The cloud has mystified people over the years. When you cut through the buzz and look at it purely from a financial standpoint, it is simply a shift in mindset from buying (i.e., CapEx) to renting (i.e., OpEx). As IT departments take their companies on a journey to the cloud, COOs & CFOs want a predictable annual technology spend that remains in alignment with their budget. Each industry has different annual IT budget benchmarks for technology spend as a percent of revenue (see figure 1 below).
For instance, in the “Business and Professional services” industry (i.e., Law firms, etc.), the benchmark is to spend approximately 5.82% of annual revenues on technology. So that means a company that earns USD 250 million in a year should expect an annual spend of around USD 15 million on technology. Of that amount, a certain percentage is devoted to business operations and incremental business change the remaining on business innovation.
In the past, IT departments spent their budgets on large capital projects that were approved and depreciated over a period (i.e., 3 to 5 years). As more services continue to shift to the cloud (i.e., OpEx), an IT department has to take a more measured approach to ensure this is done within the constraints of their annual technology budget. Essentially, this shift from buying technology (i.e., CapEx) to renting (i.e., OpEx) is dramatically changing the way IT department work.
The benefits of shifting from CapEx to OpEx:
Budgeting for IT was previously simple because businesses preferred capital expenditures over operating expenses; they could take advantage of amortization and depreciation of those investments over an extended period.
Now that IT and Finance departments see that the shift to the cloud is here to stay, they have to work together to make it fit their business. When planned correctly, this model will have distinct advantages over the traditional capital expenditures (CapEx) model leveraged in the past.
Continuing to leverage a CapEx spending model on technology poses certain challenges:
- IT Staffing: If you own the infrastructure, you have higher IT staffing costs in areas that aren’t strategic.
- Cash-intensive: Large amounts of cash is required at one time to make purchases.
- Over-purchase: It’s difficult to predict capacity needed, leaving the potential to over-purchase.
- Budget approval: Going through a budgeting process can be the bottleneck in your operations.
- Lock-in: Technology changes rapidly; what you’ve purchased might not meet your long-term needs.
In contrast, the benefits of consuming technology as an operating expense (OpEx) include:
- IT Staffing: Shift your focus to hiring talent with strategic business value (i.e., business applications, security and user experience) and get out of the business of managing patching, uptime, and upgrades.
- Pay-as-you-go: Pay for only the amount you need today.
- Faster Budgeting Approval: Working within an OpEx budget decreases the time to approval.
- Smooths Cash flow: Having predictable costs each month improves cash flow.
- Agile: Fund projects more quickly because you don’t have large upfront technology costs.
Overall there is a line of thinking that capital expenditures are generally meant for static investments while operating expenses are intended for fluctuating costs. It makes sense that rapidly changing cloud technology would naturally move to an OpEx, consumption model. IT departments have no choice but to change the way they work and deliver value. It all starts with a sound cloud strategy that aligns with their business needs.
Over the next five years, businesses will continue to shift services to the cloud. Technology will run in a mixture of private, public (SaaS) or hybrid (IaaS + PaaS) cloud service delivery models. These cloud service delivery models are characterized as follows:
- Private: service runs on firm-owned infrastructure (higher CapEx) and requires focused IT staff to manage (higher IT staffing costs to support (in the form of OpEx)).
- Hybrid: some level of the service does run on the firm-owned infrastructure (lower CapEx), and the other part runs on a cloud service providers infrastructure (some level of OpEx), and business operations still require some level of IT staffing to manage.
- Public: services do not run on firm-owned infrastructure (no CapEx), and full service runs on a cloud service providers infrastructure (full OpEx) and requires have minimal internal IT staffing to support business operations (higher OpEx).
IT Departments need to assess and baseline their business services into an Information Technology Service Catalog. This should include a business description of the service and supporting technologies/vendors and a 3-plus year cloud strategy for that group of services:
Then you can establish where the services run and plan capital and operating expenses associated with each service (see figure 3).
Your CFO will want to see a 5-year budget financial trend that aligns with the overall constraints of the targeted annual budget. As you spend less capital on people and technology, your CFO will want to see a lower capital budget that will translate to lower overall IT depreciation while the OpEx trends upward (see figure 4).
Financial & IT Staffing Strategy:
If done properly, the budget trends would look something like the following (see figure 5), essentially shifting dollars around so more are available for business innovation. IT Departments do not want to continue to be looked at as a cost center but rather as a strategic area of innovation for their companies.
As IT departments continue their journey to the cloud they are going to focus on the following:
- Benchmark: Benchmark and validate what is an acceptable level of IT spend as a percent of annual revenue for their business. Confirm this baseline with your company.
- Cloud Strategy: Inventory all your services into an IT service catalog and work to free up budget dollars as you shift services from a private cloud to a hybrid/public cloud model. This cloud strategy should free up IT budget to focus on innovation!
- Financial & IT Staffing Strategy: Overall you should see lower CapEx, lower IT depreciation and an Increase in OpEx but this should balance out with the annual technology budget for your company. Also, as you make the shift, you will need to re-align staff to focus on business innovation, vendor management, and financial management.
As we move into this new era of the cloud, IT departments need to let go of the traditional way of working. If they move to the cloud in a way that focuses exclusively on business operations and incremental business change ONLY, this will not be enough. IT departments should develop robust vendor & financial management practices that allow them the move to the cloud. As they focus more resources on business innovation, these will be ones that thrive!
- Why more CFOs are shifting IT investments form CapEx to OpEx
- Technology budgets: From value, preservation to value creation
- The NIST Definition of Cloud Computing