Building Return on Investment from Cloud Computing – Discussion: Financial Value Perspective of Moving from CAPEX to OPEX and Pay-as-you-go
Software as a Service (SaaS), utility computing, and Cloud Computing are recent themes in IT that seek to change the provisioning and utilization of IT.
Key to this is the change in cash flow and cost of capital investment.
Cash Flow
Moving to a pay-as-you-go model means the cashflow of your business is changing. Sources of revenue and outgoing cash expenditure are on a usage basis based on a unit such as time, volume, or component. Cash flow – Cash Flow after Taxes – is a financial measure of a business ability to generate cash flow through its operations. Moving from a CAPEX to an OPEX model develops the use of operational expenses rather than capital assets and the treatment of operating statements rather than balance sheet management. Cash flow describes revenue, cash, and working capital changes that flow within part of the operating expenses liquidity and available usage of funds. Adopting the Cloud Computing paradigm seeks to make more money (increase revenues) while driving capital costs down through greater efficiencies of working capital and OPEX changes. Calculations of Net Present Value (NPV) of investments often need to consider the discounted cash flows of the cost of capital (WACC) to assess the value of the investment return. Cloud Computing seeks to minimize or zero upfront investment and to drive improved asset usage ratios, Average Revenue Per Unit, Average Margin Per User, and cost of asset recovery.
Cost of Capital
Moving from CAPEX to OPEX is a change in the basis of capital investment usage as upfront and ongoing costs are changed by the Cloud Computing business model. The focus is on the ability to maximize the leverage of that capital to acquire IT and business services while minimizing the risk to the business in capital used for initial investment and ongoing maintenance charges. While moving away from investments in long-term assets may be seen as context of Cloud Computing, this implies a move towards long-term OPEX-style service where QoS and costs are still equally relevant regardless of asset ownership. The common factor is the business performance and SLA requirements.
A company with a high cost of capital (WACC) and which would benefit from bringing in their tax shield (high CFAT), is a candidate for shifting CAPEX to OPEX – but other aspects of the business context may contradict that candidacy such as availability of appropriate solutions and security constraints on using shared services. If CAPEX to OPEX is desired, then the company should be considering and evaluating outsourcing solutions, including public Cloud solutions, hybrid Cloud, and Private Cloud solutions.
Cash flow can be an important indicator if CAPEX to OPEX is the focus. Pay-as-you-go can be seen as easier on cash flow than pay-upfront. But both cash flow considerations may not necessarily exist in the same business scenario. For example, a business may want to improve cash flow through moving to a direct usage model but still retain investment in CAPEX for differentiated private business processes.
OPEX
Using an OPEX model can potentially remove and release capital that would otherwise be used for initial investment and ownership of IT assets. Alternatively, investment in a Cloud Computing platform may require capital investment and changes to the payment and funding of the service as it is amortized over a wider shared service model for economies of scale.
The cost of capital from sources of equity and cost of debt point of view can change for private and public/federal industries that have stock market/shareholders or government sources of funding.
If the overall goal is to maximize the use of capital by best use of the debt and equity funds, in Cloud Computing the use of OPEX moves the funding towards optimizing capital investment leverage and risk management of those sources of funds.
Pay-as-you-go and Pay-by-the-drink
There are other ways of getting the equivalent to pay-as-you-go besides outsourcing/public Cloud. Financing and leasing are both forms of pay-as-you-go, as is a monthly software “rental fee” – or any other form of software licensing which shifts payments into the future. A close cousin to “pay-as-you-go” is “pay-by-the-drink” – usage-based billing. This type of billing can be construed to help with cash flow, but arguably, usage-based billing is only beneficial (to the subscriber) if bill amounts are predictable and controllable. If not, then neither the subscriber or the provider can budget effectively, and consequently the subscriber pays a premium for bursting capacity, and/or the provider (and thus the subscriber) oversubscribes the resources and runs the risk of a capacity shortage (“brownout”).
If the billing basis is not tied to business activity or business outcome metrics, then most commercial utility service buyers typically opt for a monthly or annual baseline fixed rate. In other words, of the billing is tied to metrics which the business can predict and control (business metrics) then the preference is for usage-based billing: but if the billing is based on IT infrastructure and/or application metrics which the business cannot readily correlate to the business activity enabled, then fixed rate billing is preferred. Likewise, residential buyers of utility services such as cell phone service are being offered fixed rate monthly billing to ease budgeting.
The following section examines some of the metrics and performance indicators that drive business towards the Cloud Computing value model.