After figuring out that hope is not a strategy, SAP has a new one: We're gonna shift on-prem customers to the cloud!

And they're gonna like it

Hope is not a strategy, and that common aphorism is coming back to haunt enterprise software outfit SAP.

In the first quarter of the year, the business was keen to get investors to understand that, despite the adverse effects of COVID-19 on the global economy in the short term, stalled projects would come back on stream.

On a call with analysts in April, CEO Christian Klein said he thought sales were being delayed but that they would return in the third or fourth calendar quarter. "We have no reason to believe we have lost a lot of business but assume most of it as rather just being pushed out," he said at the time.

Earlier this week, announcing third-quarter results so abysmal they prompted a 25 per cent crash in company value, Klein admitted the strategy was not working.

On an earnings call with financial analysts, the CEO was keen to promote SAP's "new strategy", which involves shifting on-prem software licence customers to the cloud and investing heavily in cloud R&D.

CFO Luka Mucic underscored the reason why: An assumption that spending was delayed by the COVID-19 global lockdowns were, to say the least, hopeful.

"Back then, we had assumed that the demand environment would gradually improve in the third and fourth quarters. And while we still see robust customer interest in our solutions to drive digital transformation, regrettably, lockdowns have recently been reintroduced in some regions. Infection rates have reaccelerated, and as a result, demand recovery has been more muted."

For its third quarter ended 30 September, SAP said revenue had dropped by 4 per cent year-over-year to €6.535m. Operating profit plunged by 12 per cent to €1.473bn. The software licence performance on which the company had built its business was no stronger in Q3 than Q2, when much of the world was barely emerging from lockdown.

To navigate SAP out of the mire, Klein and his top team, which has seen a few unsettling changes in recent years, have hatched a plan to accelerate cloud adoption of its software, not just in new customers, but by strong-arming more determinedly moving on-prem customers to the cloud.

"With our strategy, accelerate the technical migration of our customers' most important business applications to the cloud," Klein said, adding that SAP was "agnostic" over whether that would mean it's own data centres, or one of the big three hyperscalers on which you can run SAP applications.

Why is SAP so keen on a strategy that involves pushing customers that may be reasonably happy with on-prem systems they have been running for years? The answer may not immediately obvious given that the shift to a subscription model has "had very material negative revenue mix effects on margins, simply because the profitability of those cloud businesses was lower than that of our on-premise business," CFO Mucic said.

"This time, we'll be moving large parts of our ERP customer base from on-premise to the cloud, move them out of the upfront software licensing model and into the ratable subscription licensing model," he added.

But the silver lining for SAP comes in the longer term as it is "increasing customer lifetime revenue" with the subscription model and not only providing software and support services, but also the IT infrastructure and operational services in many cases. "We are effectively expanding our share of the wallet," Mucic said.

But, as Morgan Stanley analyst Adam Wood pointed out on the call, SAP had given customers a choice between using current licences in the cloud or moving to a subscription model.

Both Klein and Mucic dodged the question about whether customers would continue to get that choice or whether SAP would force the transition to the subscription model.

Klein said customers wanted to move to the cloud for operational resilience and also wanted to "consume regular innovation on the fly".

The shift to the cloud comes as SAP remains in the midst of another massive customer transition – to its in-memory HANA platform.

Angela Eager, research director with TechMarketView, said implementations are dragging with just 8,100 of around 15,100 S/4HANA customers having gone live with their implementation.

"SAP's challenge is still persuading customers to upgrade and provide sufficient proof points of the business value. Add the effect of C-19 and it has a lot of work ahead," she said.

Facing the shift of major customers to the cloud, the continuing transition to HANA, and a COVID-19 pandemic stretching well into 2021, SAP will be hoping its new strategy works. But with cloud-native vendors Salesforce and Workday reporting strong results in recent months, there will be plenty of sharks in the water if it does not. ®

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