(FORTUNE Magazine) – Hasso Plattner has a score to settle with Larry Ellison. The men are not just fierce rivals in the business-software market; they have tested their mettle at sea. Seven years ago, during a race off Hawaii, Plattner's yacht snapped its mast. As Ellison's Sayonara sailed to victory, his support boat passed Plattner's struggling vessel without offering to help--an act of unsportsmanlike behavior. The chairman of SAP says he was so disgusted he dropped his pants and gave the Oracle chief's crew a full view of his backside.

But on land Plattner has bested Ellison at every turn, leaving the $11-billion-a-year database giant a distant second in the business-software market. Now Ellison's getting desperate to close the gap: The California titan's $6.3 billion hostile bid for rival PeopleSoft is a direct response to SAP's commanding lead. If the deal goes through, Oracle will put more wind in its sales pitch to big companies looking to buy software to run all their critical business functions, from payroll to manufacturing to customer relations. It will also put Oracle more clearly in contention with SAP--a prospect that doesn't seem to bother Henning Kagermann, who took over from Plattner in May as CEO of the German software company. "Even if they get PeopleSoft," Kagermann says, "they'll still be less than half our size."

SAP and Oracle weren't always on a collision course. Oracle got its start, and still derives most of its revenue, selling database software to big companies. SAP has always specialized in software to automate business functions, such as finance and factory management. (To this day, in fact, most SAP customers also have Oracle databases.) But as growth has slowed in the database business, Ellison has struggled to expand into applications. So far, says Bruce Richardson, an industry expert with AMR Research in Boston, "Oracle hasn't been able to get traction." SAP, he adds, "is now the prettiest girl at the dance."

Just look at the rise in SAP shares. Since April, when Ellison made waves with his declaration that IT was a mature industry ripe for consolidation, it has been SAP, not Oracle, that has soared. SAP shares, traded on the New York Stock Exchange as ADRs, have risen 63%, closing June 18 at $31.25. Oracle's shares are up just 9% during the same period. Tellingly, on the day Ellison announced his PeopleSoft bid, Oracle's shares dropped, while SAP's rose 9%.

SAP's stock gains are backed by solid performance. Last year the company had one of its best showings ever, gaining market share over each of its major competitors--Oracle, Siebel, PeopleSoft, J.D. Edwards, i2, and Manugistics. Revenue, adjusted for the declining dollar, rose 6%, to nearly $8 billion, and earnings were up 15%, to $1.7 billion. As a result of aggressive cost cutting, profit margins increased to 23%. In the first quarter of 2003, SAP extended its lead, growing its share of the business-software market to 54%, from 40% in 2001 (based on the revenues of the top seven companies). It's no wonder that Oracle, PeopleSoft, and J.D. Edwards, which PeopleSoft was in the process of acquiring, are engaged in an acrimonious battle that may result in a three-way combination. Even so, their total market share of 30% wouldn't topple SAP from its perch.

"If you look at his position, what can he do?" Kagermann says of Ellison. "He said that IT is becoming a commodity, which isn't true, but it might be true for databases, and this is his cash cow. He has to go into business applications because they are not a commodity. That is good for us. It tells us that we are in the right business."

SAP isn't holding back. The week after the Oracle bid, it launched a marketing offensive to capture PeopleSoft and J.D. Edwards customers who may be hesitating about buying software from companies in the thick of a nasty fight. "Will you find your business playing second fiddle to the turmoil of mergers and acquisitions?" read full-page SAP ads in the Wall Street Journal and other publications. "The relationship with your supplier is so important," says Patrick Arlequeeuw, Procter & Gamble's head of supply-chain systems, who considered other software companies before choosing SAP as P&G's global supplier in the mid-1990s. "You would want to know how that would change." Adds Kenzo Sugiura, head of management-information systems at Brother International, a Japanese office-equipment maker, which also chose SAP: "This will give SAP a great opportunity to get more customers."

Ellison's move may be only a short-term boon for the Germans. For one thing, some analysts speculate that IBM could come to PeopleSoft's rescue. Even more ominously, Microsoft has begun making moves toward SAP's turf. "IBM and Microsoft are the two largest companies in IT," says Kagermann. "And both have money. So if they decide to go into a similar business, we would have to view them as stronger competitors." IBM declined comment, citing the volatility of the current situation, and Microsoft says it views SAP as more a partner than a competitor.

The task of steering SAP through those turbulent waters falls not to the yachtsman Plattner but to Kagermann, who spent five years as Plattner's co-CEO. Plattner, 59, gave up the CEO job a year earlier than expected (though he remains as chairman), turning the helm over to Kagermann, four years his junior and the first SAP chief who isn't a founder. At the time, SAP had solved most of its product and management problems, many of which stemmed from its belated recognition of the revolutionizing influence of the Internet on business software. Kagermann's goals are to lead new growth in the industry, not just at SAP, and to boost SAP's profit margins. He also wants to boost SAP's share of the global business-software market to between 60% and 70% by 2005.

He aims to do that with a style that contrasts sharply with Plattner's. If the world of software chieftains can be divided into sassy jocks like Ellison and intense nerds like Bill Gates, Kagermann is a nerd and Plattner is a jock. Plattner lives life large, moving so restlessly between offices and homes in Germany, New York, Palo Alto, and South Africa that his own staff often can't find him. When Plattner plays golf, he does it with Tiger Woods at an annual tournament SAP sponsors with Deutsche Bank. When he talks software technology, he skips excitedly from subject to subject, madly scribbling on a whiteboard.

