SAP 3rd Quarter Results

SAP posted yet another quarter of poor results as a result of the difficult market environment.

While new license software continued its dive (-31%), it is no surprise that maintenance fees saved the day, growing by 14% to 1.3 billion euro. The company also improved its margin by to basis points to 24.2% under this situation. For more on maintenance fees and stock valuations, please my recent discussion on whether shareholders and customers may be at odds on this point.

More telling for me than new licenses are the results for SAP consulting and training. Given the amount of licenses floating on the market, and projects on hold tied to pre-existing licenses, I would suspect that consulting revenues should be the first part of the business to improve. However revenues from this segment declined a very steep 22%. Also of note is the 43% decline in training, which really indicates to me the continued lack of hiring going on within the SAP customer base.

By geography, APAC seems surprisingly weak, declined by -11% excluding Japan which was flat.
The U.S. at -6% performed "better" than Germany (-11%) and rest of EMEA (-7%), which may be due to some stimulus effect on the overall economy, as well as what seems like the priority market for cross-selling Business Objects into the SAP install base.

Having just attended SAP's "World Tour" show in NYC just last week, it does seem clear that SAP expects the market to come back and is hitting hard around Business Objects, Business Suite 7 Upgrades, as well as newer offerings such as sustainability. While the audience was a little heavy on the SAP sales people, those customers/prospects who were there do seem a bit more upbeat based on my conversations. Particularly around front-end, short-term investments in BI, since this can deliver the biggest bang for the buck, and no rip-and-replace is needed typically.

When it Comes to Maintenance Fees, are Shareholder and Customer Interests at Odds?

There has been an escalation in talk, chatter and arguing during the past two years about software vendors and the traditional "license+maintenance" business models that they have relied on for decades. As I have written previously, the SaaS model and its lack of upfront licenses and ongoing maintenance fees, as well as its much lower "lock-in barrier" (the ability for customers to leave) brought a refreshing and simple model to customers. Basically it has established for the customer: "Pay us monthly at a set user/month price, that can be adapted at intervals depending on your number of users, and at the end of the day, if you don't think we are doing a good job or delivering a good value, then simply leave." Of course, leaving a SaaS solution for another is not without its pain and expense, but moving from Salesforce.com to Microsoft CRM Online is in an entirely different cost stratosphere than implementing on-premise Siebel CRM or SAP CRM!

So SaaS has brought up new questions for customers... questions we now hear everyday (and please note “traditional vendors”: questions that are not going away!). The central questions have been: What value am I really getting for this 17, 18, 20 or 22% maintenance fees? And do I really want to get locked into this? Lawson’s CEO took it one step further last year, comparing the traditional license/maintenance model to cocaine addiction! He then went on to say that the SaaS model would collapse in 2 years (which would be next August).

Here are some other curious responses that seem to be motivated by a similar mix of perceived "Wall Street pressure," fear and complacency:

On its June 2008 earnings call, the always quotable Larry Ellison posed this answer to the question of why Oracle wasn’t a bigger player in the on-demand market?

"We've been in this business 10 years, and we've only now turned a profit……the last thing we want to do is have a very large business that's not profitable and drags our margins down."

In response, during Oracle’s last quarterly results call, the company basically made enormous margin gains, despite a poor economy, based on maintenance (license updates and product support):

“Software license updates and product support revenues grew 11%, to $3.1 billion, for

the quarter when adjusted for the change in the US dollar since last year,” said Oracle Executive

Vice President and CFO, Jeff Epstein. “This growth, coupled with our disciplined expense

management, was key to our ability to generate a record $8.5 billion in free cash flow over the

last twelve months.”

A very similar message came from SAP’s last quarterly results:

"Despite the challenging economic conditions, the strength of our business model combined with a strong cost discipline has proven itself once again by enabling us to report another quarter of strong operating margin growth," said Chief Financial Officer Werner Brandt.

Again on the topic of SaaS; last year, SAP CEO (then co-CEO), Leo Apotheker, had this to say in regards to Business ByDesign not going GA:

"We would be hurting our margin, and hurting our stock.”

And according to a purportedly internal memo described in SAPInside, SAP is in fact aiming for a 35% margin from its current 24-25% level today.

I believe these statements only reinforce the idea that the long-term benefits (both for the vendor and customer) are being overshadowed by some very short-term gains.

Don't get me wrong, I am all for SAP, Oracle, Microsoft, Lawson and other vendors to become more profitable companies, but the question that I would like to pose: are higher maintenance fees, which in turn should bring higher margins and better stock performance (I would argue, only in the short-term) mutually exclusive from customer value and satisfaction (ensuring a vendor's long-term viability)?

