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Cut cloud Opex to boost savings and improve cash flow

More than 90% of prospective cloud users say that their cloud migrations will have to meet carefully crafted business-benefit justifications. That is surely true.

The problem: Many users don't take the concept

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of "business benefit justification" far enough. The traditional argument that cloud computing reduces capital costs for hardware and software will never generate an optimum benefit case. The largest cost of computing isn't capital expense (Capex). Instead, it's operating expense (Opex), which accounts for more than two-thirds of total cost of ownership (TCO) on average.

Reducing cloud Opex can multiply your cloud savings, as well as help to manage critical cash-flow issues -- which, for small and medium-sized businesses (SMBs) in particular, may be a bigger benefit than savings.

Determining cloud computing Opex costs

In this context, operating expenses fall into three primary categories:

  • Hardware support, maintenance and facility costs
  • Software licensing and maintenance charges
  • In-house labor costs for ongoing systems support and maintenance

All forms of cloud computing services, from Infrastructure as a Service, or IaaS, to Software as a Service (SaaS), will have some effect on hardware costs and in-house systems support. Platform as a Service (PaaS) and SaaS will also affect software charges. Determining the size of those impacts is the first step in getting accurate cloud Opex figures for a cloud cost-benefit analysis.

Capex reduction may be the glamour benefit of cloud computing, but for most buyers, it's probably Opex savings that will make the business case and facilitate cloud justification.

Hardware costs are typically easy to assess. However, some users may overlook the cost of maintenance contracts on the hardware itself or the average cost of hardware repairs. Reviewing the hardware purchase contract can often uncover any maintenance plans that were purchased. It's also important to get a quote for maintenance over the full expected life of the equipment. Some maintenance contracts impose higher charges as the system ages.

Software charges include the software provider's annual licensing fees, maintenance costs and support charges, along with the average cost for support incidents that weren't covered by contract and paid directly. Again, the licensing agreement for the initial software acquisition is a good source for determining what these services cost. The most important point here: Divide your software Opex into "platform software" and "application software" categories, making sure that you allocate costs to the correct category. You'll see why in a moment.

Platform-as-a-Service cloud services include platform software, including some operating-system and middleware costs. For that reason, a PaaS justification should assume the elimination of all operating-system and middleware licensing and support costs included in the PaaS service -- and you should include them in the cloud Opex savings.

Internal support costs are most easily assessed if support personnel fill out time sheets allocating time by activity. Look for IT hardware-related costs, as well as software-support costs associated with the platform or application software that's actually part of the cloud services. But don't include the costs of supporting business users in this category: The same user support will need to be provided when applications move to the cloud.

However, any maintenance release changes, patches, reconfiguration costs and so on should be included here. If no activity logs are available, interview support management and support personnel separately to get independent estimates for the amount of hardware and software support time that the cloud will displace.

An additional Opex dimension

If total cloud-related Capex and Opex savings meet business benefit goals, no further work is needed, and a cloud migration is justified. But even where benefits fall short, there may be a second cloud Opex dimension worth considering: the notion of shifting Capex to Opex to improve cash flow.

Many IT professionals have never looked at the business implications of technology spending. For tax purposes, computer technology and some software are considered capital costs, meaning that their costs can't be taken as an expense the year of the purchase. Instead, they must be depreciated over a period of useful life, which for computer systems and software is typically five years (consult your CFO to determine your company's own practices).

The problem with such depreciation can be illustrated with this example: Assume that a company purchases $25,000 worth of computer and software technology. That money flows out of the company's accounts: It's spent. However, only a fifth of that amount (assuming five-year, straight-line depreciation) can be depreciated in the current year, which means the company will now pay taxes on $20,000 in "profits" that aren't real. If the company doesn't have the cash on hand, it will be forced to borrow the money for the purchase -- which, of course incurs additional interest costs.

However, the cloud can convert this cost to an operating expense, and Opex can be taken as an expense in the year the cost is incurred. That means that even if the cloud-service equivalent of our hypothetical purchase costs $6,000 per year, from a first-year cash-flow perspective, the cloud could be an attractive choice: All the cost is expensed as it's incurred. Further, there's no need to pay interest to borrow money to make a purchase, and SMBs often pay very high rates of interest -- if they can find willing lenders at all.

A final financial benefit: Cloud Opex is elastic with usage, where internal IT costs tend to remain constant. Changes in application usage or features, or the desire to use a different software product or database, can result in either of two outcomes: They can force a user of internally hosted technology to "write down" its investment and start over, or bear a higher cost than necessary if usage declines over time. With cloud services, the charges will always track usage better, and that can lead to lower costs and better money management.

Bottom line: Capex reduction may be the glamour benefit of cloud computing, but for most buyers, it's probably cloud Opex savings that will make the business case and facilitate cloud justification. Taking special care to get Opex numbers right up front can pay off in major benefits later.

This was first published in August 2013

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