Kagermann's sport is, well, volleyball. And he stopped playing that a few years ago because he was too busy working. He gave up tennis shortly after joining SAP because he couldn't compete with other SAPers at headquarters in Walldorf, a dull town an hour's drive from Frankfurt.

Kagermann was SAP's oldest recruit in 1982, the year Plattner hired him from the University of Braunschweig. With his wild hair, wire-rimmed glasses, and rumpled sports coats, he still resembles the cerebral physics professor who answered an SAP help-wanted ad. He left academia because his specialty, nuclear fusion, had little future unless, he says, "I wanted to think about how to damage a lot of people with a very innovative weapon. I didn't think that was fun." Plattner says he hired Kagermann because he was bright and had good grades. "He never ducks a question," says Richardson at AMR Research. "There's no smart-ass answer. Everything he tells you, he has thought about a lot. And he is almost always right."

Kagermann may not be flamboyant, but he's just what SAP needs. In his first weeks on the job, he has brought discipline to the way SAP is run and has urged the company's software developers to focus more carefully on what customers want. After years of gorging on IT products that seemed nifty but didn't necessarily make their companies run better, corporate chief information officers are under pressure from the top to justify their spending. "Customers have started to look at IT like a normal investment, not that it's cool stuff that they have to have," says Kagermann. "If there's no business case, they don't buy it."

At SAP's annual European sales meeting in Nice earlier this year, Kagermann hammered home the company's new sales mantra. To close a sale, SAP's field force must show customers how applications improve profits, raise revenue, or reduce costs. "We have to deliver on the promises of IT, that it works for customers and helps them make money," Kagermann said, pacing across the stage. "If you feel a client isn't ready for a solution, tell the truth. Sell it to them a year later."

To show customers it is serious about helping them boost profits, SAP hired a Connecticut consulting firm to churn out a series of reports analyzing returns on SAP software. One happy customer: Brother International, which got a 129% return on a piece of SAP software that helps it manage customer relationships. Among other things, the software cut call time from customers inquiring about its products by 40%, saving $1.80 per call. "The initial cost of SAP software is very expensive," says Brother's Sugiura. "But by rolling it out everywhere, it enables us to standardize business processes in each region. We save a lot of money."

It was the idea of standardizing business processes that led to the creation of SAP in 1972. Plattner and four other IBMers believed that their employer was missing a market for business software that could automate back-office functions and make calculations as they were entered in the computer, rather than hours later as was then the practice. The crew wrote its first financial package at night on a borrowed IBM mainframe. SAP steadily expanded its software portfolio, customizing applications for individual industries and moving aggressively into the U.S. market in the mid-1990s. Revenue jumped from $1.9 billion in 1995 to $4.8 billion in 1998.

Then all hell broke loose. At first Plattner had minimized the threat posed by the Internet to SAP's business. But customers, particularly in the U.S., were demanding that the company make its products more compatible with the Internet, which allowed businesses to build cheaper data networks that better connected suppliers, distributors, and customers, as well as divisions within companies. "The Internet brought any kind of user to the system," says Plattner. The late-'90s tech boom also spawned competition such as Siebel, which thrived by developing software for business functions SAP had never addressed.

So Plattner did something un-SAP-like: He went outside for help. First SAP paid $574 million for a 20% stake in Commerce One, a California startup that wrote software for Internet-based B2B marketplaces. Then it spent $400 million for Top Tier, an Israeli software company that had developed a portal compatible with SAP business applications. With Top Tier came its precocious CEO, Shai Agassi, 34, who has become Plattner's heir apparent as SAP's tech visionary.

Bolstered by its acquisitions, SAP has developed Net-based applications that have moved it from the back office to the front. To compete with Siebel, which pioneered customer-relationship-management software, SAP began selling its own CRM products in 2000. It moved into supply-chain software, competing with i2. One by one, SAP took on startups, which were writing software that used Net standards to bring new computer and communications power to corporate tasks. As customers increasingly demanded one-stop shopping, SAP gained market share. "Two years ago SAP's product wasn't there," says Mohammed Moawalla, a software analyst at Goldman Sachs in London. "Now they've got it."

Agassi is pushing SAP further on the technology front. He has insisted that SAP make its applications compatible with the underlying web-services software produced by Microsoft, IBM, and others. He has also mapped out new products called xApps, meant to combine bits of software from a human-resources application, say, with those from a financial application. Such a package could, for instance, make it easier to plan how many people to lay off in an acquisition--something Ellison might find handy should he succeed in buying PeopleSoft. "Because of the Internet, we can do things we never could do before," says Agassi. "Before we spanned a sliver of the enterprise. Now I can span the entire enterprise."

Kagermann says revenue from new applications is just one way SAP will grow. He plans to sell Internet-based software to more of the company's 19,600 customers. And he wants to expand sales to medium-sized businesses. He is also tightening the screws on the cost side. The company has taken away phone privileges from some employees and encouraged others to use videoconferencing instead of traveling. Those who do travel fly coach. SAP has also moved research to such low-cost places as Sofia, Bulgaria, a two-hour plane ride from Frankfurt.

If Ellison pulls off his PeopleSoft bid, it could allow SAP to focus on just one major competitor. "It might even be better for us," says Kagermann, "because the difference between Oracle and SAP is clearer than between SAP and PeopleSoft in the culture of the companies." Not exactly smooth sailing, but there's no need, Kagermann insists, for SAP to change its tack.

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