Granted, it’s a tough question. Essentially I am asking where should a software vendor draw the line between shareholders and customers. Right now, I believe that most customers feel like shareholders are the priority, and generally, I would agree. But I don’t believe they need to be mutually exclusive, and here’s why….

It is absolutely true that raising maintenance fee percentages across all customers will boost margins. We all know this… even if vendors want to gussy-up these higher rates with a bunch of “added value” offering, services and marketing/PR fodder. Many of its customers don’t see the added value, they see higher rates during a difficult economy… certainly not a message to secure a long-term relationship! To be fair, there are many customers who have a multitude of integrations into third-party and homegrown systems, modifications to application code, etc. Such customers should pay more to maintain their systems, and would most likely value from some of the higher level maintenance offerings from the leading vendors.

On the other hand, there are also a large portion of customers who are just doing basic legal and regulatory updates. They are using the applications in pure vanilla code, and are not overloading vendors help desks… these customers certainly deserve to pay less! The fundamental flaw of the "license+maintenance" fee model is that the same maintenance percentage (generally…) is applied across an uneven playing field, not taking into consideration system complexity. To make a comparison to SaaS yet again, everyone is running off of the same code. Yes, there is a lot of integration going on, but this is ad-hoc and offered outside of the subscription provided by and maintained by the ISV/Services partners.

Many analysts would agree with me that there is a good chance that the traditional “license+maintenance” model as it exists today will go the way of the dinosaur over the next 10-15 years (some peers peg it sooner, but I wouldn’t be so quick). So tell me exactly what kind of long-term shareholder value this business model is offering? Yes, vendors can hit-up customers for a few more years with higher maintenance fees, but these seem customers will only be looking over the fence to the ever maturing SaaS model and the freedom and value that it brings.

But, like any technology and delivery shift, there is always a chance for an evolution. Here is what I propose, which I believe makes sense for vendors, shareholders and customers alike, and I am shocked that none of the “traditional” vendors have taken this opportunity yet.

Why not a tiered maintenance strategy?

Account managers and customers themselves today can rather easily run a diagnostic test of their ERP systems (given the plethora of tools available today due to the upgrades market) to understand what is their system complexity (e.g. number of modifications, instances, integrations and how much core code is being run), and in a standardized way (agreed between the vendor and major user groups) to create a scoring for each customer. Additional KPI’s can come from the vendor, in the form of the amount of helpdesk tickets and escalations that have occurred over the past year. In fact, the major vendors can put some of their own BI software to work in order to have a better view of customer profitability, in order to help develop this scoring and ensure a fair profit.

Then, things can become quite simple by using a 1 to 100 scoring (1 being the lowest complexity, 100, the highest).

If your company is:

• between 1-25, you pay 15% maintenance
• 25-50, 17%
• 50-75, 19%... and onward

These ranges and scores are obviously not technical, I am only giving an example, but if done properly, it should make everyone happy.

"Lower complexity" customers pay LESS than today in maintenance fees, while the vendor can assure they are still making a reasonable profit on these customers.

"Higher complexity" customers pay MORE than today in maintenance fees. While of course many may “whine” at first, but from the vendors perspective, this customer can either stay and be a profitable customer, or go to another vendor, where they may very well become an unprofitable or low-profit customer for someone else! Shareholders would like that too!

In the end, the vendor, customer and shareholder should all be happy under such a model… these really are not mutually exclusive forces after all! Some may argue that Wall Street may dump the stock anyway for such a shift and disruption... but I believe that is related to the street's very short-term thinking. Short-term thinking is what got the whole economy in a mess to begin with, so why stick to this old, dated logic? So my final question is, who has the guts to do this?

What I Liked (and Didn't Like) at SAP TechEd 2009

SAP TechEd 2009 Phoenix is in the books. During my flight home from sun-soaked Phoenix to drizzly Massachusetts, I have the chance to reflect on the pros and cons of this year’s event before I am re-introduced to inhospitable weather.

SAP TechEd is first and foremost a community gathering. I am part of the SAP Mentor Initiative, a community-nominated group of “top influencers” who are often at the center of the TechEd mix. This year, we were easily spotted in our blue rugby shirts, which turned us into an odd (but fun) combination of rock stars, roving help desk extensions, and conversation facilitators. Many of us chose to have our Twitter handles (@jonerp in my case) emblazoned on the backs of our jerseys – another sign of the changing times.

As someone who has worked in the SAP market for more than fifteen years, I am struck by how much the community side of SAP has transformed, powered by the SAP Community Network, now up to 1.8 million members. The SAP community today is a colorful blend of high ideals, social networking innovation, and the messy interpersonal dynamics that make community so challenging. Leveraged properly, I believe it’s also SAP’s greatest source of competitive advantage, but that’s not necessarily an easy thing to measure.

