SAP is going to more aggressively move customers to the cloud, focus on co-innovation and move to one data model across its platforms as the COVID-19 pandemic proves to be more difficult for the company.
The enterprise software giant's third quarter results featured a number of unpleasant surprises. The biggest hit was that SAP cut its outlook. Licensing revenue was weak and customers are moving to the cloud at a faster rate and evaluating SAP's wares as well as offerings from rivals.
That backdrop led to a strategy overhaul and a reset by CEO Christian Klein. Klein noted that SAP's customer base was struggling with COVID-19 and how it was hurting demand. The supply chain, which is largely run by SAP software, has been retooling on the fly amid multiple disruptions. It doesn't help that Concur, which is a travel and expense application, is seeing less volume since business travel has largely stopped.
CFO Luka Mucic said SAP was cutting its cloud revenue growth targets for 2020 as well as total revenue and operating profits. In addition, SAP will spend more to transition its customer base and apps to the cloud and that will result in less growth that will pick up again in 2023.
Mucic said that SAP's cloud revenue previously large largely incremental to existing licensing arrangements. Today, cloud is cannibalizing licensing. As a result, SAP will be moving customers from an upfront software licensing model to subscriptions. The move is similar to what Microsoft and Adobe have done. "There is undoubtedly going to be some cannibalization effect customers moving from established license and support agreements over to subscription," said Mucic.
Two money slides that have rattled SAP shares.
Klein's plan for SAP seems solid, but it may seem a bit overdue. Here's a look at the moving parts.
Co-innovate. Klein said:
Instead of doing everything ourselves, we are co-innovating. We have always been the leading on-premise application platform. Thousands of partners and customers have built applications and extensions on SAP for almost 50 years. Our intention is to repeat that for the cloud to position SAP as the leading cloud platform to transform and change the way enterprises work in the digital age. To get there, we have put a lot of work into our cloud platform over the past 12 months, and we will continue to invest in innovation. The time when SAP developed and engaged with customers in silos are over.
For sure, SAP can co-innovate with supply chain and ERP customers, but what remains to be seen is whether the company can edge more into line of business applications where the competition is fierce.
Become cloud first and bring customers along. SAP had allowed customers to choose on-premises vs. cloud and licensing vs. subscriptions. Now the plan is to move customers to the cloud on a faster timeline.
We will accelerate the transition of our customer base to the cloud. This accelerated move to the cloud. We clearly add value over the long-haul by increasing cloud revenue. And in the short term, there will be revenue mix effect as we see less on-premise and more cloud revenue, resulting in a negative operating margin impact of 4 to 5 percentage points in 2023.
By accelerating the move into the cloud, we will even further increase the productivity improvements in our cloud delivery operations. We have decided to speed up the modernization of our cloud delivery to enable a more resilient and scalable cloud infrastructure. This will require additional investments in the next 2 years but allow us to largely complete the modernization in this time frame and achieve a cloud gross margin of approximately 80% in 2025.
Create one data model across SAP. Klein said:
We will bring the full force of our business applications and platform to drive holistic business transformation. By enabling our customers to seamlessly design, evolve or in win new business models with agility and speed. To do so, all our main solutions will adopt the cloud platform and share one semantical data model, one AI and analytics layer, one common security and authorization model and the same application business services such as workflow management, with our cloud platform, powered by SAP HANA. Process can be changed, enabling agile workflows. Innovations and extensions can be developed quickly by customers and partners accessing our open platform, using exactly the same data model in business services as our own SAP app. We are convinced that the real value driver of intelligent enterprises in the cloud will be the ability to adapt and on new business model holistically end-to-end with one consistent data model.
The catch here is that SAP will want its customers on its data model with its suite of apps. The challenge is customers will certainly want one data model, but one that spans multiple applications and vendors.
The plan for SAP looks doable, but there will be tough times ahead for licensing revenue. Klein said that software license revenue will fall further in the quarters to come. COVID-19 is hitting SAP's customer base hard.