I received a lot of back channel questions following my analysis of SAP’s Q2 results. Most of them go something like this: ‘I’m worried about SAP’s cloud revenues. Do you think they’ve missed opportunities?’ It’s a fair question given the lumpiness in that area but cloud alone is not the whole picture by any means.
Regular readers will know that I have my eyes set on what happens after 2015. That is the time frame in which we will likely see the next major change among the top management at the company. At least that’s what most people believe. In that context I am receiving increasing inquiries about what happens in a post-McDermott/Snabe era. Couple that with promises made over the years by SAP about its numbers plus the likelihood of a radical tipping point regarding the BusinessSuite and you can envision a very different picture from that which we see today. But even that is not the whole picture.
Some pundits also have their eyes glued to what’s happening with IBM and Accenture. They are all part of the same broad market and what happens in one place has impact in another. So for example, SAP’s results are thought to be leading indicators of impact on Accenture and IBM’s results.
I suspect the real problem for many analysts is that the broad market picture looks so complicated that teasing out the piece parts and then re-assembling into a coherent whole is far from straightforward. I will attempt to lay down some guideposts in an effort to clarify what is really going on in the hope it provides buyers with some talking points.
Caveat: there is a significant element of speculation in what I am saying so please bear that in mind. Please also note I am ignoring the mobile element in this discussion as I don’t have enough data points upon which to make any sensible assumptions.
Services and software background
The service market is in flux. IBM has a long term plan to significantly reduce its dependency on SAP implementations. That should be no surprise given that the secular decline in large scale on-premise implementations is in full swing. Holger Mueller pegs that decline at 20 percent year over year. He has that wrong because he ignores the inclusion of HANA revenue in the 2012 figures. Taking those numbers out, we see a decline more likely in the 10 percent range. That tracks closely with what I am hearing in the field.
Now…that decline could easily reverse if macro economic conditions in Asia Pacific improve. China in particular is not an obvious ‘cloud’ candidate yet it remains a huge and largely untapped market. SAP has confirmed that its investments in that region will continue – a sign that it believes there is long term opportunity. Back to services.
More broadly, SearchITChannel presents a picture that demonstrates a slow growing services market. I believe that headline assessment is too simplistic. While there is little doubt that services tied to large scale implementations are on a downward track, services related to cloud implementations are sky rocketing. What SearchITChannel doesn’t say is that cloud implementations are often at much lower cost than the equivalents on-premise implementation. That of itself would drag down revenue growth. But even there, the big boys are getting it wrong.
According to the Redmond Channel Partner, the Veterans Association has just ditched a five year contract with HP to move its 600,000 Office users to Office 365. The contract, worth $36 million, doesn’t sound excessively high given the per user ‘cost’ is $60 and runs over five years. However, and change management issues aside, it is folly to price large numbers of user transfers on what seems a simple multiple of a relative;y low per user cost. That doesn’t reflect value at all.
I have consistently argued that the Big SIs will not see the revenues to which they are accustomed in a refactored cloud world. Some colleagues say they will – once the numbers become sufficiently attractive. That doesn’t make sense unless you believe customers are willing to throw the same level of spend at cloud in services as they are to on-premise. More to the point, I can find no evidence that is happening. Rather, as SearchITChannel points out in quoting Jeffrey Kaplan, managing director of THINKstrategies Inc. it says:
“Just as you’ve seen in the past decade software and systems disrupted and decimated by the advent of SaaS and cloud, the same forces are at work undercutting the perceived value and, therefore, the demand for traditional consulting.”
I regularly see this same sentiment coming from Bluewolf, Appirio and others. Now back to SAP.
The SAP quotient
Looking at SAP’s results in detail, we see that cloud revenue from both SuccessFactors and Ariba tracked at an annual run rate of around €950 million. While the SI’s will get a piece of this in implementation, my sense is that most of the work is staying with SAP’s consulting group. Services popped six or ten percent depending on whether you prefer IFRS or non-IFRS numbers. In a declining ERP market, the balance of revenue must be largely attributable to cloud and HANA related sales with the likelihood that much goes to HANA.
As I have already noted, the SI multiple on cloud deals is much lower than on-premise. so if SAP is keeping much of that service revenue to itself for the time being then it is not only protecting revenue streams, it is providing pricing guidelines for the future that its partners cannot ignore. Factors in smaller players implementing vertical market solutions based on HANA and you soon see that the services market is not only fragmenting but at lower cost to the customer.
UPDATE – the maintenance equation
In my enthusiasm to get this done I neglected to add in thoughts around maintenance.
