deal architect

Auditor Independence and ERP/CRM projects - a conversation with Francine McKenna

Francine McKenna is a prolific commentator on the accounting, audit, and corporate governance issues affecting public and pre-IPO private companies. Since 2006, McKenna has been an investigative reporter and feature writer for publications including Dow Jones MarketWatch, Forbes, American Banker, Financial Times, Chicago Booth Review, Accounting Today, and Boston Review. At MarketWatch she monitored and reported on public company accounting, fraud and financial investigations, and the often questionable financial reporting practices of pre-IPO companies. McKenna spent more than 20 years in public accounting and consulting, including for KPMG/BearingPoint in the U.S. and Latin America, and at PwC. She is also an adjunct professor of international business in the MBA program at American University’s Kogod School of Business. She speaks often at universities, conferences and other forums. You may also know her from her blog, reTheAuditors.com. She also writes an online newsletter, The Dig.

I had a chance to talk to her a bit about the history of auditor independence issues and some of the risks of using accounting firms as implementation partners on ERP and other enterprise software projects. In part 2 tomorrow we will talk about differences in automation in the audit and consulting practices of such firms.

Francine, I read your story about the SEC’s recent auditor independence enforcement against PwC and thought, "What are some of the risks that companies that use accounting firms may be exposing themselves to on their consulting projects?" Talk in terms of something around an ordinary business executive, not necessarily a CPA would be able to relate to.

The rise in ERPs and the large software vendors like SAP and Oracle mirrors the rise of the Big Four public accounting firms involvement in consulting, especially systems implementation, design and implementation consulting. When you think about when Enron happened and when Arthur Andersen collapsed, if you go back to the late nineties, you had the emergence of ERP software. They started to work with systems implementers like the Big Five auditors including Arthur Andersen and other systems integrators.

Then, unfortunately, you had Enron's bankruptcy and the collapse of Arthur Andersen. There was a push already to look at how the rest of the Big Four public accounting firms were addressing or working with issues around doing both audit and consulting, in particular systems design and implementation consulting, for the same client. The firms were already under pressure.

A lot of people think that three of the four Big Four firms sold off their consulting arms because of Enron but, actually, the pressure was on them before that. They were already being criticized for potentially compromising the integrity, objectivity of audit work because of their disproportionate focus on consulting and consulting revenues from the same clients.

When Enron occurred, there were already, I think, at least two of the four had already sold their consulting arms. EY sold to Capgemini, KPMG spun off BearingPoint, and PwC eventually sold their consulting arm to IBM. Deloitte, uniquely, never sold. It's not that they weren't planning on doing it but they actually just never got to it. I think I've written more than once that they never ended up doing it because, once the other three sold their consulting arms and Deloitte saw that even though they hadn't, no one was coming after them. There was no significant enforcement of new auditor independence rules enacted as part of the Sarbanes-Oxley Act of 2002. There were no new enforcement actions at least in terms of significant scrutiny over whether they were doing consulting, systems integration, and design implementation work in their audit clients. The actions the SEC did take related to actions prior to 2002 that were egregious violations of exiting rules.

The SEC and the new audit regulator, the PCAOB, never really aggressively implemented or enforced the new rules that were put in place to try to prevent that kind of combo audit and consulting work that was blamed for Arthur Andersen’s mistakes with Enron.

Deloitte, I think, just decided, "Hey, let's hold onto it and keep going." They ended up being able to build on that base and now pretty much dominate the consulting business in the Big Four, although PwC is a pretty close second.

When I think about the conflicts of interest inherent in being a public accounting firm, Accenture got out of that issue a long time ago. When the consulting arm of Arthur Andersen split off and became Accenture, they eliminated that worry. Accenture can do any projects for anybody they want. Certainly, Accenture can have conflicts of interest like any other professional service firm, but they eliminated the inherent conflict of interest that a public accounting firm has when you're an auditor for a large public company.  In that case you're restricted, in particular now, post the Sarbanes-Oxley Act of 2002, from doing audits and financial reporting-related systems design and implementation at an audit client. Sarbanes-Oxley is the law that came into effect in reaction to the conflicting priorities issues that people thought had occurred at Enron, WorldCom, HealthSouth, and some of the other corporate frauds that occurred during that period.

The SOX auditor independence rules prohibit an auditor from doing systems design and implementation work at an audit client. It's strictly prohibited. What's happened is that those services, that software, that activity, which are the kinds of things companies want from big consulting firms has grown, changed, and developed. Now we have lots of different modules for all of the different large ERP systems and many of them can arguably not be tied directly to financial reporting, the direct financial reporting and financial statement preparation, which is where the prohibition comes into play. In other words, the auditors are not supposed to be designing and implementing software, implementing the controls, the internal controls and the configuration, developing the training and the user instruction associated with how you use those systems if they're going to go back, turn around, and go back and supposedly independently audit the company's use of those systems.

What happened after the financial meltdown? Did that have any effect on the accounting firms? Was there any scrutiny after that?

Yeah, absolutely. Actually, the financial crisis was a boon for them. Let's go back a little bit. One of the big reasons why Deloitte and PwC dominate in this arena as opposed to KPMG and Ernst & Young is that BearingPoint, the KPMG consulting firm that spun off and went public, ended up going bankrupt in February 2009. PwC and Deloitte split that carcass. Deloitte bought the federal services portion, so all of the big public sector clients of KPMG consulting, which became BearingPoint, and PwC took all the commercial clients. Those two firms got a really big head start in the midst of the crisis, which was approximately right after PwC’s non-compete clause with IBM expired.

The crisis deepened. The crisis root cause analysis really didn't focus on the accounting firms.  The perception was the financial crisis was about this cataclysmic economic event that no one could control, it wasn't perceived initially as a sort of broad kind of a corporate fraud-related crisis. It wasn't the auditor's fault, in other words, at least at first.

