In an interview yesterday with Bloomberg's Emily Chang, Christian Klein, CEO SAP said of its customers:
They had a big ask: they want to accelerate the move to the cloud. This is what we are now doing. We are following the needs of our customers.
This has two possible interpretations. First, that SAP will engage in a degree of financial engineering offering customers the option to switch to subscription costs from the traditional on-premise licensing plus maintenance model OR second that it will develop for cloud operations and, in the process, move to a subscription model anyway. The two interpretations carry their own issues. First up, how will SAP make its numbers? According to the outlook for 2020, SAP expects the following outcomes:
- €8.0 –8.2 billion non-IFRS cloud revenue at constant currencies (previously €8.3–8.7 billion)
- €23.1 –23.6 billion non-IFRS cloud and software revenue at constant currencies (previously €23.4–24.0 billion)
- €27.2 –27.8 billion non-IFRS total revenue at constant currencies (previously €27.8–28.5 billion)•€8.1 –8.5 billion non-IFRS operating profit at constant currencies (previously €8.1 –8.7 billion)
- SAP continues to expect its share of more predictable revenue to be approximately72%.
In order to achieve those figures, SAP has to achieve the following in Q4
- Cloud revenue: €2.0-2.2 billion
- Cloud and software: €6.45-6.95 billion
That means SAP has to deliver pretty much flat or declining sales for the whole year in its legacy and maintenance businesses with a comparison to 2019 where the company recorded €6,858 in that segment and more or less flat Y-o-Y cloud revenue with Concur being the biggest contributor to the hit for the current quarter. Is this possible?
The indications we are hearing in the market are mixed and the fuzzy communication contained in Klein's statement doesn't help.
In recent conversations with U.S. buyers and buyer advocates, I can sum up sentiment as follows: there is little to no appetite for large scale projects of the kind required in order to hit the Q4 number but there is an appetite to accelerate smaller projects that allow companies to move faster in their efforts to digitize operations. This will be especially true for supply chains, mobile workforce, and commerce style apps. A good chunk of those sales go straight to cloud offerings but what about lift and shift to cloud (whatever that means) in core ERP?
I just don't see it, unless SAP's core German-speaking market makes the subscription model shift while still buying on-premises S/4 with all the convoluted licensing models and terms that attach. The trouble is that as Luka Mucic, SAP's CFO said on the last earnings call, SAP still has '30,000 classic ECC customers.' Those same customers may extend their commitment to SAP but for large scale deals? Again, I don't see it.
As is usual at this time of the year, companies like SAP rev up their top salespeople to bring home the proverbial bacon. A few of those same salespeople can be relied upon to act as the corporate equivalent of the CEO's ATM, tipping up with €10, 20, 50 million deals in their hands. Apart from the shift to subscription models, which would allow SAP to report blowout cloud backlog, we are now living in a world where the business landscape has changed out of all recognition to where we were a year ago.
The ongoing pandemic is causing companies to rethink tactics and strategy on a near-constant basis. This week, for example, Austria and Germany - two of SAP's largest markets - went into another lockdown for four weeks. While not as strict as the proposed lockdown in the UK, the impact on business cannot be ignored. As I write this story, I'm well aware that all eyes are on the U.S.A. where a historically important election is underway. Whichever way the result goes, there are important impacts for SAP and its peers, not least because of all SAP's major markets, the U.S. has so far singularly failed to deliver a coordinated approach to handling the pandemic. Most reports say there was a record bounce back in GDP in Q3 following a general re-opening of the economy. But that can't hide the fact that the U.S. Covid infection rates are climbing exponentially and that will surely mean yet another fall in economic activity and a consequent crimp on non-essential tech spending.
To make matters more complicated for SAP, the current German-dominated leadership is largely unknown in the U.S. One of the most frequent things I hear is 'Christian who?' often followed by a bemoaning of SAP's gutting of the U.S. based leadership in the last year. What is more worrying, when asked, we can't say who is leading the U.S. sales charge. I'm sure we can expect that to change but will it happen in time for SAP to make up for sluggish sales in the U.S. which, as I said before. "should be gagging for cloud," even if German-speaking companies are more ambivalent.
And then finally there is the approach to sales that SAP usually takes. It often goes something like this: the customer asks for a specific solution for a specific problem and as the sales process lumbers on, the customer is persuaded to buy all manner of other things. That doesn't work in an environment where your number one priority is paying the bills and keeping what business you have in good order. It does however explain the massive disconnect between reported S/4 sales and the number actually implemented.
There is an upside to this element of the puzzle. Both Infor and Oracle provide examples of a business model 'lift and shift' which, while not spectacular in outcome provided some cover while the firms switched their technical underpinnings to cloud-native. Check this story by Phil Wainewright from 2015 about Infor and this from Denis Pombriant on Oracle in 2018.
But for this observer, the bigger question lies in what SAP is doing about the 'cloud-native' question. While there is general agreement that any shift by SAP's largest customers to a full cloud stack is a long way into the future, and, to its credit, SAP has said that it will leave no customer behind, it's an open question about how many of those 30,000 classic ECC customers will make any move in the next few years. Pushing back financial 'ambition' to 2025 looks an awful lot like a prelude to offering continued support for ECC through to 2030. That may sound unpalatable, drawing giggles from those in the cloud already but for SAP, it is one lever they can pull to preserve the highly lucrative maintenance model. For its part though, SAP has to do more than salt away 95% margin. It has to accelerate and focus on performing the integrations that were sadly ignored under the previous leadership.
That work is ongoing but the potential rewards are enormous. It's not just a UI lipstick on a pig that's required, it's proper, digital, and modern process integration. SAP focuses our attention on the data but that's not enough unless all you want are sophisticated analytics. As Holger Mueller of Constellation Research might say - "Where are the insights to action?" Oh - and did we mention industries?
It may be election day with many in the U.S. tuning out almost everything else but this is an important question. The markets have not responded kindly to SAP's announcement and in one sense I am not surprised. The messaging is shambolic, incoherent, and confusing. If you know the players then you have a good idea of what they're trying to communicate but that's not a done deal. Right now it looks like SAP is trying to shoehorn pieces of a past narrative that sound good into tomorrow's reality. It's bit like trying to put new wine into old wine skins. It doesn't end well.
We can only hope that changes come quickly as the current SAP leadership start to communicate directly with its U.S. customers and get their unflitered feedback. There is a wake-up call a-coming.
In the meantime, founder Hasso Plattner, along with the executive board may have tried signaling confidence in the company's future by sinking their own money into the market but since then the shares have declined a further eight percent. Not a good start.