The Cloud is Changing Finance as Well as IT
The bottom line is always the focal point in any company. Where to spend money is a constant tug of war but it’s not the only battle being fought. How to spend the money can be just as contentious. CFOs have to consider multiple factors to determine expenditures and every year might bring with it a host of changes and market conditions that impact those decisions.
Traditionally for technology investments, CFOs most often preferred capital expenditures over operating expenses because they could take advantage of amortization and depreciation of those investments over an extended period of time. There’s a growing argument, however, that operating expenses (OpEx) have distinct advantages over capital expeditures (CapEx) that have made it a favored investment approach by finance departments
The Growing Role of OpEx in IT Spending
There are plenty of hard costs that require large, upfront investments and should be a part of the approved budget (CapEx). They are costs that can be planned for in advance, but the comfort of having spending certainty is dependent on the accuracy of the estimation of future requirements. Although the actual spend for approved projects is “predictable,” what was planned does not necessarily align with what is actually needed by the business over the life of that investment.
In light of the rapid advancement of technology, IT infrastructure needs are becoming less and less predictable. Today, technology options and how they’re delivered is simply incredible. What once required dedicated real estate, skilled employees and loads of time (costs) can be fulfilled remotely via the cloud or by dedicated companies that specialize in a certain area and charge a subscription fee for its service. Organizations have more options because they can afford the latest and greatest technology without having to find a large bucket of funds upfront to pay for it. Instead, they can focus on their core competencies and transition many of their CapEx investments to OpEx spending, freeing up cash for those investments and other projects that drive revenue and growth.
“I used to argue that a chief benefit of purchasing solutions was that eventually one owns it, whereas in hosted, the monthly cost never ends,” says Dave Michels, contributing editor and analyst at TalkingPointz. “We have all run into extremely old platforms that just chug away – with zero or low recurring costs. But those days are disappearing because premise-based solutions increasingly require ongoing maintenance charges.”
Other inherent difficulties with capital spending on technology can include:
- Large amounts of cash required
- Error-prone guesswork to estimate future capacity needs for static hardware/software
- Lengthy and arduous processes to estimate budget and get it approved
- Once the technology is purchased, the company is stuck with it – despite technology advancements or changes in company growth
Operating expenses, on the other hand, are generally used for the day-to-day costs of running a business and often fluctuate. While some CFOs are still reluctant to move much of their IT spending to the cloud and other providers, technology developments are occurring faster than companies can digest and are the exact reason why many CFOs are shifting from a reliance on capital expenditures to operational spending.
Technology as an operating expense allows a company to:
- Pay only for the capacity it needs at the moment and scale as requirements change
- Ease and speed up the budgeting process because short-term spending requirements are less
- Make multiple investments across the business since capital isn’t tied up in large upfront expenditures
- Fund expenses faster through operations rather than needing to borrow money or divert money from other projects to pay for large, upfront technology costs
- Smooth out cash flows over time instead of requiring lumpy outlays*
*Some might argue that the move to OpEx might make cash flows less predictable since costs are based on actual usage. Imagine that your website traffic spikes because someone features your production on a YouTube video that goes viral. You didn’t predict the surge in traffic so your costs will spike for that month. At least you have the agility of getting the needed capacity on demand. However, what was the alternative in the CapEx model…have the website crash because you hadn’t planned for a sudden spike in traffic during your budget planning process in January?
Some Technology Was Meant to Be an Operating Expense
When companies decide to move their IT infrastructure to the cloud, additional benefits are immediately felt. The company no longer needs to dedicate the same resources, time and space for the hardware and software. Many processes are automated and standardized, improving efficiencies. Services, features and options can be purchased as needed and used on demand, so companies aren’t paying for underutilized components.
“The shift to the cloud is actually the buyer shifting the responsibility for actual results to the provider.” – Dave Michels, contributing editor and analyst at TalkingPointz
If capital expenditures are generally meant for static investments and operating expenses are intended for fluctuating costs, it only makes sense that rapidly changing technology should be considered for OpEx. IT procurement, therefore, is turned on its head: instead of purchasing technology based on long-term projections decided years ago, the company pays only for the IT services it needs, when it needs it and can scale as it needed.
Michels brings up another point. “Don’t get caught up in OpEx vs CapEx. The shift to the cloud is actually the buyer shifting the responsibility for actual results to the provider. It’s a combination of pay-as-you-go, the reduction or elimination of capital equipment, and shorter-term commitments. Many [cloud] providers will fail, and when they do, the customer will exercise its newfound agility by swiftly moving to a new provider.”
Ultimately, the CFO and CTO will have to find common ground on what technology is needed, where the money will come from and how it will be allocated. With so many capabilities in the cloud, companies may see their capital expenditures decline as their operating expenses increase, altering the appearance of their balance sheets forever.