Embraer moved from SAP to Rimini Street in 2011 for support of its SAP system to achieve better value and improve the level of service received. As a result, Embraer immediately reduced its annual SAP maintenance fees by 50 percent. Furthermore, Embraer was able to significantly add to its overall savings by cutting expensive support and maintenance costs
Standard fare when it comes to third party maintenance alternatives. But here’s the kicker. The savings:
…made it possible for Embraer to redeploy its substantial savings into new innovative initiatives that create competitive advantage in the marketplace and enable international business growth…
[My emphasis added.] Bingo! This is the kind of thing that customers who are in steady state with their ERP want to achieve. SAP says that as many as 70 percent of its customer portfolio have switched to the latest release of its core ERP. But…if the remaining 30 percent remain stubbornly wedded to older versions, which will be supported anyway through 2020, then that leaves a considerable amount of maintenance fees at risk.
How will SAP respond to the ongoing threat from Rimini and others? So far we have seen little to suppose that it will do more than throw the odd sop where the customer is clearly at risk. The threat represents a negotiating opportunity. Does SAP want 50 percent of something or 100 percent of nothing? Even at 50 percent it can still make solid margins of 90 percent on maintenance rather than 95 percent. But does it have the will to sacrifice margin? I think it will.
What of the future?
Financial analysts in particular hate this but SAP is playing a long game. It may have to endure the lumps of quarterly reporting but it is building both a platform (HANA) and subscription revenue streams (SuccessFactors/Ariba) that will see it keeping much of the overall revenue, i.e. software, subscriptions and services, to itself for the foreseeable future. Good news for customers as we shall see.
I argue that based upon its current course, SAP will reshape the SI world to one that is based more closely on delivering value rather than one that seeks to maximize billable hours. If it achieves that and keeps to its promise of delivering €2 billion in cloud revenues by 2015 then it is in much better shape than is apparent today. This scenario is not without complications.
Whatever the reality, my sources tell me that there is sufficient doubt over HANA’s true capabilities to stall some deals. But that only works in the short term.
Picking apart the SAP ecosystem and reshaping it for a possible scenario in 2015 is far from straightforward. Macro economic factors in any major market could blow head or tail winds. Much depends on the extent to which SAP can convince the buying market that it is a value player and not just replacing old systems at what have to become commodity pricing. Much also depends on the degree to which SAP can entice third parties to build applications of the future on HANA.
Executive Board Member SAP Vishal Sikka has consistently said that HANA serves as the technical underpinning for SAP’s renewal. If he is correct, then I can envisage HANA related revenue topping €2.5 billion by end 2015. Factor in promised €2 billion in cloud revenue (which I now think is conservative) but a continuing secular decline in on-premise ERP at a compound 10 percent. Net net, you still see growth for SAP but at lower levels than it has been accustomed.
The good news is that IF SAP delivers on all its promises then the company not only reshapes the business applications market but becomes more profitable while delivering genuine customer value. Many of my more cynical colleagues will see that as an over optimistic big IF. I see it as realistic based upon the manner in which SAP appears to be adjusting itself internally.
Plain sailing? No. Do-able? Absolutely.
As for IBM and Accenture, the two other dogs in this game? Much depends on their ability to get into software and reshape their own business models. They will likely get there but not before kicking and screaming about how unfair everyone else is. Those of us sitting on the sidelines will watch carefully for those crocodile tears.
In the meantime, it’s worth studying the relative stock price performance of SAP, IBM, Accenture and Oracle. Notice any trends?
Dennis Howlett has been taking the buyer's perspective in analysing application vendor offerings for more than 22 years following a 20 year successful career in IT and finance related roles. 'Never knowingly under opinionated,' Howlett takes strong positions in the interests of getting to the truth of what drives customer value.
having worked at 1 of the companies mentioned in the title and now "enjoying" the independence, i simply cannot see SAP being able to do it alone, ie without access and the deep pockets that premier SI's can provide. large clients don't want to deal with small and layered consultants/contractors and many times they grudgingly have to, but expecting large SI's disappear and leaving it to SAP (and Oracle and Microsoft) alone may be just a wishful thinking behind the goal of getting some of someone else's margins.
@greg_not_so Greg - history teaches but not always. Of course the big boys will have a piece of the pie but I am seeing far more agile players of the kind I've mentioned doing extremely well.
What I am suggesting is that SAP uses this as an opportunity to reshape the SI environment to meet its own needs. Salesforce.com and Workday are doing exactly that. Why not SAP? It's simply a matter of willpower. Hasso knows this. We've had that discussion.
Plus - SAP HAS to promote the activities of the tier 2 guys - why? They're better aligned with agility of solution plus it plays to the startups I've seen.