Later, when it became apparent that there had been a lot of fraud related to subprime mortgage origination and securitization, mortgage and foreclosure processing, mortgage servicing, how people who went through or were threatened with foreclosure and were charged multiple fees, in error in many cases, then that sparked or was a catalyst for a whole new area of consulting called GRC, Governance Risk & Compliance. Many of the biggest banks and many other financial firms ended up on the wrong side of regulators in terms of how they had addressed those issues. In order to get out of civil and criminal liability for those issues, they signed settlements and consent decrees that said they were going to go back and fix those problems. They were going to calculate what the damage was to consumers and find a way to repay consumers for that damage.

This Big Four firms stepped into that arena in a huge way, in particular in a process called the foreclosure reviews that were ordered by the Fed and the Office of the Controller of the Currency. Three of the Big Four firms participated in the process in addition to Promontory, which was an independent consulting firm and now is part of IBM, and a couple of other smaller firms.

They did these humongous projects at the banks, which were essentially sort of hybrid audits. They went in looked at systems, looked at compliance with agreements and they tried to develop and extrapolate calculations of damages to consumers from having been inappropriately foreclosed on or inappropriately charged fees or other kinds of penalties related to mortgage servicing and processing.

Deloitte made out big, but PwC was the biggest winner in that arena. For everybody that PwC or Deloitte or EY didn't audit, they could do that foreclosure review. Deloitte, however, did a big project at JP Morgan that focused on mortgages at Bear Stearns and Washington Mutual that JP Morgan bought in a forced acquisition, essentially a bailout of those firms. Deloitte had been the auditor of Bear Stearns and Washington Mutual. PwC and Promontory did almost everyone else. Ernst & Young did a few small ones.

The only one who didn't really do much on that was KPMG. That created an enormous opportunity to do that kind of work in many other realms later. Any time a company is charged with some kind of a regulatory issue, whether it's anti-money laundering or something, like in the banks, related to their processing of some kind of consumer loans or something like the subprime loans, you have an opportunity for someone to be appointed as a monitor or as some kind of a consultant after the fact to help that organization correct the issues, often systems related issues.  The Big 4 consultant or monitor then also does the work to calculate the number used to repay customers for the damages that occurred from the violation.

The firms have cleaned up on GRC. And it’s a whole new area of software that Oracle and SAP have incorporated into the ERP systems that’s required by regulators.  The Big 4, especially Deloitte and PwC, now partner with Oracle and SAP to implement the software on behalf of clients.

What I'm seeing is that a lot hasn't changed since the time when I actually was last working in a Big 4 firm. The last firm I worked for was PwC in 2005 and 2006. At that point, I was part of an internal team looking at how well PwC was responding to the new rules under Sarbanes-Oxley, things like auditor independence and making sure that they were prepared to respond to inspections of audits under the new independent regulator the PCAOB, established by Sarbanes-Oxley.

There were things that I was concerned about then, things I looked at and said, "Hmm. You know, I don't think that some of the people in the firm understand that they can't do these things anymore." The ability of the large global public accounting firms to control partners, to monitor partners' activities, and to actually have good governance to make sure that there's a structure that identifies and addresses when somebody wants to go rogue or do something that is against the rules is always, always a challenge. The bigger they grow, the harder it is, especially because they're global firms.

Tell us your opinion about the recent SEC enforcement action against PwC

I looked at the recent SEC enforcement action against PwC that covered almost a five-year period from 2013 to 2016 and it said there was one person responsible for implementing governance risk and compliance systems from Oracle in multiple audit clients. PwC, as a firm was charged with violating the auditor independence rules in 15 different clients 19 different times during that short period and seemingly attributable to one partner. The SEC said one partner was the cause of these violations.

That one partner was a hybrid IT audit partner, who participated in the audits with as a specialist, with expertise around IT general controls and other IT controls. He was also a partner who was responsible for identifying opportunities for advisory or consulting projects related to Oracle ERP products.

That sort of hybridization of partners, with a dual incentive structure, is inevitably going to lead to potential conflicts and will present a constant challenge to try to interpret the rules, and for somebody to actually be willing to say, "No, you can't do that." When you say, "No, you can't do that," you're forcing the partner to turn down revenue. I saw that that was going to be a challenge for some partners to comply back in 2006, and it seems like PwC has not implemented any better rules or governance structures in all this time. PwC had one partner running around doing this over and over and over again and obviously without any real, effective constraints.

Given that, now talk about two audiences - the clients and the software vendors. When a company is implementing packaged software, it could be ERP, CRM, whatever. They look at consulting firms and they end up hiring a Deloitte or a PwC, an accounting firm. Are they exposing themselves to some risks?

They're exposing themselves to multiple risks, and not just the risk that a regulator is going to decide to crack down on this and they're going to be left without a consultant or having to change consultants suddenly, mid-project. When the rules were implemented in 2002, we saw companies come down into two different camps, and they're kind of distinct. One is the company that loves, loves, loves their auditor, that's been with them for 99 years and has built their whole professional services relationship around that firm. Usually, it's obviously one of the Big Four and if it's one of the Big Two, PwC or Deloitte, it’s a special problem because of their ubiquity in consulting.

Companies still get full service from that firm. They look for every opportunity to use that firm whenever possible. They know that there are some things that are prohibited. But if the firm and someone else within the company, in their board of directors audit committee, can find a rationalization or can find a way to interpret the rules such that that audit firm can do the work, that company will always choose the audit firm to do the work.

On the other hand, you have companies that only tolerate low risk. They're very much oriented around following the rules and not buying anything beyond the audit. It's so obvious, it's so stark, the comparison between the two kinds of public companies.

