SAP's Software-To-Cloud Growing Pains Reflect Industry Shift

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Just because the technology is ready for the cloud doesn't mean it's an easy move for the business to make -- especially for a publicly-held company that must report financials each quarter. It was SAP's turn last week to acknowledge that the road can be a little rough sometimes.

The company issued a late Friday afternoon press release offering a preliminary look at its first-quarter 2016 earnings. Full earnings will be released on April 20.

Software license sales -- that's on-premises software licenses -- declined by 13% year-over-year in the first quarter, according to the preliminary results offered in the press release. CEO Bill McDermott said in the statement that, while the EMEA and APJ regions showed solid execution in the first quarter, "the Americas got off to a slower start."

However, cloud subscriptions and support, which are still a much smaller part of the overall business, grew by 35%, and new cloud bookings grew by 22%.

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Normally when companies put out financial press releases on Friday afternoons after the markets close, it's news that they think could spook investors. But in spite of SAP's timing and mixed news in its preliminary earnings statement, the company's stock gained slightly on Monday closing up 19 cents at $76.90. Perhaps investors are becoming more comfortable with the tradeoffs that come when companies move software license sales to cloud sales.

Industry analysts weren't surprised by the news.

"These results are in line with the overall industry shift to cloud subscription billing models, especially among the top enterprise application software vendors," Dave Bartoletti, a principal analyst at Forrester Research, told InformationWeek in an email. "During this transition, when customers demand cloud-like subscription models -- especially for new products and development tools they use to extend SaaS apps -- there's pressure on traditional on-premises license revenue. The trick is to grow cloud revenue faster than declining on-premises licenses."

But there's a difference in how revenue is realized from software licenses and cloud bookings, too, which makes it tougher for companies to show big revenues with cloud sales. Companies charge for software licenses up front when they are sold, so all the revenue from the sale is generally realized in the quarter it's sold.

Cloud services, however, are different.

Even if the sale is booked, the revenue is realized in smaller increments over the course of the contract.

Plus, the cloud business makes up a much smaller portion of total revenues. Think of it as a startup with small revenues that grow fast on a percentage basis. But sometimes they don't grow fast enough to make up for declines in software license revenue (which still make up most of the revenues of these companies).

"One or two sets of quarterly results tell us very little about a company's transition to the new technology world," said Duncan Jones, vice president and principal analyst at Forrester Research, in an email to InformationWeek. "You have to look at the numbers of several quarters, in addition to looking at criteria such as product quality, progress in transforming culture, introducing true-cloud commercial models, etc."

But tell that to the investors who beat the drum for transition to the cloud, but are short-sighted when it comes to weathering the quarters during a company's transition. 

"The problem is that vendors have to balance their customers' expectations for cloud technology and their investors' demands for high profits," Gartner vice president and research fellow Massimo Pezzini told InformationWeek in an interview. Some companies like Informatica and Tibco have gone private in order to pursue their business transformations from on-premises to cloud revenues out of site of the scrutiny of public markets.

Pezzini said that SAP's financials in the first quarter saw impacts from a few other factors, too. In the fourth quarter, SAP extended a special offer to customers to move to its newest SAP S/4HANA -- and 2,700 customers took the deal. The offer was made at a very low price. (It expired on Dec. 31, Pezzini said.)

"There's less incentive now for customers to quickly move to S/4HANA," he said. "Moving to S/4HANA is not a piece of cake. Most customers are adopting a wait-and-see attitude. The 2,700 who moved are the classic leading-edge organizations. Now, the more mainstream adopters want to see how successful those early adopters are."

Plus, the first quarter is traditionally a weaker quarter for SAP, too, Pezzini noted.

The Americas experienced some economic uncertainty in the first quarter, and some concerns about instability in Brazil.

Finally, there are the growing pains that come from making any kind of business transition.

"You don't turn a software company into a cloud company overnight," he said. "There's a learning curve in terms of sales and marketing. And there's a transitional piece from collecting huge amounts of money up-front towards this scenario when there isn't a huge amount of money up front."

SAP Numbers

SAP said it will report its full results for the first quarter on April 20. The company also said its previous outlook for the full year is still on target. 

SAP said that first quarter 2016 total revenue would be €4.73 billion ($5.4 billion), up from €4.50 billion ($5.1 billion) during the same period a year ago. First-quarter revenue from cloud subscriptions and support is expected to be €680 million ($774 million), up from €500 million ($569 million) during the same quarter last year. First quarter software licenses and support revenue climbed to €3.17 billion ($3.6 billion), up 1% from €3.15 billion ($3.6 billion) during the same period last year.