While SAP’s FY22 Q2 earnings showed mostly favorable results, the call also revealed some interesting insights that all customers should be aware of. Revenue topped estimates thanks to an uptick in cloud business, but operating profits declined, prompting SAP to lower their full-year operating profit outlook.
SAP cited macroeconomic challenges that they, and many others in the business technology industry, are experiencing from the ongoing war between Russia and Ukraine. They also cited unprecedented global inflation rates as a key reason for their profit decline in Q2 and stated their intentions to offset these losses.
With so many factors affecting SAP’s earnings, it is critical for customers to understand how SAP will continue to attack their goals and influence customers. Here we will give a recap of some key financial highlights and share what customers can learn from these earnings to prepare for future negotiations and renewals.
Q2 Financial Highlights
SAP bolstered favorable revenue results in Q2 as they brought in 7.5B Euros, up 13% Year-over-Year (YoY). SAP’s largest revenue stream was cloud revenue, which was up 34% YoY despite a decline in traditional software license revenue as customers adopt RISE.
This comes after a push from SAP over the last few years to move their customers to S/4HANA on public cloud infrastructures with the goal of boosting their reputation as a reputable cloud platform. SAP’s CEO, Christian Klein, backed this shift stating, “our transition to the cloud is ahead of schedule and we have exceeded topline expectations, with cloud revenue becoming SAP’s largest revenue stream.”
More than 650 customers selected S/4HANA in Q2, which raised their total adoption to nearly 20,000 customers, up 15% YoY. Of those customers, 73% are live. Additionally, net new S/4HANA customers make up 60% of their revenue share.
SAP’s IFRS operating profits were down 32% and non-IFRS operating profits were down 13%. SAP acknowledged the ongoing war in Ukraine, a withdrawal of operations in Russia and global inflationary pressures as the primary reasons for the deficits. SAP responded by lowering their full-year operating profit outlook and estimates the total revenue impact in 2022 from the war in Ukraine will cost them 300M Euros.
Finally, SAP emphasized increasing its predictable revenue and has targeted an 85% clip by 2025. They have already reached the 80% mark through Q2 and has achieved this mark by moving customers over to the cloud and subscription renewals for SAP’s other cloud options like SuccessFactors and Ariba.
Predictable revenue has become an important by-product for most organizations in the software space and an important indicator of each software company’s long-term success. In summary, SAP’s Q2 earnings were strong considering the current state of the global economy and prospects of an impending recession.
SAP Customer Takeaways: Prepare for Price Increases
SAP stated in their Q2 earnings call that they plan to redirect the financial burdens they are facing from the current macroeconomic climate onto their customers with impending price increases in the weeks and months ahead. With the burden of cost pressures being directed to their customers, you need to immediately take measures to protect your commercial and contractual terms if you are working with SAP.
SAP customers should target contractual flexibility and predictability during negotiations and utilize various levers to secure favorable commercial terms such as renewal protections, cloud extension programs and product repackaging rights to mitigate financial risks. These negotiation levers should be a key point of emphasis prior to securing a commercial agreement and as you work through software transformation initiatives.
Too often, companies don’t put enough emphasis on renewal. As a result, many do not have long-term financial predictability because SAP’s standard contract language allows them to increase subscription costs. When SAP has the contractual ability to increase your subscription fee at the beginning of each renewal term, they will do so to increase their predictable revenue stream. In the same way that SAP is going to protect their interests through these tactics, there are several countermeasures you can undertake to successfully fight back against these tactics and protect your own interests.
While SAP has certainly put up its own protections, customers can simplify the negotiation process with internal due diligence, executive engagement, and by developing a strong negotiation strategy. With cloud deals, SAP has been willing to renew early in order to lock down predictable revenue, but it is critical to have the correct executives engaged on both sides.
Customers should also note that SAP stated their President of North America, DJ Paoni, is retiring from the company after 26 years. Paoni’s primary responsibility was centered around managing day-to-day operations in SAP’s largest market. A search for Paoni’s replacement is underway and the pending replacement will play a critical part in the future landscape of SAP’s North American business practices.
SAP RISE Highlights
A large portion of SAP’s Q2 earnings call was focused on customers’ transition to RISE. It is important for customers to take the time to understand why RISE would be or would not be a fit for your company’s current technology needs. RISE is a cloud-based, subscription ERP platform featuring a single contract that is inclusive of software, infrastructure (delivered by a hyperscaler), maintenance, and technical services.
Customers with a highly customized ECC or S/4 environment and complex integrations face significant challenges implementing RISE. The reason RISE is a poor fit in this instance is simple: RISE doesn’t support customizations and integrations which makes it an inefficient option for these highly customized environments. With RISE, we have seen a decreasing level of control, flexibility, and commercial transparency. The lack of transparency comes as SAP strives to get a commitment from their customers as opposed to delivering and driving what their customers’ requirements are during the transformation phase.
SAP’s pitch for RISE is centered around a value proposition that they deem can “create 2.5x the value from a customer after they have adopted RISE with SAP.” During their earnings call, SAP referenced that they closed deals with more than 400 RISE customers in Q2, bringing their total RISE customer base to over 2,000. Of the clients moving to RISE, nearly 85% are also adding other SAP products. The 400 new RISE customers were highlighted by the following: ABB Information Systems, Baker Hughes, Bridgestone Australia, Capitec Bank, Defense Logistics Agency, EisnerAmper, Hisense Group, Mitsubishi Materials Corporation, Moderna, Pitney Bowes, RWE, Sumitomo Rubber Industries, Zoomlion.
Strong Cloud Performance
As highlighted above, SAP’s cloud revenue performed strongly at $3B in Q2 (up 34% YoY) and made up 40% of the total revenue. This performance helped bolster SAP’s desire and expectation to be a reputable cloud platform. On top of their revenue, the current cloud backlog exceeded 10B Euros for the first time in their history and was up 34%. S/4HANA cloud revenue increased 84% YoY. In addition, the business technology platform was up 40% YoY while SAP’s cloud margin increased 2.3% YoY to 69.8% and is expected to be higher than 72% in 2023.
SAP’s Q2 performance reflects that they are effectively retaining their customer base and showing the likes of Workday or Oracle that they are here to stay in the cloud war. As SAP continues to push its customers to move to the cloud, it is critical to understand not only your cloud landscape, but also to read between the lines and be aware of your contractual and commercial language within your cloud agreements.
The Bottom Line
Organizations that are not prepared to face the upcoming SAP price increases are susceptible to take on unnecessary commercial and contractual pressures that could be prevented with proper negotiation preparation. Taking time to prepare and align internal resources can help you ensure your program is securing competitive terms and meeting your technology platform goals.
Our SAP advisory services can help determine whether your SAP services and support deal is competitive and to ensure your deal includes transparency around SAP’s services and rates, contractual flexibility, and commercially competitive terms. Contact us to learn what we can do for you.