SAP’s Failure to Adapt Just Cost It $38 Billion, , on October 26, 2020 at 1:19 pm

Financial News
By High West Capital Partners
On October 26, 2020
In Financial News
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(Bloomberg Opinion) — If you’re trying to convince your customers to change how they spend 15 billion euros ($17 billion) a year and the pandemic-induced lockdown accelerates the process, that should be good news, right?Not in the case of SAP SE. The stock tumbled 20% on Monday after the German enterprise software giant said that increased demand for its cloud product, prompted in part by more people working from home, would prove detrimental to profitability. The 32 billion euros in lost market value meant SAP sacrificed its crown as Europe’s largest technology company. Chief Executive Officer Christian Klein is reaping the sour fruits of his predecessor’s missteps.It’s an unenviable position. Historically, SAP has made most of its revenue from selling licenses to its software, the cornerstone of which lets companies track how they spend money. The approach let SAP book the earnings upfront and then return a few years later to sell an updated version of the software, while earning some associated support revenue.In recent years, SAP has been shifting to a cloud-based subscription model. Rather than charging the customer a lump sum, the costs are spread over the duration of the contract — usually three years. That hits not just short-term revenue but also profitability, as installing the new setup costs money.To make matters worse, Klein is having to invest heavily to ensure that SAP’s gamut of products all work well together. His predecessor, Bill McDermott, spent $31 billion on acquisitions during his nine years at the helm but did little to integrate them. The upshot is that, in some instances, SAP customers have systems operating on 25 different software architectures. Fixing that costs money, and profitability suffers accordingly.SAP expects the investment to pay off eventually. For now, however, the company has not only revised down its full-year profit and revenue outlook, but it has also abandoned its 2023 goals in favor of new targets for 2025. It expects to have 22 billion euros in cloud revenue by then, up from 6.9 billion euros last year.This isn’t just a question of asking investors for more time — there are deeper concerns. The failure to adapt to the cloud quickly enough means that SAP may in fact be losing customers. While cloud revenue is increasing, the pace of that increase has slowed as the order backlog for the cloud has actually declined since the end of March. In other words, the bump in sales likely stems from deals signed in previous quarters and may not continue.It’s hard to fault Klein since much of this is not of his doing, but it does raise the urgency to fix it. The stock rout indicates that investors have already lost patience. His options to restore confidence are limited: Existing plans to sell a stake in the Qualtrics experience management business will release capital, which might allow another stock buyback to follow the 1.5 billion euros in repurchases earlier this year. While that would boost the share price, it would do little to fix the underlying operational issues.Klein has a steep mountain to climb.This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.Alex Webb is a Bloomberg Opinion columnist covering Europe’s technology, media and communications industries. He previously covered Apple and other technology companies for Bloomberg News in San Francisco.For more articles like this, please visit us at bloomberg.com/opinionSubscribe now to stay ahead with the most trusted business news source.©2020 Bloomberg L.P.,

SAP’s Failure to Adapt Just Cost It $38 Billion(Bloomberg Opinion) — If you’re trying to convince your customers to change how they spend 15 billion euros ($17 billion) a year and the pandemic-induced lockdown accelerates the process, that should be good news, right?Not in the case of SAP SE. The stock tumbled 20% on Monday after the German enterprise software giant said that increased demand for its cloud product, prompted in part by more people working from home, would prove detrimental to profitability. The 32 billion euros in lost market value meant SAP sacrificed its crown as Europe’s largest technology company. Chief Executive Officer Christian Klein is reaping the sour fruits of his predecessor’s missteps.It’s an unenviable position. Historically, SAP has made most of its revenue from selling licenses to its software, the cornerstone of which lets companies track how they spend money. The approach let SAP book the earnings upfront and then return a few years later to sell an updated version of the software, while earning some associated support revenue.In recent years, SAP has been shifting to a cloud-based subscription model. Rather than charging the customer a lump sum, the costs are spread over the duration of the contract — usually three years. That hits not just short-term revenue but also profitability, as installing the new setup costs money.To make matters worse, Klein is having to invest heavily to ensure that SAP’s gamut of products all work well together. His predecessor, Bill McDermott, spent $31 billion on acquisitions during his nine years at the helm but did little to integrate them. The upshot is that, in some instances, SAP customers have systems operating on 25 different software architectures. Fixing that costs money, and profitability suffers accordingly.SAP expects the investment to pay off eventually. For now, however, the company has not only revised down its full-year profit and revenue outlook, but it has also abandoned its 2023 goals in favor of new targets for 2025. It expects to have 22 billion euros in cloud revenue by then, up from 6.9 billion euros last year.This isn’t just a question of asking investors for more time — there are deeper concerns. The failure to adapt to the cloud quickly enough means that SAP may in fact be losing customers. While cloud revenue is increasing, the pace of that increase has slowed as the order backlog for the cloud has actually declined since the end of March. In other words, the bump in sales likely stems from deals signed in previous quarters and may not continue.It’s hard to fault Klein since much of this is not of his doing, but it does raise the urgency to fix it. The stock rout indicates that investors have already lost patience. His options to restore confidence are limited: Existing plans to sell a stake in the Qualtrics experience management business will release capital, which might allow another stock buyback to follow the 1.5 billion euros in repurchases earlier this year. While that would boost the share price, it would do little to fix the underlying operational issues.Klein has a steep mountain to climb.This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.Alex Webb is a Bloomberg Opinion columnist covering Europe’s technology, media and communications industries. He previously covered Apple and other technology companies for Bloomberg News in San Francisco.For more articles like this, please visit us at bloomberg.com/opinionSubscribe now to stay ahead with the most trusted business news source.©2020 Bloomberg L.P.

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