By Jim McGittigan, Gartner | Mar 20, 2012
The public cloud is, by nature, a service, and does not generally require capital purchases. And the opex vs. capex discussion related to public cloud vs. on-premises is not new.
What is new are some of the unexpected roadblocks to cloud adoption that are financially related. Since the annual cost of a cloud-based environment is often the equivalent of or less than the annual operating costs of a similar on-premises environment, it is essential that financial roadblocks are addressed in order to ensure the best decision for the enterprise is made.
For 2011, the worldwide market forecast for public cloud is estimated at US$89 billion, with a five-year compound annual growth rate of 19%. Compared to the forecast for all IT marketplaces in 2011 of US$2.6 trillion, cloud represents only 3.5% of the IT marketplace. Cloud services are forecast to account for 5.9% in 2015.
Opex vs. Capex
Looking at Figure 1 below, the cross-industry trend from the Gartner IT Key Metrics Data shows opex rising from 71% of total IT spending in 2007 to 74% in 2011. This trend is partially due to increased usage of cloud services.
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However, a majority of the increase is due to a number of other factors, including a clampdown on capital spending due to the economic downturn, changes in enterprise policies related to capitalization thresholds and more effective usage of operating leases.
While we expect the percentage of opex to continue to rise due to the continued adoption of cloud services, it is difficult to project the impact of the increased opex and reduced capex spending due to cloud computing.
There are a number of other variables that could potentially offset some of the increases in the opex percentage, including the potential release of some of the cash that has accumulated over the past several years to purchase direly needed IT assets or the threat of recent U.S. accounting regulation changes to end off-balance-sheet operating leases.
Assuming all of the projected increase in cloud spending by 2015 represented a dollar-to-dollar shift from capex to opex, the opex percentage would still only rise from 74% to 76% by 2015 (assuming no other changes).
This represents less than two-thirds of the increase that has occurred in the opex percentage during the past four years.
Therefore, concerns about a material shift in the mix of IT opex vs. capex are unwarranted. The opex/capex mix of IT spending should not be an inhibitor to the adoption of cloud-based services.
Any potential investment in cloud computing requires a solid business case that evaluates the associated financial and nonfinancial costs, benefits and risks. While there are several operational and risk reasons impeding the growth of cloud computing, there are also financial roadblocks.
The first three roadblocks listed below are structural in nature and have nothing to do with cloud adoption; the remaining five could be triggered by moving to the cloud:
- IT budget excludes capital/depreciation
- financial performance management excludes depreciation
- austerity programs focus on cutting opex
- high upfront costs
- inability to manage utilization
- IT financial management skills
- lower working capital
- extra cash required on the balance sheet
Regardless of root cause, any of these roadblocks could potentially lead organizations to avoid moving to cloud computing, even if it is the right thing to do (that is, all nonfinancial issues are mitigated, and the business case contains a positive net present value and favorable ROI).
Capital/depreciation excluded from the IT budget. Some organizations, especially public entities, do not have capital and the associated depreciation within the IT budget. Therefore, when a business case is presented for cloud computing, there is a funding issue that needs to be resolved, because the IT budget may significantly increase while the savings from lower depreciation shows up elsewhere.
Action: Build a proper business case, and if the overall benefits (both financial and non-financial) of moving to the cloud are significant, then begin the internal discussions about how to get the right thing done. For IT, this can be a very difficult, highly political discussion.
Financial performance measurements exclude depreciation. Some organizations measure financial performance for organization success based on measures such as EBITDA. While perhaps useful in valuing companies on a basis that is capital-neutral, it can impede adoption of cloud services, even with a solid business case and ROI if capital is seen as free.
Action: Follow the same action as capital/depreciation excluded from the IT budget, but it will, perhaps, be even more politically charged.
Company-wide opex-focused austerity programs. Beginning with the recession in 2008, many companies instituted enterprisewide cost reduction programs focused on opex (and often capex as well). Cloud computing, especially public cloud, will often cause an increase in a single cost category (generally a services category), and a decrease in capital/depreciation and other opex categories, such as maintenance.
Action: Ensure that it is clear that the increase in one cost category will be more than offset by decreases in other categories, and that the organization will experience a net reduction in cost (assuming cloud computing has a less expensive total cost of ownership than on-premises).
Upfront cost. While cloud computing can be less expensive than an on-premises solution, this is not always the case. Occasionally, upfront costs, such as the write-off of existing assets, R&D costs, setting up data centers and training personnel to manage both on-premises and cloud environments, can cause cloud computing to be more expensive.
Action: Identify any upfront, one-time costs, and make plans to offset them by lower operating costs, due to either cloud or other operating efficiencies. If you cannot, you may want to delay moving to the cloud.
Inability to manage utilization. Cloud computing shifts the burden of utilization risk from the user to IT. The inability to effectively manage utilization can lead to serious financial consequences, because pricing is related directly to utilization.
Even when cloud computing provides significant per-unit cost advantages, companies can end up spending more if demand is not properly managed. There are several documented cases where the per-unit cost of a technology has declined significantly, but total spending has increased (see Figure 2 for examples).
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Action: Put in solid demand management practices that ensure any increase in usage is justified and funded. Ensure that shadow IT spending is closely monitored.
Increased need for IT financial management skills. The movement to cloud necessitates a better understand of IT costs, utilization rates, pricing and so on. Running IT like a business has been around for more than 30 years. Cloud computing just accelerates the need to actually do it.
Action: Ensure that the necessary IT financial management skills are in place. This requires more than people (solid process and IT financial management costing tools as well).
Lower working capital. Net working capital is defined as the difference between current assets and current liabilities. Movement to cloud computing, especially public cloud, can make an organization more liquid – and potentially inject additional risk.
: The 2011 Gartner report The Impact of Public Cloud Adoption on Working Capital
discusses this topic in detail. To ensure that current assets and liabilities are more or less matched, the payment period should be synchronized with the external payment cycle with the cloud service provider. A healthy level of current assets also needs to be maintained.
Extra cash required on the balance sheet. Paying a monthly service fee instead of capex upfront requires companies to carry more cash each month. The reduction in capex requirements is often an incentive to adopt cloud computing for those companies trying to reduce their capital spending. However, the opposite can be true for companies with significant cash reserves.
Action: Finance should work closely with the IT organization and the CIO to ensure that the movement to cloud does not affect the company’s overall financial position.
The goal is to ensure the best decision for the enterprise is made when investing in technology. If any of these roadblocks exist, then ensure that they are recognized and adequately addressed as part of the decision-making process.
Otherwise, you will not manage investments in technology effectively, and limit the value of technology to the organization.
About the Author
Jim McGittigan is a US-based research director within the Gartner CIO Research group, where he focuses on delivering value to Gartner clients through his insight and experience in IT financial management. New York-listed Gartner is an information technology research and advisory company. This article was extracted from the Gartner report, Be Aware of Financial Roadblocks When Moving to the Cloud
, published 6 March 2012, and was re-edited for clarity and conciseness..