SAP's big challenge: Live up to its 'Best Run' motto

SAP CEO Bill McDermott foreshadows some middle management cuts, better margins and more shareholder value. Can SAP hit its operational goals without hurting innovation?

SAP: A look at its challenges, opportunities ZDNet's Larry Dignan caught up with Vinnie Mirchandani, author of SAP Nation 3.0, to talk about the enterprise software landscape and the evolution of one of enterprise software's largest vendors.

If you Google "best run," you'll get a bevy of SAP marketing. Now the challenge for SAP will be to live up to its marketing and keywords.

SAP is forgoing big acquisitions and going the tuck-in route, conducting a big evaluation of its business operations to bolster efficiency, growing cloud profit margins, and looking to boost shareholder value spurred by an investment from activist investor Elliot Management.

All that news is great for Wall Street. What remains to be seen is whether customers will agree.

SAP's first quarter earnings, which had bright spots, took a back seat to CEO Bill McDermott's master plan, which will be revealed in November at an investor powwow. The 2023 ambition is pretty heady:

  • An annual dividend payout ratio of 40 percent or more of the prior year's profit after tax.
  • A multi-year share repurchase program.
  • Tuck-in acquisitions over big purchases such as the Qualtrics deal, which was a tad pricey at $8 billion.

SAP CEO Bill McDermott said on a first quarter earnings conference call:

SAP is going to win operationally. What you will see over the next several years is that SAP will become the very best version of itself and achieve our vision for a best run SAP. This is the motto of the company, the maxim of the brand and the organizing principle on our path to further expand our profitability for our shareholders.

The good news is that SAP wants to be operationally strong. The other bit of good news is that SAP won't be able to hide its organic growth once it stops making big cloud purchases. SAP and Oracle have adopted similar merger and acquisition playbooks: When the growth gets tough you just buy something.

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Here's the bad news: Companies that focus mostly on shareholder value often scrimp on innovation, research, and development and customers. Money used for share buybacks could be funneled into R&D. Maybe there's a tipping point between innovation and dividends. And perhaps a more flat org isn't such a great thing when a company's true core competency is closing large software deals.

Meanwhile, there will already be disruption from SAP's latest restructuring and McDermott hinted there may be more to come. McDermott said:

Companies don't become great by the number of people that work in them. They become great by having the absolute best quality and the absolute best talent. When we do bring people into the company now, they will be the most-skilled people in the world at what they do. When we bring people into this company, they will code software, or they will be very on the front lines with the customer relationships. We don't need the middle layers, we already have enough of that and our HANA software can give us all the insight we need. So you're not going to see us bringing in middle management and thick layers in this company. People are going to be writing software and people are going to be backing customer relationships in the field. We're going to expand the margins in this company and run a profitability machine.

You could read that as a fancy way to say there's some restructuring ahead in those middle layers to get to those margins SAP wants in 2023. SAP wants non-IFRS cloud gross margins of 75 percent by 2023.

Today, non-IFRS cloud gross margins are 66 percent.

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Wall Street analysts were generally upbeat about SAP's plan. What's not to like about a shareholder value? At SAP Sapphire, there will be a better read on customers and what they're thinking. One thing is certain: SAP will be judged on organic growth going forward. That fact alone should make the cloud wars a bit more interesting.  

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