These companies have very, very, very strict rules that the audit firm can do nothing but the plain vanilla audit. But then those companies are faced with, whenever they want to do something else, any kind of systems implementation, any kind of upgrade to an existing system, any kind of evaluation of internal controls, any kind of enhancement of any kind of operational system, they put out a tender, entertaining bids and reviewing RFP responses, doing the whole vendor demo thing, and being forced to select from another firm. Then obviously, they have to work with another large firm on something financial or accounting related, negotiate another big professional services contract and vendor relationship and manage all the complexity that entails.

They've signed up for the fact that they're going to have to manage multiple, significant professional services vendor relationships and they do that because they want to keep everything nice and clean and legal. They don't want any trouble with the SEC, and maybe they don't want to let any one vendor get too much power over them. There are advantages and disadvantages to both approaches.

In the Big 4 firms, obviously, individual partners are rewarded for getting what we used to say way back in the '90s at KPMG, “A bigger portion of the client wallet.” That's not changed. Even though it might be frowned upon for the audit partner or anybody else to get a bigger piece of the client wallet for the firm by selling more consulting or tax work, in the end, the Big 4 firms have become these very large organizations with gray lines between the various practices.

From a customer's perspective, though, there's no legal risk. The risk is what?

There is somewhat of a legal risk. For example, if the audit committee and the company executives are not aware of the auditor independence rules, do not fully evaluate those rules when contemplating opportunities for the vendor to do certain kinds of work, and they choose the auditor despite the fact that that work will violate the auditor independence rules, the SEC can sanction the company or sanction its officers or its audit committee. That happens rarely – rarely, rarely.

In the case that I wrote about with PwC, what happened was it all came down on PwC and on that partner in particular. They didn't even name the names of the companies that were subject to these 15 engagements and 19 different instances. They don't want to embarrass the companies because they want to make the assumption that it's the auditor's responsibility to fully inform the client and, in particular, as cited in the PwC case, if the auditor or the audit partner fudge the information in the scope of services, in the engagement letters in order to kind of get in under the wire or fool somebody, then the SEC really holds the auditor and the audit firm responsible.

What happens then? You have to look at the company, you have to look at its audit committee, and you have to look at sort of the company executive who is the purchasing executive or the one that's responsible for hiring, evaluating the vendor, and say, "How could they not know? They know what they want to have done and they are allowing for a contract or scope of services to not accurately state the work that's going to be done." What's going to happen then if there's a dispute?

In order to get in under the wire and be able to use the auditor as a vendor, the SEC enforcement action against PwC implied that there were executives at some of these companies that knew very well that they were fudging the information in the contracts, scope of services, and invoicing. That presents a very significant risk to the company if they do that and then there's a dispute.

Certainly, if the SEC wanted to come back to the company or come back to the audit committee, they could if they thought that there was some kind of collusion in order to create an opportunity, let's say, for a particular official to get some kind of kickback or if there was some other kind of illegality involved. You could have a situation where an official of a company or of a board of directors allowed for this kind of a situation to occur in return for some kind of an illegal payment.

How about software vendors? Do they have any liability given these situations? You look at Salesforce or Infor or whoever has these as partners. Do they have any risks?

As you know, most often when these types of big projects occur, the Big Four firm, the consulting firm, whether it's Accenture or whether it's one of the public accounting firms, they take the lead as the prime contractor. They might have subcontractors and the software vendor is the subcontractor. To that extent, they may be sort of "see no evil; hear no evil" in that situation. It may be that, as a subcontractor, they're doing their part and they're not responsible for the other piece.

What was stated in this SEC enforcement action against PwC is that there was an ongoing relationship between this PwC partner and the Oracle rep. There was probably an ongoing multiple engagement relationship and the vendor provides all kinds of other monetary and nonmonetary benefits to PwC as a strategic partner, an implementation partner, and also to this specific partner potentially on a personal and a professional level. In the end, the SEC said the partner actually provided nonpublic material, nonpublic information to the software vendor about at least one client.

That's public knowledge?

Yes, that's in the SEC enforcement action. I'm assuming that if this partner felt compelled to provide nonpublic material, nonpublic financial information to the software vendor, it was probably so that that software vendor could evaluate pricing or creditworthiness of particular clients. That to me is not very kosher.

What other risks does a software vendor have when they evaluate an accounting firm as a partner?

Well, certainly, if the accounting firm is fudging the information in the scope of services or in the contract in order to get it under the auditor independence wire and they're a subcontractor, if for some reason someone in the company or someone at a regulator determines that that's not allowed, prohibited, and tells them they have to stop the project, well, the software vendor is going to have a break in the project. They're going to have a delay. They might have the contract canceled and have to start all over again with a different integrator or, potentially, have some kind of a breach of contract with regard to the software licensing because the whole contract is canceled if the system integrator has breached some kind of terms.

That's hypothetical, right?

Right.

You don't know of any that have gone to that extent.

Well, in the case of one of the clients cited in the SEC enforcement action, PwC bid on two different projects at one client. I identified that client as Logitech. In that case, PwC had to resign as the auditor because of these independence issues.

Now, in some sense, that might actually be a blessing in disguise because, once you resign as auditor, then you're free to do the consulting work. But the question is, did that cause a stoppage of the project or were the projects delayed because these issues are being fleshed through and potentially there's a lot of back and forth and issues around whether or not the contract is going to go forward or whether or not the contract is going to be completed.

What else should buyers of consulting projects, implementation projects be aware of when they look at accounting firms?

Well, I think the biggest lesson from the PwC enforcement action was that audit committees either are still not aware of these prohibitions against the auditors doing certain kinds of work or they're willfully kind of trying to deflect the understanding or appreciation for those rules to other people. In other words, executives and board members, including audit committee members, claim plausible deniability or delegate the responsibility for evaluating auditor independence.  Sometimes they delegate it to the auditor itself.

