With a market capitalization of $99 billion, SAP AG (NYSE:SAP) is a German enterprise that develops various Customer Relationship Management, Business Process Management and Business Operation Management software products. It is the largest software developer in the European region and the fourth largest in the world, with revenues over $20 billion. The company has traditionally competed with Large Cap On-premise Enterprise software development companies like Microsoft (NASDAQ:MSFT), IBM (NYSE:IBM) and Oracle (NASDAQ:ORCL). However, the dawn of the hyper-growth Cloud Computing industry has contributed to a slow erosion in On-premise software revenues.
In the January through September 2013 period, SAP reported a 4% decline (in Euros) in traditional On-premise software new license revenues from the prior-year period. However, in USD terms, the decline was relatively lower at 1.3% due to a strengthening Euro against the Dollar. During the same period, new Cloud subscription revenues increased 238% to reach €488 million. Weak dollar performance in 2013 helped SAP post a revenue growth of 248% to $643 million in the nine months so far. To help support its growth in Cloud-based services, and also to help offset the decline in On-premise software sales, SAP has begun bundling its Cloud application software with its high-performance HANA in-memory platform.
The present note focuses on SAP’s on-going shift to a Software-as-a-Service (SaaS) business model and its influence on new Cloud subscription revenues for the company.
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The option of deploying both its Cloud and On-premise offerings on the HANA platform has helped SAP increase the Cloud subscription revenues it generates. The On-premise option benefits large Enterprises that deal with huge sets of data within the confines of their own secure networks. Additionally, these mostly large companies can offer HANA within their own secure Private Clouds. More importantly, HANA can now be deployed in the public Cloud by third party providers (most notably Amazon’s AWS), which opens the power of this especially expensive hardware/software platform to small and medium business (SMB) enterprises that are better served by the leaner SaaS model. This is evident from the fact that Cloud adoption from SMB organizations increased 30% in revenues in 2012 and is expected to grow at a compunded rate of 28% annually between 2012 and 2015. 
The primary reason for this rapid move to the Cloud by smaller enterprises stems from the fact that SaaS eliminates the need for huge upfront investments into physical IT infrastructure. This has leveled the playing field across various Application software markets. An example of this would be the exemplary success of Salesforce.com (NYSE:CRM), the global leader in On-demand CRM software. In comparison, large organizations have adopted similar Cloud services at a lower pace because of the security risk attached to having entire data sets off-premise at an external data center. The recent snooping activities by the National Security Agency (NSA) has increased the concern for security. Accordingly, large corporations are often reluctant to deploy their data and applications onto Cloud despite their significant positives.
Going forward, we should see strong growth in new Cloud subscription revenues for SAP, driven by its leadership position across its Application software portfolio and the increased integration of its HANA platform. Currently, 77 SAP applications are being offered as a bundle with the HANA platform and more are expected to follow suit.  As more applications are offered on the HANA platform, its functionality grows; large applications gain the advantage of increased processing and application handling without a reduction in security. Additionally, large enterprises should benefit from SAP’s latest HANA Enterprise Cloud offering that gives organizations a hybrid Cloud approach. Although current application deployments on hybrid Clouds are at present less common, Gartner estimates that 50% of global large enterprises will have hybrid cloud deployments by 2017.  Through the on-demand option, SMB organizations stand to leverage HANA’s high performance capabilities at lower prices.
On the flip side, SAP’s growth in cloud subscriptions could be contained as smaller players continue to offer point solutions for the Cloud at lower cost. Additionally, the recently launched ‘Salesforce1’ mobile platform will be a strong competitor to SAP’s applications on cloud, especially its CRM applications. CRM application sales account for approximately 17% of SAP’s stock valuation, and an increase in migration towards Salesforce could create a downside for SAP’s valuation.Notes:
- Parallels SMB Cloud Insights™ for 2013, February 2013 [↩]
- SAP AG Management Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, October 2013 [↩]
- Gartner Says Nearly Half of Large Enterprises Will Have Hybrid Cloud Deployments by the End of 2017, Gartner Newsroom, October 2013 [↩]