Let Them Eat Margins: Elliott Management, SAP, and the Future of Customer Success

The announcement that activist investor Elliott Management has taken a one percent stake in SAP has widely been seen as something between a potential problem and an outright disaster for the company. These guys play hard and they play for keeps, and anyone dismissing them as a distraction needs their head examined. This is serious business for SAP at a crucial time in the company’s history, no doubt.

But there’s more than one possible outcome to this new chapter in SAP’s never-a-dull-moment existence. Certainly, if Elliott comes in and plays a basic slash and burn game, the SAP we know will be drastically, and in my opinion, disastrously altered, if not outright neutered as a leader in the enterprise software market. But if they play it smart, and support SAP’s current efforts to seize what I think is a unique opportunity for changing an entire industry, then SAP may actually end up bigger, stronger, and better than before Elliott showed up.

First, let me say that I think SAP and much of the enterprise software industry has been undervalued for years, and with that in mind I agree with Elliott that the stock could use a boost in price. The difference in basic metrics like the PE ratios between, say, SAP and Salesforce.com, can’t have escaped notice. I think SAP can and should be worth more – just as a I question why Salesforce.com shouldn’t be worth less. Of course, I’m just an industry analyst, not a financial analyst, so what do I know?

What I do know is that SAP is like no other company in the enterprise software industry, and certainly like no company Elliott has ever been involved in. Sure, Elliott’s done software – BMC Software and Informatica, among others  – and they’ve done German companies with a works counsel (Thyssenkrupp, and that one promises to be interesting, as the union is planning to fight an attempt at massive layoffs, the result in part of a mismanaged divestiture that was from the Elliott playbook.) But Elliott has never ever encountered an enterprise software company that has a Germany-based management board that is increasing diverse and US market-centric, a German works counsel, and, most importantly, an activist and very independent user group community. More on that last factor below.

With this unique confluence of components in mind, it’s important to note that Elliott is arriving on the scene at an important inflection point in the enterprise software industry, which is why they can either do irreparable damage to SAP or become a catalyst for greatness. That inflection point is the realization, across the industry, that customer success has been neglected to such a degree that what I like to call the “culture of mediocrity” is threatening the growth and margins of every vendor, SAP not in the least.

The threat embodied in the culture of mediocrity is at its core a threat to renewal rates – and therefore long-term revenues and profitability. While sales are growing across the industry, particularly in the cloud, and as the cloud is clearly one of the core contributors to SAP’s margins – and therefore of profound interest to Elliott – the success rates of these cloud implementations aren’t looking as nice as they should or could be. Which, as I have said innumerable times, will begin to impact renewals, potentially with seriously negative consequences: an unhappy customer looking at a messy cloud implementation will hesitate to spend as much at renewal time as a happy one with a successful implementation, to say the least. In a cloud business where total contract value is spread over at least one if not two renewal cycles, there’s a butterfly effect that could negatively impact those very margins that Elliott is so interested in improving.

The sad irony of the culture of mediocrity is that it’s engendered an almost Stockholm syndrome-like acceptance of this unfortunate reality. While everyone bemoans the sorry state of affairs, and every enterprise software company, SAP included, has a growing cadre of execs with “customer success” in their title, the tendency to fall back on the culture of mediocrity is strong. I spoke to numerous CIOs last fall about this very issue, and their response was to acknowledge their own personal experiences (emphasis on multiple experiences) with implementation mediocrity and failure. But virtually to a man and woman none were willing proactively do something about it. “We have other priorities” was the typical meh response.

My fear is that the call to action for doing away with the culture of mediocrity will end up being a resounding meh across the industry. While vendors like SAP and others are on board at the executive level, I have yet to hear about what the consequences will be for “customer success” executives when there’s something less than success taking place. A fancy title is just that if there’s no actual accountability. And if there’s no accountability for failure, what’s the incentive to really knuckle down, make the hard decisions, and be willing to take the consequences?

Meanwhile, vendor, service provider, and customer teams show up to work every day on poorly concieved, poorly sponsored, poorly staffed, and poorly managed implementation and upgrade projects trying for the most part to get through the day without too many broken bones and black eyes. Ironically, these foot soldiers also resist being proactive regarding the deployment of the only viable solution to problem: a drastic increase in transparency and accountability about what’s actually happening in the day to day work on the project. Can you blame them? Their bosses dumped another lousy project on them – oversold and underdelivered – and now, in order to keep an eye on the mess they created, they expect the worker bees to be the ones to shed a spotlight on how poorly things are going so that they – not their bosses – can be hung out to dry for what is fundamentally a management problem, and not something that they would have chosen to do if they could. Yuck.

So, Elliott Management, with improving margins in mind, take a moment to consider what it costs to remediate this rampant pattern of mediocre projects (hint: big $$$$). And remember, as the vendor is the one that nine times out of ten will get the headline when things go south, take another moment to consider who bears the brunt of these costs –  both in real costs and in damage to the brand. Finally, now that we’re officially in the “experience economy” trying to close the “experience gap”, take a moment to ponder what would happen if some serious headway could be made towards solving this culture of mediocrity problem.