Despite such growing pains, the community side of SAP is working, and therefore, the community-building part of SAP TechEd was a smashing success. But SAP TechEd is not just about community. For industry observers, it’s a chance to take the temperature of SAP during its second biggest event of the year after Sapphire. Four months removed from Orlando, we can assess SAP’s progress on a range of issues. I am also part of SAP’s blogger relations program. During those sometimes contentious (but always worthwhile) blogger sessions with SAP executives, I got a better sense of the criticisms of some of my analyst colleagues, not all of whom are enamored with SAP’s current strategy. (Check out Brian Sommer’s post on the future of ERP for one cogent sampling).

For the rest of this blog post, I will share my own likes and dislikes from TechEd in terms of SAP’s overall direction, with a couple of recommendations thrown in at the end. Before we continue, I should say that at TechEd, SAP seemed realistic that the downturn we are mired is not likely to improve much next year (though some inside SAP are optimistic about modest improvements). That’s a context all ERP vendors are dealing with, and while it’s not necessarily fun for those who rent a booth at TechEd in search of eager buyers (I spoke with several booth vendors who weren't happy with the buying temperature), it’s certainly a reality that frames all of our critiques. But there are opportunities for innovation and re-invention within these constraints, and that’s what the analysts I spent time with were looking for.

What I Liked at SAP TechEd 2009

1. SAP’s sophistication around social networking is leading in two useful directions: better “virtual” live coverage of SAP events for those who are unable to attend, and on-site integration of the Twitter conversation into the live keynotes and events. (Many replays of the SAP TechEd live streaming are available now).

SAP also recognizes the importance of “socializing” their applications in ways that will enhance the user experience and facilitate crowdsourcing (though the emphasis on social networking in the enterprise also creates a surge of unstructured data, exacerbating the existing problem of tying that unstructured data to the ERP transactions it is relevant to). SAP's acknowledgement of the importance of unstructured data is reflected in the expanded SAP-Open Text partnership, one of a handful of SAP news announcements issued during SAP TechEd Phoenix.

2. Vishal Sikka’s emergence as SAP’s technical “visionary” is a role he is well suited for. Sikka does not put his head in the sand regarding the impact of cloud-based approaches, and I welcome his honesty regarding SAP’s product rollouts. For example, unlike some other comments about SAP Business By Design (ByD) I read from another SAP executive prior to TechEd, Sikka did not try to blur the lines to give an appearance that ByD is in general release. When asked, he accurately described ByD as in “limited release” in several countries. He also conceded that SOA has not accomplished what many hoped it would. Sikka’s view is that SOA was a step in the right direction, but in terms of true ease of interoperability, it did not take us far enough.

3. SAP seems to be shifting internally from an overemphasis on upgrading to SAP ERP 6.0 to paying more attention to the existing install 4.6C/4.7 install base. I was able to get verification of these existing install base numbers at TechEd. The ballpark figure: 13,000 SAP ERP 6.0 customers out of a total of 36,000 total SAP ERP customers.

Most of those not on ERP 6.0 are on 4.6C or 4.7. In my view, these customers, who still form the majority of SAP’s ERP user base, have been underserved by SAP in terms of innovation. No surprise: this is the portion of the install base most frequently targeted by outside vendors from NetSuite to Rimini Street to SalesForce.com (and, someday soon, Fusion?), looking for the so-called “low hanging fruit” who may be disillusioned with paying maintenance costs without access to new functionality.

The most compelling things SAP has to offer are either easier to do, or only possible to do, on ERP 6.0/NetWeaver 7.x. The use of the NetWeaver Business Warehouse Accelerator for in-memory database capabilities is one example, though a 4.x ERP customer can run a separate BW 7.0 server to access BWA, but they must upgrade their BW instance to 7.0 to make that possible. Other examples within the ERP 6.0 suite would include the service-enabled ERP 6.0 framework, the new General Ledger, cutting edge talent management functionality, and the list goes on.

But at this year’s TechEd, I saw signs of real change in this thinking. Unfortunately the bulk of this information came during private SAP Mentor “functionality preview” sessions that are under NDA. Not all of these previews will become formal parts of SAP’s product release, at least in their current state. But I don’t think SAP would mind me saying they are increasingly looking at how they can improve the user experience and access to innovation for 4.6C/4.7 customers. SAP will certainly continue to push upgrades, but I expect to see more balance in that marketing as more nifty products are available to SAP users regardless of release. I believe customers will welcome a shift in emphasis to "get value out of SAP now, without having to upgrade."

4. SAP is reckoning with the cloud. Even in Sikka’s keynote, there was an emphasis on cloud-based SAP possibilities, though the examples came off as more visionary than proven use cases. Still, on a day when I was reading Tweets from the Oracle “Open World” event mocking the lack of mention of the word “cloud,” SAP seemed more locked in.