When you ask the audit firm itself to evaluate whether it's independent in providing services, you're basically giving the fox access to the henhouse. The vendor is not the one who is supposed to be evaluating whether or not providing those services presents an auditor independence risk to the company.

I would say the biggest lesson was that audit committees, in particular, and executives who are hiring the firms for these types of projects really need to get better acquainted and take more seriously these prohibitions. They are on the books. Whether or not the SEC or the audit regulator, the PCAOB enforce them at any point in time doesn't mean that they can't come back later and doesn't mean that a sudden spike in enforcement action or scrutiny is not going to disrupt the project for the company as a whole and cause a lot of money and a lot of delays on perhaps a mission-critical project.

I'm sure some people will say, “She is a little too alarmist.” I think it's healthy – it's important to look at a segment of the market from different eyes.

Tomorrow, we will talk about how the audit and consulting arms of the accounting firms have evolved differently when it comes to automation.

Okay, enough of the silliness about SAP

I am stealing words about silliness from my friend, Bob Evans as he recounts here Larry Ellison's comments about competitors during the recent Oracle earnings call.

Larry was particularly vocal about SAP's vulnerability. My response to SAP competitors (many whisper more than scream like Oracle does), when they say that is: "Tell me exactly why?"

There are over a million SAP, Oracle, Infor, IFS, Unit4, Epic, Cerner and other legacy application customers. They are all "vulnerable". Have been for a decade.  None of the vendors has shown much momentum moving their on-premise customers to next- gen. The cloud competition has not delivered knockout punches. They are narrow in reach - don't cover operational areas. Besides, the cost of migrating to a completely new platform, with little automation, with the need to retrain users on the new UX and IT on the new architecture is daunting. Show me how you are making it compelling to move SAP customers. If anything I see a bit of the reverse. I see SAP's broad range of applications and customers looking at application portfolio rationalization. They are looking to reverse a decade of "ring fencing" their ERP with best of breed cloud applications.

Also, I see SAP with plenty of assets to turn the tables against the competition. It has a dominant Asia-Pac presence. I wrote after an event in Bangkok "SAP has been in Asia over 30 years and now has over 9,000 employees spread across 31 office in the region. The event in Bangkok showed me just how far the competition has to go to catch up." With all the musical chairs in the executive suite at many CRM vendors in the last few weeks I get the sense that market is poised for disruption. SAP's CX portfolio, especially the Commerce piece, and with new leadership under Bob Stutz, will get another shot. The SAP Analytics Cloud keeps growing in reach and maturity as I wrote here. The recent "Microsoft Embrace" opens up support of the vast Microsoft channel, and also simplifies the hyperscaler choice for many undecided customers (while keeping open support for customer loads on AWS, Google and Alibaba clouds).

Yes, SAP has had plenty of executive turnover this year. However, as I recently told a journalist "Not just Jen and Christian, the exciting thing to me is how young SAP management is now, yet how technologically and globally sophisticated." Show me a vendor which has not had changes at the top in the last year or so - in different ways, Oracle, Infor, ServiceNow, Salesforce, Workday, Unit4 all have. The turnover in their customer tech teams and budgets is even more dramatic. And that has opened the door for many new competitors

I wrote recently "In the last decade, we have seen Google and Facebook run away with digital advertising spend. Amazon has commoditized order taking and fulfillment functionality by offering it as a service to millions of SMEs. Foxconn, Flex and design shops have taken over contract manufacturing as products of every stripe get smarter with embedded technology, GE, ABB, Rockwell and others are getting the lion's share of IoT generated revenues. None of the major enterprise application vendors have seen much revenue from any of these markets. And in industries like financial services, many customers are back to custom building and even becoming vendors in their own right."

Tongue-in-cheek, I had sent a copy of SAP Nation 3.0 to the editors with the sub-title of "In the land of the blind, the one eyed man is king". Looking at the last few years, I had been taken aback at how little its direct competition had grown and taken advantage of SAP's challenges.

So here's my question: if SAP is vulnerable, what would you call its current crop of competitors?

The Evolution of SAP Analytics

I had been invited to an SAP Analytics influencer summit earlier in the year. Many of the sessions were under NDA, so I had not written about it. However, my notes showed:

• Ambitious, exciting vision, but fragmented execution across portfolio of  tools. Presentations did not appear well connected.
• SAP should be drawing on the operational data and scenarios it has access to across so many industries and geographies. Many of its presentations focused on financials and hcm data.
• The Qualtrics acquisition is still new, but should give SAP a chance to blend X and O metrics - that could be a significant differentiator
• SAP has a partnership with Cloud Elements to access 150 cloud data sources
• 3 customers who presented got into operational metrics, integration with other SAP tools like IBP.
• Lots of Microsoft product mentions across the sessions - O365, Power BI, Surface Hub, HoloLens etc.
• Microsoft with all its tools, Workday with Prism Analytics and Adaptive Insights, and Salesforce with Tableau, MuleSoft and Einstein scenarios, appear to be doing a better job presenting their analytical credentials in the field

This week I heard an update webinar and the messaging was much tighter (with not as much focus on HANA, the database and related services in this webinar). BTW - click on each slide to enlarge.

The SAP Analytics Cloud continues to evolve as a "one-stop shop" for BI, broad enterprise planning and augmented analytics (use of machine learning for pattern recognition, insights etc)

 

SAC is being gradually embedded into various SAP cloud properties. Slow integration (not just with SAC) across SAP cloud applications is a sore subject with many customers so it is good to see this progress

 

BusinessObjects lives on and will continue to be supported till (at least) 2027, (see SAP statement of direction here) and as customers adopt SAC will call for various hybrid management strategies.

