SAP SE (SAP) Earnings Call Transcript & Summary

Yes. So basically, we believe that the growth of the existing portfolio plus the new categories that we are developing around industry cloud and others will actually bring us to mid- to high-teens of growth as a CAGR over the next couple of years, and then the rest will be basically the business model transformation. And when you take a look at this, I mean industry analysts are expecting the entire cloud business around the globe to grow at close to 20% growth rates. Our peers are running at around about that growth levels. In particular, the scale here is, of course, smaller ones are growing even faster, then that SAP in the past has been, I would say, growing at or above those levels. The rest of our portfolio outside of spend is growing at that level. And on top of that, we believe that also in spend, we will come back to those assets being, again, a contributor rather than a detractor from a growth perspective as we leave the pandemic behind us. So that, coupled with the new areas of innovation and obviously, the big plus that we have is huge installed base on-premise customers who are becoming more and more eager to transform to the cloud should give us ample room to reach those targets.

Perfect. And then just talk a little bit about the margin impacts that you see over the next couple of years. So as you described, there's a dampening impact on margins. Some of that comes from the payment method change that we go towards more subscription. But I think some of it also comes from investments that you want to make. Could you just talk us through a little bit around, can you give us any help with the balance of those 2 things? And can you talk a little bit around what you're investing in and what you need to do from an R&D point of view over the next 2 years to enable all of this to happen?

So first of all, the business model transformation itself, when you take a look at the 2023 numbers, that alone will have a dampening impact on margins of 4 to 5 percentage points, coupled with the incremental investment in R&D that we are taking. Because, frankly, when you take a look at the investment plan of the company, there are only 2 pieces that we're doubling down on: one is the R&D ratio. So we have -- 2 years ago, we had around about 13.5% of R&D expenses as a percent of revenues. In 2019, we went to slightly above 14%. For the next couple of years, we want to drive towards R&D rate of round 16%, so a 2% percent increase because we want to be focused primarily on organic innovation. We see great new categories that we can open up where we have a strong right to win such as industry cloud, and we want to double down on this. This is less a matter of investing in S/4HANA, which we, of course, continue to do, but they are the big lifting of making the solution ready also in the cloud to handle all types of customers is really completed. And so therefore, it's rather about the new categories that we're developing there. The second large area of investment for the next 2 years is the investment in completing the journey of moving our installed base customers from their legacy cloud delivery infrastructures, in particular, with our acquired line of business cloud solutions onto our converged cloud infrastructure. I had talked about this already at last year's Capital Markets Day of SAP. Back then, we had the assumption that we would kind of achieve a good part of this lift by the end of 2023 and would then leave kind of a long tail to take longer to be migrated. And given that we now clearly see an acceleration in the move to the cloud, we wanted to make sure that we get done with this faster. This will require a mid-triple-digit million euro incremental investment over the course of the next 2 years, partially in additional hardware capacities to then house these customers and partially then also in customer migration expenses. But the good news about this is once this is completed, it will almost immediately make room for significant efficiency gains in our cloud business because we have greater volume leverage and can better utilize the Converged Cloud, we have better automation capabilities and chat service capabilities, also greater resilience and performance for our customers, which is another positive benefit because we are removing some of the latency challenges that we currently have between different parts of the portfolio by also harmonizing the locations across all of the cloud assets that we have. And then on top of that, obviously, the additional incremental opportunity to automate the delivery processes in the cloud through the Converged Cloud. And that's why we believe we will be able to achieve roughly 80% of cloud gross margins by 2025. We will also meet the original cloud gross margin target for 2023, by the way. And that tells you -- should tell you as well that in the underlying, while we have the significant headwind of 4% to 5% on the margin side in the short-term through the business model transformation, we remain absolutely focused on driving the efficiency of our business. You have seen 2019, 2020, we had increases at the operating margin level. We continue to increase the cloud gross margin as well. In 2020, it would have been actually even a better increase without the revenue drag that we have seen in the high-margin intelligent spend assets. But in the underlying, the efficiency continues to increase. And with those investments, you will see actually much faster progress there. And so we absolutely remain focused on driving efficiencies where we can. And the function of the lower margin progress that we are seeing in the next few years is really the business model.

And the other question I get quite a bit is, the certainty on modeling this. Because you've now given longer-term guidance, but it does depend, to some extent, how customers choose to run and buy. So if this -- let's take one -- let's go to one side of the coin that your customer base grows more quickly. That would obviously have a further negative impact on margins. Have you left any room in the guidance for that? Or if that happens, would you then have to come back and kind of reassess what your expectations are?