One point I'd disagree with is the prediction of €2.5 billion in HANA revenues by 2015. Anything close to that could only be sleight of hand with revenue allocations and gaming of discounts in the product mix. I doubt HANA and related *technology* sales will approach €1 billion. Competitive pressures and alternatives will also be eroding the price/margin for it. There maybe a lot of application sales on top of HANA, but the majority of those would like have happened with or without HANA in the mix. The SAP sales force is not a "technology" sales force, and I can't envision that changing to any great degree in less than two years, nor HANA as a platform gaining that much traction other than captive customers and as "pull through" in other deals. Maybe I'll be wrong. But I doubt it. ;-)
Another area I'd like to comment on is the evolution of the SI role. I feel that SIs will need to fundamentally alter their processes, focus, and execution model to realize a shift from "operating" to "innovating", and from large size "big bang" projects to a continuum of many smaller, high impact, innovative projects. And that shift affects just about everything in the way an SI does business with its clients.
@RickBullotta Depends how you bucket HANA. They're tracking €650-750 million in this year so they say which is consistent with 2011-12 predictions at their end. If they can accelerate some of the really good stuff I have seen elsewhere there is no real reason not to suppose €2.5 bn. Might be a stretch but it's not a moon shot in my view. Why?
They've already done a 9 figure deal. I can see potential for multiple 8 figure deals. You don't need too many of those to create solid momentum. It doesn't matter the salesforce are not tech sellers. SAP will get the right sales people in place for solution selling, not just the DB piece.
Enjoyed hearing your perspective on this topic Dennis as it is pretty obvious SAP is disrupting itself (and being disrupted by competitors) and it will obviously have implications for the big SI's such as IBM and Accenture if they don't do the same. They are both doing mass retraining of their OnPremise consultants to the Cloud but I think it will have to be customers that drive differently SI consulting models as my fear is they will try to bring the same methodology to these engagement if left uncheck. It is one of the reasons I think that Jon Reed's recent post is so important
Curious on your "The good news is that IF SAP delivers on all its promises then the company not only reshapes the business applications market but becomes more profitable while delivering genuine customer value" as my take is some of the new business will not be as profitable due (ie Cloud Subscription vs OnPremise Maintenance Revenue) so how will this shift make SAP more profitable. My thought was we will see a SuccessFactors price increase in the coming 1-2 years to help provide the margins Wall Street is looking for and that doesn't necessarily provide value for their customers.
On a side I have read SuccessFactors state they would like to have a 70% SI and a 30% vendor provided services mix by the end of this year (although I doubt they will get there).
There are some interesting dynamics in play on a number of levels and looking forward to pulling this post up in 2015 to see how accurate you were :-)
@SAP_Jarret If they're solely selling into the installed base then they don't need to increase marketing spend. If, as they say, they're coming the sales people in the same way as the on-prem people then they are taking the cost of sale up front while having a revenue stream going forward 2-3-5 years. That's if they're accounting correctly.
On that 70/30 split - it only happens if they get very large deals where they don't hold enough of the relationship or are short of hands.
The interesting phenomenon here is how SAP needs to disrupt and disintermediate the channel to achieve a competitive advantage. The implicit deal, in the past, was for SIs to promote ERP vendor products (create a practice) in return for long-term sustainable revenue opportunities through customization, upgrades, business process re-engineering, training and even more customization. This made the model 'scalable' from the vendors' point of view. And, vendors with a high percentage of services revenue were thought, by investors, to be less scalable.
ERP companies were disincented to bake services out of products. There has been a slow trend to 'quick starts' over the years but the fundamental ERP-SI calculus has changed little until cloud achieved levels of maturity. The concept of scalability in cloud is that heavy customization reduces the pace of adoption.
The other signal that confirms your analysis is the heavy marketing of private clouds. Somehow, the on premises data centre has become a 'cloud.' I know that there is more to it than a change in definition, but it's clear that the shift to the public cloud impacts ERP and SI revenue potention. The large analyst groups are running webinars about private clouds, SI and large equipment vendors are delivering white papers. Private cloud seems to be winning the PowerPoint arms race over public cloud. And, traditional vendors are trying to squeeze into the something middleware as a service - yet the players in the public cloud infrastructure market seem to enjoy huge economies of scale.
You're also right in your observation about value. Price points are established in mature markets based on the competitive market. There is often a disconnect with value. Significant technology and deployment methodology changes gives customers the opportunity to examine value. Perhaps SAP has realized this. As Intel realized after the pentium fiasco, maybe SAP has learned that their real customers are the end user organizations and not the SIs.