I would like to see SAP Analytics continue to evolve so it stands out in the competitive landscape - here's where I will be looking for progress

• Embedding SAC into each SAP cloud app is a good start, but ideally should allow for bi-directional navigation across the properties
• Plenty of sophisticated customer data is in SAP tools like Qualtrics, IBP, AIN, Leonardo ML. Be nice to see them show up in SAC demos.
• Be nice to see more real life customer scenarios in demos, especially those with operational data.
• As it tightens its relationship with Microsoft around Azure, clarify how will that impact the "frenemy" status when it comes to analytics
• We should hear more about automated migration and hybrid management tools SAP is developing to help customers move from the on-premise to the SAC world
• Similarly be nice to hear how license conversion credits will work for customers looking to adopt SAC.

Look forward to the continued evolution.

A perspective on the SAP Capital Markets Day

I am a customer and market analyst and tend to not attend too many earnings calls or Wall Street presentations. But I made time to listen to the SAP presentation yesterday. It was a coming out event for the 2 new co-CEOs, Jen Morgan and Christian Klein and there has been much speculation (with a capital S in my opinion, not fact based) about the activist investor impact on SAP trajectory. The full set of presentations is in the video here - without the breaks its about 3 hours long. The theme was "Growth and Operational Excellence" and I liked quite a bit of what I saw and heard.

To me, growth comes from market differentiation and here are key areas where SAP executives scored well

Momentum in Asia

Both Jen and Adaire Fox-Martin made repeated points about Asia/Pac. SAP is very well positioned in that region as I wrote a couple of months ago "SAP has been in Asia over 30 years and now has over 9,000 employees spread across 31 office in the region. The event in Bangkok showed me just how far the competition has to go to catch up."

Cross-selling

I always shake my head at how little cross-selling has taken place across SAP's product portfolio (listen to Jen starting around 0.16 and Christian around 0.34 about inter-dependence and synergy across SAP products). Most of their competitors can only play in one or two categories.  I am seeing many customers look at application rationalization, and reverse a decade of "ring fencing" their ERP with best of breed cloud applications. As SAP better breaks down its many siloes, starts to show more coherent road maps and delivers better integration, its broad suite should open up many new opportunities within its incumbent customers. 

S/4 adoption

SAP is associated with large, multi-national customers, but the CIO of Chobani, the yogurt company, Parag Agrawal (starting 1:29) was a good representative for the mid-sized, fast growing market that S/4 is doing well in. 40% of S/4 adopters are net new to SAP. The ECC to S/4 conversion market is also gathering steam. As Adaire says, the question for most customers is not 'if" but "when" "why" and "how". As I described in SAP Nation 3.0 - "tilting its bell curve of customers" is its largest single opportunity.

XM and CX

Qualtrics is still a missionary sell to many operationally focused ERP buyers but Ryan Smith humorously reminded the audience that precisely a year ago, he was presenting in a road show which valued the company at nearly $ 5 billion, and that now, as part of SAP, the deal size and customer growth has accelerated. It is another differentiation for SAP. Similarly, SAP has had fits and starts when it comes to the CRM market. But with all the musical chairs in the executive suite at many CRM vendors in the last few weeks you get the sense that market is poised for disruption. SAP's CX portfolio, especially the Commerce piece, and with new leadership under Bob Stutz, will get another shot.    

The Microsoft "embrace"

Microsoft and SAP have been 'frenemies" for decades. At Gartner and since I have written about many joint initiatives like Mondecino and Duet (nearly 15 years ago). The collaboration around Azure opens up support of the vast Microsoft channel, and also simplifies the hyperscaler choice for many undecided customers (while keeping open support for customer loads on AWS, Google and Alibaba clouds). The cloud version of S/4 and SCP should in particular benefit.   

Turning to Operational Excellence, there was quite a bit of focus on margin and cash flow improvement.

Christian has led a digital transformation within SAP for a couple of years and it is accelerating. It's the tagline of "Best Run Business" applied to SAP itself. His points, starting around 0.38, lay out the high level agenda.  Adaire described some of the digital and AI impact on the sales function around 1:26. Thomas Saueressig, starting at 1:09 talks about changes in the development organization. He also addressed the thorny issue of integration, especially across the slew of acquisitions in the last decade,  that customers constantly complain about. In his previous role as global CIO at SAP, he is acutely aware of the pain points (It's also something Bob Stutz in the CX area will have to accelerate). He also touched on centralization of infrastructure. which CFO Luka Mucic quantified (starting at 1:40) as they move from 25 mostly acquired technology stacks to a converged one, and also shifting many cloud loads to the 4 hyperscaler partners.

Luka also touched on improvement of cloud gross margins and marketing and SG&A efficiencies - consolidation of many sponsorships, supplier base among others.

Three areas I would like to understand more:

Margins at the expense of customers?

There is plenty of fat to be removed from within SAP and that should deliver the improved margins SAP is promising to investors. But the temptation in our industry is also to milk the customer (Oracle and the fast growing SaaS vendors are not much better). In the last few years, we have seen quite a backlash to Indirect Access and other SAP audits. I am also seeing SAP propose license conversion fees to move from on-prem to cloud versions. Customers are willing to pay for new functionality, not so much for what they have already paid years in maintenance. So, trying to extract more from older function points, which frankly have been commoditized over the last couple of decades, will only slow down incumbent customer traction.

Focus on total cost to customers?

Historically, SAP has not been very good at benchmarking and managing its partners. That led to my quantifying the huge "GDP" of SAP Nation. As we look at moves from ECC to S/4, I am starting to again see scary SI proposals. Labor intensive and not much automation, with the suspect quality and economics those threaten. Now with the 4 hyperscalers customers could face significant additional exposure. SAP likes to brag it has 000s of partners - without pointing out that cost is borne by customers. I would like to see more SAP detail on how it will better manage its ecosystem, and accelerate its automation and application of ML to its many of the routine conversion, testing, training and other tasks - see more ideas here. Adaire did mention conversion factories - like to hear more about that.

Not enough R&D or Capex to grow the functional footprint?