Yes. Look, I think we -- obviously, there is some uncertainty in the pace of the pickup, but we wanted to cater to that by really having a very, let's say, thorough and, I would say, careful approach towards the planning assumptions. I mean we are planning for similar on-premise license declines in the next couple of years than the ones that we have seen in 2020, around about a 20% CAGR of decline. I think that leaves quite some room. And certainly, our pickup on the cloud side at the same time, we have also not gone through the extreme of what would be possible if we saw a faster transformation there as well. So I think we have tried to balance this out properly. Frankly, I would love to see a situation in which we would be able to drive the transformation even faster. At the moment, the implied license assumption for 2025, just taking this CAGR as a proxy, is for around about EUR 1 billion in software licenses, come 2025. Frankly, if I had no software license business left then and had everything in the cloud, that would be something I would be extremely happy about and would certainly not try to work against that. But I think we have taken all of the market intelligence into consideration the feedback that we are getting from customers, the momentum that we are seeing in the market as well, and we believe this is an appropriate planning horizon, obviously, with the opportunity to go either one of the directions. But we wanted to, in particular, be sure that the EUR 22 billion or more in cloud revenues is something that we have strong conviction we are able to deliver against.

Perfect. And I remember it was last year or the year before that we discussed in Barcelona, the competition to SAP. And I remember at the time, we did a survey of investors around who they thought your biggest competitive threat was. And actually, I remember you saying, you thought it was Amazon. And this brings kind of into focus this debate around hyperscalers. And Christian has talked about the need for SAP to retain the relationships with customers. Could you talk a little bit about where the battleground with hyperscalers is? Because for most of them, they're not competing with you at the ERP or the application software layer, and you clearly don't want to compete with them at the infrastructure layer. So it looks as if it's the platform layer where you're competing. So I mean, first of all, the business technology platform that you now have, are you happy with the majority of that product that it's competitive? And could you maybe just outline the risk there? Is it that, that they kind of take data out of your system and they're the place where analytics and AI and insight happens, and you want to keep that within the SAP product set. Can you just help us talk through a little bit what you see as the risks and opportunities there?

Yes. So let me be very clear from the start first. I mean all of the hyperscalers are strong and extremely important strategic partners to SAP. And they are, by far, more partners than they are either current or future competitors. We have a great joint opportunity in working together to bring our customers to public cloud infrastructure. Those are some of the chunkiest workloads that a hyperscaler can wish for a significant ERP estate from SAP. So I think we are all well served in working together and following this offering that we are putting out there as that will greatly accelerate the move to all of the hyperscalers' infrastructure, and therefore, the partnerships are extremely important and positive. From a longer-term perspective, and that's, I think, the point that I made last year in Barcelona, obviously, what we want to make sure is that our customers continue to follow an innovation path with SAP, meaning that they see the core business process platforms that we are providing ERP and then the innovation platform -- the business technology platform on top where you can do advanced analytics, you can do machine learning, where you can design new industry applications on top of it, that our customers continue to turn to us as the primary innovation partner around those categories. And if our customers make the alternative move that I've explained before, which would be, let's just take what we have in the classic ERP systems that we have today, highly modified and obviously aging, and let's just consider this as a kind of a back-office transactional backbone, and just lift it to a lower cost public cloud infrastructure out of our own data centers and then work with some of the data tools that the public cloud providers offer to design new scenarios. That is a risk for SAP because it would potentially, over a longer period of time, alienate ourselves from the innovation that the customers want to consume. And that's where certainly, there is a certain level of tension here that we want to make sure that we have this design authority. We believe that we have unique capabilities that our customers will require and cannot get elsewhere in the foreseeable future. The most pronounced of them is our deep vertical competency, in particular, as it is introduced across our application portfolio in core ERP. There are certain industries where after a certain size, it's really only SAP, which have as an option, but we have a great opportunity for all of our cloud solutions, which is now the current absolute mandate to adopt the business technology platform, make sure that their data models, that their business process artifacts are exposed on the business technology platform so that it's valuable for our customers to use this as the innovation hub on top of the underlying deeply verticalized applications that we have available. And is the business technology platform right for this? It absolutely is. I was very glad to see that recently, it was named as a leader in the Gartner Magic Quadrant for integration and development platform. So this is a positive testimony. We don't want to necessarily establish our SAP business technology platform as a general-purpose development platform, but for our ecosystem to build on top of our enterprise applications based on their business process, logic and data models being consumable through the technology platform, we absolutely believe this needs to be the prime and best development platform for our ecosystem of customers and partners. We believe we are getting there. And that's why we are bundling this as well with our offering here. And that's certainly a layer that we want to own and then work with our customers in the design authority fashion, while the much bigger player together with the hyperscalers and where we are in full partnership, certainly the infrastructure layer.

So I'm going to start to move to some of the investor questions now. A few people are asking about KPIs to try to track this shift. And I know in other meetings, you've said, we're open to disclosure into discussion. I mean, I think one of the things people would value is it's quite difficult now to kind of keep track with what's in the cloud subscription line because we've got transactional revenues, which are being impacted, we've got renewal, new subscriptions, the renewal rates importance. But could you -- are there any obvious KPIs that you would encourage us to look at to help us track and anything you're thinking about adding to the mix to aid understanding?

