SAP Looks to Procurement Services Market to Boost Revenues and Protect Margins

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Earlier this month, German software giant SAP SE (NYSE: SAP) stated that it plans to capitalize on the burgeoning business-to-business (B2B) ecommerce market by providing online procurement and vendor management services. [1] Steve Singh, head of the newly created Business Network division for cloud-based corporate procurement services, called it a $75 billion opportunity in the form of fees on facilitating purchase of trillions of goods and services.

Corporate procurement services is a lucrative market that is already served by software bigwigs like Oracle Corp. (NYSE: ORCL) and Salesforce.com (NYSE: CRM). Research firm Frost & Sullivan estimates that the B2B online retail market will grow to $6.7 trillion by 2020, due to rapid adoption of online purchasing platforms. [2] Corporate procurement service providers stand to make billions of dollars in fees by providing cloud-based platforms and management services to facilitate such online purchases by big companies.

We have a price estimate of $78 for SAP SE, which is about 10% higher than its current market price.

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See our complete analysis of SAP SE here

Building Upon SAP’s Transition to Cloud

SAP has invested heavily in recent years to adapt to the ongoing transition from on-premise to cloud-based software. Its latest ERP platform, the SAP S/4HANA, is also optimized for cloud, on-premise and hybrid deployments (Read: Has SAP Bet The House With The Biggest Update to its ERP in Two Decades?) The company spent nearly $20 billion in acquisitions designed to expedite its entry into cloud computing. These acquisitions included ecommerce specialist Ariba, contract staffing firm Fieldglass and staff travel and expenses manager Concur. These acquisitions are now planned to be combined into a single ‘Business Network’ for procurement services. According to SAP, the Business Network generated over $1 billion in revenues and is expected to grow at a CAGR of 30% through 2020. [1]

Further, SAP already has an existing customer base which uses its Resource Planning and Supply Chain Management software. The company is likely to attempt to cross sell its new procurement services to such customers. By leveraging its existing customer base, SAP plans to create a network of preferred B2B suppliers for corporate purchases, which may result in lower costs for its customers.

This strategy will give SAP a leg up against smaller competitors in the newfangled market. However, it is worth noting that SAP will have its work cut out for itself as it will also face competition from software behemoths like Oracle, Salesforce and Microsoft (NYSE: MSFT). Moreover, SAP will face competition not just from software vendors, but also from companies like China’s Alibaba (NYSE: BABA), which is a pioneer of B2B ecommerce and already has a gross merchandize value of over $27 billion. [3]

Margin Buffer in Low-Margin Cloud Computing Era

SAP has maintained a commendable gross margin of around 80% for its software products, since as far back as 2008. This status quo is likely to change in the cloud computing era, which is characterized by aggressive pricing and intense competition from large and small players alike. In short, services businesses do not command software’s rich margins.  Therefore, it is widely feared that SAP may not be able to retain its high margins for much longer.

In such a paradigm, the corporate procurement services business has the potential to provide a buffer for the overall margins of the company. The cloud computing industry has far lower margins than the 30% operating margins historically maintained by SAP. Thus, the higher-margin Business Network could prove crucial in protecting SAP’s margins as it transitions to a cloud computing company.

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Notes:
  1. SAP sees procurement services as the cloud’s silver lining, Reuters, March 17, 2015 [] []
  2. Future of B2B Online Retailing, Frost & Sullivan, December 31, 2014 []
  3. B2B eCommerce Market Worth $6.7 Trillion by 2020, Forbes, November 6, 2014 []