As previously announced, I recently spent quality time with Luka Mucic, CFO SAP. I initially profiled Mucic almost exactly two years ago but it had been some time since our last conversation. Since then, Mucic has grown in stature, and today provides a fluent style of explanation that tends towards saying as much as possible but without giving everything away.
It helps that Mucic is one of the most charming people with whom I am privileged to get time. An example. I flubbed an important data point in my initial earnings report. Rather than berate me, he chose instead to casually ask about the data source, came back with a good explanation and duly earned a change in the way I explained the point. I have no problem with that. On to the main discussion.
I had pre-briefed my main point of contact at SAP about the direction I planned taking but first I wanted to hear what Mucic thinks are the main topics in which analysts are interested, following a break neck week of interviews and earnings calls. Perhaps unsurprisingly, my topics more or less aligned with questions he fielded last week and, will no doubt, expand upon, at the upcoming Capital Markets Day. First up, cloud and all things SaaS.
Cloud, SaaS, S/4 HANA
Regular readers will know I had a detailed conversation with Markus Schwarz and updated the numbers. However, one number that bugs some people is the S/4HANA split between on-premise and cloud customers and those that are net new. SAP does not provide that breakdown and for good reason. According to Mucic the split on swaps is 'not material.' What does this mean?
I can offer you some modeling help for cloud as it relates to cloud. This would be customers who were paying maintenance and then retiring those licenses in exchange for cloud under our cloud extension policy. It is mostly a partial move at this time. The amount of maintenance revenue lost per year is in the mid - to high double digit millions migration. You have seen what we have reported elsewhere on overall cloud revenue.
Of those 5,400 customers we have for S/4 HANA they’ve almost all licensed, so they bring their own license but we get a subscription for HANA infrastructure. Public cloud is just not a meaningful number. We are targeting upper mid-market for 2017 for cloud but today, there is a low number of pilot customers. We don’t want to make same mistake we made with Business ByDesign and set expectations and then find we have a problem.
Make sense? The TL:DR is this - S/4HANA is primarily delivered on-premise today but the cloud shift is in play and SAP will make that shift in a way that is optimal for both itself and its customers.
Cloud purists will no doubt shriek but I am OK with this. It plays back to a consensus view among more seasoned analysts that what amounts to a hybrid strategy is the correct way to go for SAP customers who are modernizing their back office infrastructure while minimizing risk. On to the data center topic.
Data center development
Mucic told me that in the last year, SAP has spent more than €1 billion on data center and facilities capital expenditure. I pointed out that Microsoft and Amazon dwarf that by orders of magnitude and that surely must represent a potential pricing problem as those companies continue to drive down end user cost and TCO. Mucic's answer is interesting and you have to listen carefully to understand where this is going.
We are a different business to Microsoft and Amazon and we don’t intend to compete with them. If anything, they, along with IBM and HP are natural born partners for us. We can and should subcontract the IaaS element because we are not going to match the scale. In our own data centers, we have to have a certain level of critical mass for those customers who want one throat to choke. That means we must operate best practices to provide a reference architecture for our products.
It would be great upside if we could leverage Amazon for example. But the truth is that these are not yet operating procedures that allow 50 terabyte systems for a Nestlé or other global business. But yes, we are working with them so that they can put on a larger T-shirt size than is possible today.
SAP has taken plenty of criticism for spending years on technology rather than applications in the shape of HANA. But then there are plenty who will argue that operating the full stack provides a solutions company with the means by which to drive out as much cost as possible.
The reality is that Amazon and now Microsoft's massive investments puts them so far ahead of anyone else in the market that it would be impossible for any other vendor to catch up. This is a theme that Bob Evans picked up upon in his assessment of who is winning in what he describes as the Cloud Wars when he said of Amazon:
Indeed, the looming cloud-database face-off between AWS, Oracle, and Microsoft will determine the ultimate winner in the Cloud Wars because over the next several years, the workloads and applications that run all of the world’s big corporations, agencies, and large organizations will be up for grabs. (While Amazon is #1 in the new Cloud Wars Top 10 rankings, Microsoft is #3 and Oracle is #6.)
For reference, Evans puts SAP at #7, asking whether SAP can convert all those databases to HANA? It's a good question for some but not for others. Most of SAP's current big ticket customer base runs on Oracle. The fact Evans thinks there is a competitive opportunity for Amazon to sweep up, coupled to Mucic's view of where SAP sits in the overall landscape sets up an interesting set of questions for SAP.
My best guess is that while SAP will continue to work hard on getting those S/4HANA migrations it will pursue multi-path cloud development and announcing when it is good and ready, provides it with options that its competitors do not have. That in turn should play well to the topic of customer choice.
At the same time and, as Mucic explained, SAP continues to drive down its own data center cost profile by a combination of consolidation and harmonization across its acquired cloud assets like SuccessFactors, Concur, hybris and Fieldglass. That will be a cost reduction exercise contributing to what Mucic forecasts will be an improvement in operating margin in the coming few years.
The political landscape
In common with my ongoing theme of discussing the impact of Brexit and a Trump presidency, I asked Mucic to comment on how he is seeing the mood among buyers. He replied that in both the UK and Mexico, SAP reported some of its best numbers in a while. He believes that in times of uncertainty, SAP benefits from a degree of counter cyclical behavior. Hmmm...
I had to stop and think about that for a moment and concluded that SAP is positioning itself as both a safe haven for IT investment earned over 40 plus years of serving the largest companies in the world coupled with a recognition among buyers, that an uncertain climate represents a good opportunity to re-examine crusty business processes and modernize with a view to achieving step change value ahead of any trading head winds. Make sense?
On the political front, Mucic provided another interesting answer:
You know that the US is not just a distribution country but also a place where we invest heavily in R&D. But I also think that smart city infrastructure is an interesting field and a good opportunity to find areas where Germany and the US could collaborate well. We have a lot of assets that can help them to become more efficient.
But yes, there are areas where we could face challenges. SAP has always been a proponent of free trade. We welcomed the US/EU privacy shield which provided the legal basis for doing business [in a globalized economy.] This is something that is very important to us and the economy overall. If we had a big change then that will be a difficult and possibly cumbersome problem to overcome.
That's an elegant answer which opens the door to the kind of considered discussion I hope technology company leaders will have with the current US government executive and administration.
There is very little for me to add. Mucic's answers were clear and precise to the extent that he is prepared to lift the covers and give well thought out answers. His comments continue to add nuance and reflect the direction SAP is taking.
The only thing that was missing was any real reference to IoT topics but then we ran out of time and if I was to guess then I'd say that 'smart cities' covers part of that point. In any event, we can save that for another day.
In closing out, I like here that there is a continuum you can see playing out. SAP doesn't always market its intentions as well as it could, but it is directionally consistent. That kind of certainty is important to customers in a world where everything seems to be changing.