So first of all, from a present perspective, I would really argue that SAP is probably among the companies that is providing most transparency around the different lines of business. And certainly, in our segment reporting, we are breaking out the performance of the spend group. And therefore, you can also follow the development of revenues there versus the rest of the portfolio. And we are -- we have introduced from the beginning of this year on the current cloud backlog, which basically is a measure that gives you really a good indication of our success, not only in new cloud bookings, but also in renewals in terms of the development from one key date to the next one on an annualized basis. And that is something that is very commensurate, I would say, with what others in the market are doing. They call it RPO, but essentially, it's more or less the same thing. I think what is important -- going to be important for us is, in particular, give additional transparency around the success of our core to cloud migration because that is obviously a significant new part of the equation. And in that one, certainly, we want to further break down at a more granular level, the pickup that we have from S/4 customers. As you know, we are disclosing this since a number of years but so far only as an aggregate number. So on that one, we definitely want to be more specific towards what is the pickup in the cloud, how many installed base customers have made the shift, and certainly also -- we are also looking into underpinning this, not only in terms of a customer account, but also in the pickup of ARR that we are driving from such transformations. So I think that's important to assess against the performance on the maintenance side, back to the discussion that we had previously with the multiple of maintenance revenues that we are looking to drive from the offering. But that's an open invitation to investors as well. I mean we are just currently finalizing our thoughts on how we will provide this transparency starting from next year as we move into the broad offering of this core to cloud solution from SAP. And if you have any input for us to our IR department of which kind of metrics would be considered particularly helpful, now is the time to approach us as we are then looking to finalize our view. But the one basic stance that SAP has always had will not change. We're always looking at giving a very decent level of transparency around our performance and not bury everything in one single revenue line, like some others in the market are doing it.

I imagine who you're referring to Luka. So a couple of more questions, maybe just to finish off with. So first of all, on this move to subscription, is it customers entirely driving this? Or what changes are you making on your side to help the shift? Are there incentives for customers to move? Are you changing sales force incentives to push this shift? Can you help us a little bit with that side of things?

Yes. Well, first of all, on the customer side, as I said, I mean, of course, we are crafting an attractive offering that we have also, of course, had significant field intelligence on. It needs to be attractive enough versus a pure move to cloud -- public cloud infrastructure to justify it. So that's -- we're certainly -- not only we are working on the pricing, but also on the bundle, as I said, including the business technology platform, including additional value-adding elements and also standardized services that are going to be very attractive to help our customers simplify and standardize their landscapes as part of the shift to the cloud. On the SAP side, we are also making changes, for sure. In the past, we had quite substantial on-premise and cloud targets out there for our sales force and in the way how we were incentivizing both; we were not really differentiating. So we were leaving a level playing field there. Now we are actually emphasizing the cloud business and our targets there more. And not only in terms of the quantity of targets that we are signing, but also in terms of the value, so to say that our sales force can derive from it. So that will create a certain bias towards positioning the cloud solutions. And across the entire company, we are changing compensation also with a stronger focus on the adoption and consumption of our cloud solutions. That's another cultural shift that you need to go through when you're purely transforming to the cloud, you need to have as maniacal focus on retention of customers as you need on funneling new customers through the pipeline. And therefore, across the board, we have significantly expanded the incentives for everybody to focus on high customer retention and customer satisfaction. And that goes not only for the field, but also all of the engineering functions and all of the back-office functions of the company and is part of this cultural shift that we are driving for.

If I could be cheeky one, last one, hopefully, this is simple. There's a lot of concern around the mix between what's multi tenants and single tenants in terms of how customers move. Do you have any view on what that mix could be as those clients move?

Yes. So first of all, in terms of the customers, I think for many of them, it will be a journey, where as we move them to the cloud and as we work on simplifying and standardizing and moving more differentiation to the business technology platform, more and more of these customers will be in a position to adopt the public cloud version of S/4 right away. I mean, as of now, it has around about 80% of the functional coverage of S/4 on-premise, which is pretty good. You will never get to 100% because there are some bells and whistles that we have in S/4 on-prem that have been developed perhaps for 2 handful of large customers who will anyway never adopt a multitenant public cloud solution because they have hundreds of thousands of employees and a massive kind of differentiated processes that they are running. But so therefore, in terms of the pure customer count, I believe that easily 80% of the customers that we are looking to shift should be in a position to go to S/4 public cloud right away. On the rest, it will be a journey where they might start hybrid and then progressively adopt public cloud over time. You see this already now, some of our largest customers have private cloud deployments for their main units and then look at public cloud to accompany this for some of their smaller and less complicated business areas as is the case with some of our most well-known broad customers, such as the one toothpaste company that we work with since many, many years, who have done the very same for some of their smaller units as for public cloud; for the other ones, they go with the classic S/4 solution. And private cloud is not an inhibitor at all to adopt the cloud because it's available with the full functional coverage that we have in S/4 on-prem. And in terms of revenues, of course, the share of private cloud versus public cloud will not be 20/80 like on the customer account, that will be slightly more favorably skewed at least at the beginning towards the private cloud. But that is something that we are kind of putting into perspective and taking into account as we have developed our multiyear guidance, including the one for the portfolio level gross margins in the cloud that we are expecting. So that is pretty much baked in.

We're kind of past time now, Luka. Very, very interesting. Really appreciate you taking the time to join us. Hopefully, that was useful for the investors as well. Thank you all to them for joining us. And hopefully, we'll be able to speak to them again soon. Thank you, Luka.

Thank you. Thanks for your interest in SAP.