There was surprisingly little on industry functionality. SAP keeps promising its partners are working on it. For the next few years, it appears there will be little excess R&D or capex for acquisitions. While SAP needs that discipline in the short term, markets don't wait for ever. Beyond verticals, as I wrote earlier this week "the definition of the "enterprise" continues to rapidly expand and morph, and I see a very fragmented market for the next few years". SAP says it has a shot at a TAM of $ 500 billion by 2023. In my opinion, they could already be aiming for a trillion.

Overall, there was much to like in the 3 hours. As an analyst, it is my job to keep pushing vendors to do more for customers, but realize the new executives already have a very full plate to tackle. Should be a very exciting next few years. It is a great way to kick off a new decade!

Gradually, then suddenly

Lots of people are rattled by all the executive changes in the industry over the last few months ...Bill McDermott and Rob Enslin at SAP...John Donahoe at ServiceNow...Mark Hurd and Thomas Kurian at Oracle ...Charles Phillips at Infor....Bob Stutz at Salesforce....

There is plenty of speculation ... Call me old fashioned, but I take the long view and being one degree of separation removed from many of these executives, I prefer to do my usual 360 degree calling around. Besides, as a colleague said "The signals were there if you knew where to look". Hemingway was even more poetic when he wrote “How did you go bankrupt?" Two ways. Gradually, then suddenly.”  

To me, change is healthy. And often builds up over a couple of decades. Unlike many, I am not that agitated by what is happening in Washington or London. I ignore the shenanigans and the political media but I can see why we got to where we did. And look at ways to adapt to the changes.

Same thing with enterprise tech. In my recent book, I cataloged the last twenty years and described how Apple near dead, Google, Amazon, Foxconn and many others, mere babes then have thrived. I looked at how over a million on-prem customers have not budged. How 80% of the geographic and vertical white spaces have not been filled with modern solutions. Systems integrators continue to try and do business the same old, labor intensive ways they did in the last go-around. 

It would be silly to not expect major changes given this build up. The key is not to confuse individual with corporate trajectories. The good news is we are seeing new leaders like Jen Morgan get a chance to put her imprint. With McDermott headed to ServiceNow and Stutz to SAP, we will see plenty of activity in the customer/revenue-centric segment of the market. There will be lots more activities in areas that did not see investment in the last few years.

Here's my advice to customers. Take time to revisit your application portfolio. There are plenty of opportunities to modernize, consolidate, better integrate your applications. Your legacy has security and compliance risks and plenty of recruiting risks as you look to attract younger talent.

To vendors - question what may have worked over the last decade or so. Plenty of new opportunities and threats to focus us.

There will be plenty of distracting noise and speculation as we are seeing in politics.   Ignore all that, disrupt yourself and embrace the change.  Lots coming.

A wide open race in enterprise software

If you are into speeds and feeds, last week in sports was particularly interesting. It marked the 19th anniversary of Dale Earnhardt's improbable win at the Talladega Superspeedway. Seemingly hopeless in 18th place with just 4 laps to go, Earnhardt somehow went on to win that NASCAR race. It was his last major win. Watch the last few laps in the video below.

Earlier in the week, Eliud Kipchoge of Kenya ran 26.2 miles in Vienna is a record-breaking time for a marathon in just under two hours. It was not an official race but it showed the art of the possible when technology (supplied by Nike, INEOS and others) and technique come together as I posted on New Florence. 

As we approach the end of this decade, I have thinking a lot about the race in enterprise software.

In my recent book. I looked at the last 20 years in software. By many metrics, the pace of change has been glacial. Over a million on-prem customers have not migrated core applications to modern cloud or in-memory architectures. On the vendor side there are all kinds of neglected white spaces when you look at industry or country specific coverage.

And yet the vendor landscape has changed considerably. You could argue Apple, Amazon and Google have had more of an influence on enterprise applications than did SAP, Oracle and Microsoft. Salesforce, ServiceNow, Adobe, Workday and others have become major players. Plenty of global and vertical players are nipping at the heels. With customers building more than buying applications players like VMWare have become more influential. Service providers have evolved - many these days are as much contract manufacturers, digital agencies and third party maintenance providers. Telcos are gearing up for a next wave of 5G and satellite services. Customers are themselves becoming tech vendors as they make their own products and services smarter with software and sensor support.

When I talk to CIOs these days, I hear of opportunities and challenges like vendor end-of- life dates, automation, digital transformation, multi-cloud leverage and application portfolio consolidation. They increasingly worry about their recruiting profile as younger tech staff show little interest in supporting their legacy applications.  Vendors are themselves showing signs of big change - there is new management in the last few months at SAP, Infor, Oracle and Unit4.

It should be an exciting next few years. May be the roaring Twenties again? But they also raise some interesting questions: Will we see an Earnhardt break away from an increasingly crowded vendor market? In that race he was described as"...suddenly, seeming out of nowhere, Earnhardt charged forward, parting the field like Moses parting the Red Sea.."

And who like Kipchoge is working on stuff that makes you go wow. 

In my role, I am paid to help clients put bets, so I have my views on the likely Earnhardts and the Kipchoges.  But I would love to hear your perspectives. Comment away!

 

Why the changes at SAP may be timely for the industry

Since Thursday evening I have heard from many if I am surprised by the changes at the top at SAP

My answer is "only slightly"

From Sapphire in May, I wrote after some of the changes earlier in the year

"Nick Tzitzon, EVP of Marketing and Communications had told me "we have individuals in some cases who collectively have worked for SAP for 100 years, and who decided that it was time to try something else in their career. Does this not happen in every company?" Hasso Plattner was even more emphatic when he told a few of us that several customer executives have marveled at the smooth transition. He told us SAP is much "younger" now and he has never been more proud of the company. Watch this keynote and see the energy of execs like Christian Klein, Ryan Smith, Jen Morgan and others."