Elliott Management, this is your challenge. You’ll find the margins and profits you’re looking for – not all, I’ll admit, but considering mediocrity effects from one half to two-thirds of all projects, the opportunity is pretty big  – by supporting SAP’s efforts to tackle this culture of mediocrity problem. In the long run it’s hugely customer-centric in an industry that is a little too focused on the investor as the primary customer to be take care of. Admittedly you’re that investor/customer, but you have the opportunity here to take a dramatically different perspective on customer-centricity and still come out a winner.

I know you’re already talking to knowledgeable people around the SAP ecosystem, looking for the weaknesses in the strategy that might form the case for some boardroom activism. My recommendation is to do your due diligence on SAP and its customer relations in a very different manner than you might look at other kinds of companies. The evolution of enterprise software in recent years has made it relatively easy to move from vendor to vendor, and one of the best times to do that is when a company is contemplating moving from on-premise to the cloud, which just happens to be what the majority of the consumers of enterprise software are in the middle of doing. It’s a delicate moment in enterprise software, and this might not be the time to stir the pot by doing a 21^st century impression of Gordon Gecko.

Successfully moving to the cloud means having confidence that you’re taking a journey with a vendor (and its partner ecosystem – which SAP is about to revamp, under a new leader, to be more customer-centric as well, another great initiative that will put SAP in a very competitive light and help those margins significantly) that is going to be at your side and on your team. I wonder how warm and fuzzy Thyssenkrupps’ steel customers feel about their vendor now that the Tata deal has been called off? You don’t want SAP customers to tossed around the M&A wash cycle like that, it won’t end well.

So, while you’re making those calls and doing your due diligence, take time to consider this customer success problem and what solving it could mean to SAP. Think about what the Japanese auto industry’s embrace of quality did to their profitability – and to the serious erosion of the market share of  their erstwhile American competitors. Think about how much the problem embodied in the “Solow Effect” –You can see the impact of technology everywhere but in the productivity statistics – can be traced to this culture of mediocrity. And take a look at whether that old saw that the CIO’s budget for innovation is hampered by the need to spend too much money keeping the lights on can be traced to what happens when mediocrity meets the Solow effect. If the majority of implementations are in the mediocre category, it makes sense that keeping these meh implementations running would cost more. It’s like that old clunker that still takes you from a to b. But with a clogged carburetor, miss-matched tires, and a head gasket leaking like a sieve, you’re paying a whole lot more than you need to keep the jalopy on the road. There are a number of ways to free up the IT budget for more innovation, but one of the principal ways starts with doing implementations right in the first place.

I won’t pretend to know how to do the analysis on margin impact that reversing this problem could have – just an industry analyst, after all – but I know that the company that can convince that enormous silent majority across the industry still running those old tired on-premise systems to move to the cloud will become the Toyota of the enterprise software industry. Just look at how Edsel-peddlers like Oracle are doing with customer-centricity and market leadership: I hope you realize letting SAP devolve into another Oracle would be a huge misstep.

Not I think it could happen without hugely negative consequences for you recent investment. Unlike any vendor in the industry, SAP has some very activist and highly independent user groups, and whether you like it or not they can play a major role in your success or failure. ASUG in the US and DSAG in Germany were instrumental in making enormous changes in SAP’s pricing and licensing strategy, positioning the company for market leadership in an industry that has been sweeping user-hostile licensing and license audit practices under the rug forever. If what you end up proposing – assuming your one percent share can be increased via proxies or additional buying and you move into activist mode – looks too hostile to the user community, watch out.

When SAP shot itself in the foot by suing two customers for licensing violations, the user groups moved into full activist mode, and the results were potentially devastating for SAP’s growth. There were a shocking number of SAP CIOs who told me they were putting on hold their future spend with SAP until the issue was resolved. They were flexing to a certain extent, but many told me their CEOs and boards were willing to take a look at an SAP competitor as a potential exit option considering the uncertainty around total cost of ownership that the licensing mess exposed. The fact that this was occurring at the beginning of what SAP hoped would be a major upgrade cycle from ECC to S/4 HANA made the threat of a “boycott” all the more acute.

SAP worked hard with its users groups, and over the last few years they came up with a solution that is a model of vendor/customer collaboration. With this major upgrade cycle to S/4 HANA and the cloud still a work in progress, the anger is gone, cooperation is on the table, and SAP is in a stronger position with its customers than its been for years. Taking the slash and burn approach, and making enemies of the user groups by making SAP customer-hostile, could be the road to ruin for all concerned. Make no mistake, ASUG is certainly keeping its eyes on you. I can assume DSAG is too.

If, on the other hand, your activism takes into account the need to do right by the customer base, fix their margin (of success) problem, and ensure a thriving ecosystem of mutual self-interest, then you might find some strong allies in the user groups. They definitely don’t see SAP through rose colored glasses, and sycophancy is not on the table here. Striking a balance that helps the customer and helps SAP’s stock price improve could be a win/win/win.

Can Elliott get what it wants and still play a long game that favors customers? Call me an optimist, but I don’t think it’s impossible. Playing to win means using all the tools at your disposal, and being customer centric might sound out of place for a company with Elliott’s fearsome reputation, but there’s no doubt these guys are smart and successful as hell. Hopefully they’ll make sure SAP, its customers, and its shareholders are as successful as hell too. Après Elliott, le déluge? It doesn’t have to be the case.