5. SAP is expanding the conversation on BPM beyond tools. Events like the Process Design Slam showed an emphasis on “process thinking” in action. Though SAP is still evolving its NetWeaver BPM release (see Sandy Kemsley’s blog for more on NetWeaver BPM 7.2, currently in beta, as well as her reviews of the Process Slam), I see a shift in focus beyond tools to BPM as a strategic shift. This shift involves creating and innovating business processes on the fly, using whatever tools are best suited for the purpose.

During the Process Design slam, the bulk of the modeling was done on Gravity, the intuitive modeling environment that SAP built for Google Wave. As a tool, NetWeaver BPM got mixed reviews from those I talked to at TechEd (not intuitive enough, too many steps to build a process, too technical for the business user), but now that SAP has shifted the conversation from pushing tools to pushing a BPM-enhanced approach to ERP, we don’t have to wait until SAP gets the tool just right. I expect NetWeaver BPM will eventually have some unique advantages, especially once it is tied into Solution Manager and the user experience is simplified to the point that the business users rave about it. In the meantime, events like the Process Slam that emphasize process thinking and composing on top of ERP can further the BPM conversation.

What I Didn’t Like at SAP TechEd 09

1. Lack of conversation about SAP Business By Design (ByD). The absence of a general release version of ByD puts SAP on the defensive when it comes to the impact of SaaS trends and demonstrating that SAP is going to be a leader and not a laggard in this area. It seems that SAP continues to struggle with how a pure SaaS play like SAP ByD can fit into SAP’s existing business model without cannibalizing existing (and potential) revenues from on-premise products, in particular SAP All-in-One.

However, that is solely my opinion and I don’t have an on-record quote for you on this topic from an SAP executive. That’s part of the problem – absent such dialogue, the speculation about SAP ByD in blog posts like this will continue. SAP can address this by making sure that an SAP ByD product representative is present at every significant SAP event going forward. To give you a sense of the problem, I was pinged on Twitter by an analyst not present at SAP TechEd asking me for a ByD update. All I could dig out was the basic message from Sikka from the post keynote press conference: SAP is happy to take its time getting SAP ByD right. I don't disagree with that stance, but it's not enough information to further the conversation.

2. The "pockets of innovation" approach. This one is kind of a double-edged sword, because SAP showed off plenty of cool stuff to bloggers and Mentors from a lot of product teams who are doing compelling work, from UI enhancements to sensor-driven applications. Those who perceive SAP as a core ERP monolith out of step with the times are dead wrong. However, outside of the SAP BusinessObjects push, most of these innovative internal teams are small ones, creating the perception of pockets of innovation within SAP. At some point, SAP needs to take the work of these trailblazing teams and put that work front and center. This might involve culture change as well as overcoming obstacles to scale such innovation. But those are challenges worth grappling with.

My Post-TechEd Recommendations

1. Expand the teams of innovation inside SAP. Groups such as Denis Browne’s Imagineering team in Palo Alto are producing important projects that can change the value of SAP beyond transaction processing. Browne’s team is involved with customer co-innovation, and the use cases are starting to come in (a team from Browne’s group also won DemoJam this year - you can view the DemoJam replay, as well as an interview with Browne, on the SAP TechEd live archive). Browne reports directly to Sikka, so as his team’s success stories come in, SAP should look to increase investment and take on the challenge of scaling the best work.

2. Don’t wait for the numbers, invest more in the community. SAP’s community is working amazingly well, but like all such communities, some of the greatest benefits are hard to track on a spreadsheet. If I were SAP, I’d take that lead in the vendor community space and push ahead with aggressive investment. You can’t put a price on a passionate community of advocates pushing SAP conversations all across the web. If you get into too much head-scratching on the numbers side, you miss out on the chance to reward those who have worked so hard to take SAP SCN to this level and to build on its existing strengths.

3. Emphasize and expand the SAP BPM Methodology. I doubt that many are aware that SAP defined a BPM methodology that should eventually replace the ASAP methodology as the recommended approach to implementing SAP ERP. Right now SAP’s BPM methodology has a wiki, but I think all would benefit from a more visible and focused discussion on what this change in methodology is all about. I did a video with SAP's Ann Rosenberg, co-author of Business Process Management: The SAP Roadmap, on the significance of BPM to SAP going forward, including the upskilling of all SAP's application consultants into "process consultants" via the SAP BPX curriculum. As soon as that video is processed I will link to it here.

4. Get an SAP ByD product representative to SAP TechEd Vienna and provide a detailed business and technical update to analyst and bloggers. Ideally, bring a ByD customer or ByD customer panel along as well.