At the event, Bill McDermott had asked me what I thought of the new-gen of executives.  In background, I had heard from many customers as I was writing SAP Nation 3.0 that their legacy ECC (and PeopleSoft and Baan) systems were increasingly a recruiting liability as they tried to hire younger tech talent. So, SAP's changes were in line with what many customers were experiencing. 

However, there are more executive changes since at SAP. So people ask did McDermott need to leave along with Rob Enslin and others this year? Who exactly are Jennifer and Christian? What's wrong at SAP?

Let me try and address them. I have not talked to Bill since Thursday but his decision to leave after 10 years as CEO is really not that dramatic. According to Korn Ferry, the average Fortune 500 CEO tenure is less than 5 years.

People speculate he wilted under pressure of activist investors. Frankly, as I wrote in the book, the last 3 years have been quantum more demanding.

"That (McDermott HBR) interview was conducted before President Trump came to office. I imagine there are now additional challenges in being an American CEO of a European company."

About Jennifer, Fortune included her in its list of the 50 most powerful women in the world. They described her meteoric rise at SAP "going from head of regulated businesses (till January 2013) to overseeing all of the Americas, Japan, and Asia Pacific in just five years.”

In my book, I cataloged the Digital Transformation that Christian has led within SAP. This extract should give you some dimensions of the complexity

"We are tackling the whole value chain at SAP. We are looking end to end, looking at marketing, sales, finance, service and support, cloud operations and the cloud infra- structure. That’s the first aspect of our transformation. Next, we are infusing machine learning, IoT, predictive analytics and these new technologies to bring the intelligence into play. It’s about adapting business processes to the new digital age. It’s about fixing the data architecture. Last but not least, it’s about change management, and taking the people with you. In the end, everything that we do in the cloud impacts our 90,000 employees and our 400,000 customers.”

They are both impressive executives. The Co-CEO arrangement is unusual, but not at SAP. McDermott was co-CEO with Jim Hagemann Snabe for several years. They replaced Léo Apotheker, who himself was once an co-CEO.

Honestly, I think the industry needs a jolt. While the book overall is positive to SAP, it highlighted the under-achiever performance of the industry in the last two decades. I mean that to include SAP and Oracle and Salesforce and Workday and Infor and IBM and HP and many others.

Amazon shows authors "popular highlights" that a cluster of readers mark on their Kindles. Chapter 2 of the book looked at the disappointing performance of enterprise vendors. The majority of the highlights so far for my book are in this chapter - see some extracts below, courtesy of Amazon's algorithms

Page 32

In the meantime, SAP and its competitors, who mostly focused on each other while trying to one- up each other and impress Wall Street, have missed out on large opportunities emerging around them. (the chapter discussed cloud infrastructure, smart products, digital advertising, IoT and many other markets that new entrants like Amazon, Google, Foxconn, Siemens and others took advantage of)

Page 40

In October 2018, Oracle co- CEO Hurd predicted that 80% of business applications would be in the cloud by 2025. Today, even after two decades of cloud computing, industry and geographic coverage is spotty — by my estimate, less than 20%.

Page 45

More alarmingly, we are starting to see customers get tired of waiting for vendors and go back to building their own replacement systems. With microservices, open source and other options, we are seeing the pendulum swing away from buy back to build. That’s a stunning reversal from the 1990s.

Page 53

However, they don’t have enough process visionaries who can dream up next- gen shop floors, emergency rooms or warehouses. So you see the industry continue to invest in infrastructure, platforms and tools.

 

If Jennifer and Christian only focus on financial performance, they will do little to change the industry trajectory. We desperately need them to aim differently. Much as I respect what McDermott did, I am looking forward to the next era at SAP with that hope.

SAP Nation 4.0?

I sent Bill McDermott a “please stay in touch” note last night, and sure enough a couple of hours later, even on what must have been an emotional day for him, I got a nice note back. I have always admired his polite grooming and his always-positive vibe.

 

As an analyst, though I have to unemotionally look at technology vendors from a customer pov and my trilogy of SAP Nation books provide a nice summary of McDermott’s legacy at SAP.

On Wednesday, before I knew of his decision to resign, I had the opportunity to summarize that at an ASUG Executive Exchange event. On a panel with CEO Geoff Scott I laid out what I have liked about SAP in the last few years

A) It has been a product launch machine, and I encouraged the audience to not just look at S/4HANA, but also C/4, Leonardo ML and IoT, Qualtrics, IBP, AIN, SCP and other newer products.
B) I told them I liked what Bill and Hasso have done to make “younger” the SAP leadership with Christian, Jennifer, Juergen, Alex, Ryan, Jared and many others.  I suggested the audience similarly think about their recruiting profiles to attract younger tech talent and make that a consideration and not wait till 2025 to consider migrating from the ABAP world
C) I told them Bill, in particular, had made SAP a lot more open and humble. I certainly saw that in writing volume 3.0

I also told them what I would like to see SAP deliver and what will now become Jennifer and Christian’s legacy

A) I want to see SAP become much more serious about the public cloud. I have told Christian I worry that in a few years we will have 000s of single tenant S/4 installations. That will only replicate the implement, upgrade, AMS economics of the previous generation that led to my writing volume 1 which was not flattering to SAP. It will also prevent SAP from gathering substantive data in the cloud for effective cross-customer ML scenarios. SAP has always been better at developing code more than supporting it, so it will take a sea change for SAP to build and importantly scale its public cloud at demanding SLAs. It does have pockets of multi-tenancy experience with BYD and its cloud properties but needs to expand that. 
B) SAP’s “digital core” is already the widest in the industry compared to that of its competitors. However, even that is tiny compared to the industry footprint of the customers it serves. SAP needs to deliver vertical functionality - every industry has gone through seismic changes in the last 15-20 years - and it needs to step up not keep looking for partners to help deliver industry specific operational functionality that its customers have been paying it maintenance for all these years.
C) SAP has to significantly prioritize its customers above its partners. It has to push its SI and outsourcing partners to automate their operations or even cannibalize them with its own IP. Additionally, the market pendulum is swinging back to build technology from the last few decades of buying. SAP needs to view its hyperscale partners - Amazon, Microsoft, Google among them - not just as infrastructure but as platform plays. They have to be viewed as co-optetion, not just as partners and it needs to make its own cloud platform and other build capabilities much more vibrant. 

