SAP posted mostly flat revenues but significantly improved profits in its third quarter. The enterprise software giant is still feeling the effects of the difficult economy, but management was pleased by the results in the United States, where software revenues increased by 35% from 3Q02.
The Bottom Line: SAP’s results are another indication that the enterprise application market is slowly recovering as buyers and seller learn to operate in a much more challenging economic environment.
What It Means: SAP has done a particularly good job this year of increasing its profitability in spite of shrinking software revenue. Unlike many firms that have lowered costs through massive layoffs, SAP has kept its worldwide headcount stable, actually increasing its level of research and development spending. There is no question that SAP made cutting costs and increasing internal efficiency a priority, but it may also imply that the installed base revenue that makes up so much of SAP’s (and its competitors’) current revenue mix, is an inherently higher margin business than new customer revenue.
The Results for 3Q03:
- License Revenue--433M euros, unchanged from a year ago
- Total Revenue--1.652B euros, down 3% from 2002
- Operating Income--413M euros, up 23% from last year
- Earnings per Share--81 euros, up 25% from 3Q02
While SAP’s business is far healthier than most application vendors’, it is still affected by the global recession and a business climate that is restricting most technology investment. SAP executives believe that the company is continuing to gain market share against its major competitors, but the reality is that the number of new vendor selections is so low that there hasn’t been much real movement in wins or losses of customers. SAP has been very successful in expanding its presence and product scope within its existing customer base, which generates nearly 70% of its software revenue.
SAP’s CEO, Henning Kagermann, told AMR Research that even though software revenues were flat, the actual number of sales transactions has increased 16% the last year. The problem is that the average deal size has shrunk dramatically, a reflection of several factors, including smaller IT budgets, an inclination for customers to purchase in smaller increments, and considerable pressure on license prices. Dr. Kagermann indicated that he felt there was enough sales volume for the ERP market to return to double-digit revenue growth, but deal sizes will need to increase and license discounting will have to diminish.
Conclusion: SAP remains the dominant market leader in enterprise applications. It continues to expand its business in three dimensions: geographic penetration, small and midsize businesses, and vertical industries. It is very much an engineering-oriented company and it is committed to using software development and innovation to grow. We expect SAP to invest nearly 1B euros in R&D next year for application enhancements, architectural improvements, and vertical industry extensions. The real challenge for management may be how to keep this very large organization and enormous product portfolio agile and accessible in a rapidly changing application market.
AMR Research originally published this article on 17 October 2003.