Software industry revenue is migrating to cloud subscriptions like geese migrating south in the winter. Whatever doubt there was should have been dispelled by SAP’s latest earnings announcement.
According to the SAP announcement, “Second quarter non-IFRS cloud subscription and support revenue increased 166% (171% at constant currencies). SAP’s non-IFRS cloud subscription and support revenue in the second quarter outperformed many cloud competitors on a sequential quarterly growth basis.” That’s triple digit cloud subscription growth and better growth than seen elsewhere. Of course, “growth” is a funny thing. If you start from a very small amount then growth of this sort is not all that remarkable.
What is more interesting is how much revenue SAP realized from from cloud subscriptions and services. SAP pegged cloud revenue at €183M (non-IFRS), up from €69M the year before. That makes cloud revenue a bigger portion of the overall revenue picture than it was a year ago.
This should not surprise anyone but it did. Financial analysts, who operate on rules different from the rest of the business world, were not happy. They seemed to key in on the 7% drop in on-premises software revenue that SAP experienced. Of course, the acted similarly when Oracle made it’s quarterly earnings announcement a few weeks ago. There was a bit of talk about missing “expectations”. Even SAP said “the rapid transition to the cloud have resulted in lower software revenue expectations”. That’s like a dinosaur saying that the giant meteor collision had resulted in lower than expected herbivore birth rates. When big shifts happen it’s nearly impossible to really know what to expect. It’s hard to imagine SAP thought that the shift to the cloud would be neutral to the on-premises software business.
In terms of revenue, the new cloud revenue more than made up for the lost on-premises revenue. That’s very important. It says that SAP customers, and enterprise IT purchasers in general, are not abandoning their long term information technology providers and are, instead, shifting to their favorite vendor’s cloud services. This bodes well for a company such as SAP. They are not losing customers, only migrating them from one form of software delivery to another.
It’s not clear what the effects of customers moving to cloud subscriptions will have on gross margins in the long-term. Cloud services are more convenient, accessible, and flexible but not necessarily less costly from a license point of view. From a total cost perspective, one that does not include running a data center with all the requisite equipment and personnel, it might well be less expensive for the buyer. Much of that cost has shifted to the vendor who must now operate data centers and hire personnel to run them – or pay a partner to do so. That can’t be cost neutral to software vendors.
That aside, the shift to cloud software is happening no matter what it does to software vendor margins. It’s better that SAP customers make the move to the SAP cloud than another vendor’s cloud software. Focusing on lost on-premises revenue misses the big picture – SAP is retaining and growing it’s customer base through an industry transition that they cannot stop from happening.
SAP has shown that they are smart by embracing the cloud software movement and making the transition easy on their customers. They have migrated with their customers rather than try an act like a prevailing headwind.