Attention SAP Customers: Read Between the Lines

SAP painted a rosy picture in its Q4 2018 earnings call this week.  But beyond the numbers, they also provided a narrative and certain insights that customers should pay close attention to as they manage their relationship in 2019.  Here we detail observations of certain risks and opportunities to be aware of based on SAP’s positioning.

Is SAP’s On-Premise Software Business Dead?

Far from it!  SAP made it a point to highlight the strength of its on-premise software license performance versus its goals and Wall Street’s expectations.  McDermott attributed this growth to SAP’s commitment to offering customers a choice to license via a perpetual license and/or a cloud-based model.  Although SAP is assuming single digit declines in on-premise software license revenue, McDermott clearly sees an upside opportunity in this area.

Although I agree with McDermott’s bullish sentiment (every deal we have advised on has a material on-premise component), I believe SAP’s success in this area is more attributable to:

  • The organic growth of organizations and a favorable economic environment that is creating a new software license demand.
  • Mergers and acquisitions continue to present a material license revenue opportunity given the restrictions associated with SAP’s software license agreements.
  • Software audits and SAP’s new digital access license model is also driving revenue. In fact, a contingent of SAP employees are under consideration for the SAP Founder’s Award due, in part, to this model driving significant software license revenue.

Customer Implications: Continue to expect SAP sales executives to make on-premise license revenue a priority.  McDermott is clearly setting Wall Street’s expectations low and you can bet SAP is counting on its sales organization to exceed these expectations.  The question is how it will balance its drive for on-premise software sales while balancing its commitment to customer empathy.

McDermott Taking the Role of Bill Belichick?

I’m not sure if Mr. McDermott’s inspiration for positioning Qualtrics via an X’s and O’s analogy was attributable to the upcoming Super Bowl (Go Pats!) or not, but he certainly made his point clear that SAP is betting big on connecting the customer experience (X) with operations (O).

SAP is bullish on capitalizing on a Qualtrics 45% growth rate and exceptional gross margins.  It highlighted JetBlue as a case study for supporting its value proposition and referred to SAP’s Value Engineering assessment program (focused on operations) as a model for conducting Customer Experience assessments.

Customer Implications: Prospective SAP Qualtrics customers have a lot of leverage, especially if they are also SAP ECC customers looking to migrate to S/4HANA.  Those in this position should certainly seek SAP’s investment in value engineering services and very favorable pricing and commercial terms.  A word of caution for existing Qualtrics customers – be mindful of any potential changes to SAP’s pricing methodology for Qualtrics and less favorable terms and conditions in SAP’s Cloud GTC in comparison to your current Qualtrics agreement.

Is SAP’s Restructuring an Early Indicator for ECC Customers?

SAP made it clear that savings associated with layoffs of up to 4,000 employees will be reinvested into enabling its growth via IoT, blockchain, and quantum computing.  In fact, SAP has indicated that its total number of employees will likely increase in 2019, exceeding 100,000.  While this may resonate with Wall Street analysts, ECC customers should seek to understand the path SAP is on with respect to implementation of its longer-term strategy.

  • Will the restructuring impact support of ECC?
  • Will the restructuring impact SAP development and enhancement plans?
  • Will the restructuring impact SAP’s ability to extended support for ECC beyond 2025?

The restructuring can certainly be viewed as an early indicator of SAP’s intention.  The front end of SAP’s narrative has already taken shape.  SAP is:

  • Committed to enabling the intelligent enterprise and improving lives;
  • Re-positioning itself to deliver against this mission (e.g., people & technology);
  • Committed to supporting its customers on this journey (e.g., value engineering services);
  • Planning to provide financial incentives to support customers on their journey to S/4HANA.

However, there is a back-end narrative for SAP customers lagging in their migration from ECC to S4/HANA that should be anticipated:

  • SAP innovation will occur via these new technologies (e.g., limiting ability to innovate);
  • Support of SAP legacy technologies is not sustainable (not profitable) beyond 2025;
  • SAP may support legacy for a period, however, this support will come at a material premium;
  • SAP’s financial incentives (e.g., ECC license credits) to support a migration will not last forever;
  • Once SAP’s ECC migrations reach a tipping point, S/4HANA price increases will be positioned.

Customer Implications:  SAP has made a clear commitment to positioning itself for the future and meeting its financial goals.  Rest assured, if the company is going to impact 4,000 dedicated employees and make these commitments to Wall Street, they will certainly be committed to driving its installed base to migrate to S/4HANA.  The R/3 migration playbook will be dusted off and a combination of carrots and sticks are going to be presented to the market. The question is whether SAP customers are prepared for the game.

Are Wall Street Analysts Missing the Forest Through the Trees?

Most of the Wall Street analyst’s questions on the SAP call focused on margins.  We had to wait until the very last question to obtain some level of insight on the topic of S/4HANA migrations via Mark Moerdler of Sanford C. Bernstein & Co.  Although Mr. Moerdler did not directly ask for numbers related to S/4HANA migrations, his question did provide insight into SAP’s view of the opportunity that its install base represents.

During this part of the discussion, SAP’s CFO, Luka Mucic, was particularly enthusiastic on SAP’s opportunity stating, “The S/4HANA upgrade cycle drives potential for substantial further renovation of a company’s IT architecture and gives us multiple cross-selling opportunities.”

Mr. Mucic went on to say, “Most of these cross-selling opportunities are giving us a chance to double down in our cloud businesses, whether it’s spend management, which is a very natural attach to an S/4HANA upgrade with Ariba and Fieldglass and Concur; whether it’s to renovate the HR side of the house with SuccessFactors; or whether it’s about going into adjacencies and creating and co-innovating on new capabilities with the SAP cloud platform — that’s where the big attach opportunities are.  And so, you can absolutely make the claim that S/4HANA as an upgrade cycle reinvigorates our growth opportunities in the cloud, while we have a great opportunity to continue to enjoy a nice runway on the ERP upgrades.”

We certainly hope that the Analyst community will use SAP’s Capital Markets Day to obtain insights into the progress of migrating its customer base to S/4HANA, which will provide additional insight into your leverage as an SAP customer contemplating a move to S/4HANA.

Customer Implications:  If you are looking for leverage with SAP, look no further than this statement from Mr. Mucic.  Based on our experience, SAP customers in this position have maximum leverage, however, their biggest challenge, by far, is obtaining the internal alignment across multiple internal stakeholders necessary to drive a strategic discussion with SAP.

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