On the ASUG panel, I was asked when I would write SAP Nation 4.0. Not anytime soon I said. McDermott’s move has me rethinking, but I really want to give Jennifer and Christian time to make their mark. 

 

I look forward to their success, and in the meantime I promise to be tough but fair in my blogs and importantly, in the advice I provide to customers. 

 

Exciting times ahead. 

Oracle: Gen 2 cloud, but Gen 1 applications

Larry presented on Fusion applications in his second Oracle OpenWorld keynote yesterday. It is a bit unusual for him to dedicate a full keynote to applications. He tends to focus on database and infrastructure topics, and mostly tweak application competitors where it suits him. In a nice touch, he did take time to talk about co-CEO Mark Hurd who is out on medical leave.

I have followed Oracle for three decades and even when talking applications, Larry emphasizes what at Gartner we called "speeds and feeds". So, buy Oracle apps "because we use native stored procedures, we have a thin client architecture" etc. The reality has always been that customers buy applications based on functionality and economics as much as architecture and tools. However, he continues to mostly emphasize the technology not what the business user needs.  Yesterday it was about using the autonomous database, multi-tenancy in the cloud and machine learning.

History has shown wave after wave of Oracle applications do fine, but never get to dominant market share, and Oracle ends up catching up with acquisitions. That's partly because they don't benchmark their features and functions against world class customer needs. Could their manufacturing software run the BMW plant in Greer, SC with its massive amounts of automation - robotics and sensors? Could their warehousing functionality run an Amazon fulfillment center which utilizes concepts such as "chaotic storage"?  Can their supply chain run last-mile and same-day delivery concepts being tried out in retail, grocery and other distribution markets? Can their applications run a world class 'operating room of the future" for a healthcare company? Could a MNC customer looking for a global 2 tier ERP strategy count on NetSuite to support it in Indonesia, Brazil and Poland?

What was striking yesterday was how narrowly Larry defined enterprise applications. He said cloud infrastructure competitors (Amazon, Microsoft, Google etc) don't have such applications, ignoring that the pendulum in the industry is swinging from buy to build and tons of enterprise application code is being written on their infrastructure and platforms. He ignored that massive amounts of VC and customer investment has gone into vertical functionality like in FinTech - just visit Shanghai or London and see the vibrant startups there - and that for healthcare and other industries.  

He claimed Oracle has "more applications, more features, more functions" than any other suite - ignoring all the vertical functionality SAP has. He said Oracle is replacing SAP at customers - but none of his examples showed SAP customers moving industry functionality like utility billing or oil and gas functionality to Oracle. He took shots at S/4HANA as "hosted, not in the cloud" ignoring that many of his own customers are still not convinced about the public cloud. In fact his own announcements this week with VMware and "Oracle Cloud at Customer" reflect that reality. Or that SAP's contemporary portfolio today vastly exceeds his - it includes S/4, C/4, all its cloud acquisitions, AIN, IBP, ByD, Qualtrics and much more.

To his credit, he acknowledged that Fusion applications have taken "12 or 13 years" to bring to market. Actually, it has been longer than that because in January 2006, Oracle was already announcing it was "Halfway to Fusion". But let's not nitpick. The reality is in those 12, 14, 16 years Oracle has and in fairness its peers have completely missed out on developing applications for several trillion $ markets. Those included smart products, digital marketing, IoT, various verticals - - download the chapter from my recent book in link here if you want to read about all the missed markets. Google, Facebook, Foxconn, GE, Siemens and a whole bunch of vertical players have thrived in those markets even as Oracle and other applications vendors ignored them.

The good news is those markets are not closed. They are looking for their own Gen 2 applications.

That's Oracle huge opportunity - Gen 2 applications on its Gen 2 cloud. But it needs to get serious about developing or acquiring those Gen 2 applications, not just peddle its long-delayed Gen 1 applications.  

Oracle OpenWorld from afar

I have been watching bits and pieces of OOW from afar. Some observations

Larry, can I please have some of the anti-aging stuff you are on? Damn you look good

Marc Benioff and Aneel Bhusri, I know you are good friends but I want to know which of you, and after how many glasses of wine, thought up this brilliant placement at Oracle Park

The Oracle autonomous database does work. No DBAs on Howard Street during OOW week! Replaced by autonomous cars

Vishal Sikka, curious minds want to know whether you were thinking of your escape from SAP or Infosys here

Jeff Bezos should talk to Marc and Aneel - buy some space at Oracle Park and Larry may just leave him alone

Safra, my wife similarly wants to know your anti-aging secret.

Three pivots on one slide! I watched the whole Accenture pitch and ended up with a whole new buzzword dictionary.  

Oracle freemium......I cannot want to see the anti-aging stuff for this

Good to see Moscone center infrastructure has dramatically improved. NOT, but at least people are good humored about it. Or at least the female of the species.

More anti-aging - Steve Miranda's baby face never ages. He need not have had 2015 call in.

And the Oracle Twins - they age together and ever so gracefully

You know, I may never physically go to an OOW again. I would be wasting time with silly bloggers and missing out on all these astute observations!

BTW, I also have some drone generated pics. As they say, I could show you, but then I would have to .....:)  

Photo Credit - Oracle session replays and the #OOW19 Tweet stream.