy" recommendation on Oracle after the contract controversy surfaced. (Of the 35 analysts who cover Oracle, Mendelson is one of only six who are currently giving the company that rating.) He believes that Oracle is fundamentally sound, and that it did the right thing by immediately offering to withdraw the California contract.

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That said, he agrees that Oracle is suffering from the negative publicity and needs to make some changes. "They'll have to make more of an effort to make customers more comfortable doing business with Oracle," he says. "Oracle needs to be more of a partner and less of an adversary."

Yet software customers hoping the Oracle controversy will trigger rapid changes in the way software payments are structured are likely to be disappointed: If changes come, they're going to take a while. Wall Street demands strong quarters and steady growth from software companies, and with capital spending in a funk, it's unlikely that the Oracle controversy will pack enough punch to immediately force software firms to distribute revenues across multiple quarters. But some feel that change has to come.

"The software industry once had the keys to the kingdom," Forrester's Schadler says. "But buyers are becoming more sophisticated. The software industry should share in the risk instead of running and gunning."

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