Financial Disincentives for Cloud Computing

In general I think cloud computing is a great thing. Elsewhere I have talked about the benefits that it can bring to many organisations. Many of the positive financial benefits of cloud computing are well-known: pay only for what you need or use; cost certainty; being able to reduce the cost of ICT as the demand for ICT services reduces;  reducing the need for massive upfront investment in infrastructure and so on. One of the benefits that I have been more sceptical about, however, is the way that cloud computing moves the cost of ICT from capital expenditure to operational expenditure. From my point of view money is money. Merely moving it from one line on the budget (capital expenditure or capex) to another line on the budget (operational expenditure or opex) seems to me to be no benefit at all. On investigating the issue further it seems that there are some unusual circumstances where this is a bad thing. These situations really only exist for large enterprises or government agencies rather than smaller users of cloud services. But for these organisations these problems can be significant disincentives to the adoption of cloud services. Understanding these factors can mean the difference between a cloud adoption initiative succeeding or failing.

If your organisation is capital rich and opex poor then the financial model of cloud computing does not work for you. In particular many government departments have capex and opex allocated separately by the central treasury (this is how the New Zealand Government works, and I would be surprised if other governments don’t also use this model). If your organisation has large chunks of funds allocated to capital expenditure and it cannot effectively move it to cover operational expenses then the cloud computing economic model of moving costs from capex to opex is a tricky thing for your organisation to manage. This can be an effective barrier to the adoption of cloud computing services in central government and will be something that treasury departments throughout the world will be looking at as the trend towards governments adopting the cloud continues.

Even if an overall organisation doesn’t work like this individual business units often do and if business units fund IT projects (as is often the case in large organisations) then similar considerations apply. Sometimes organisations pool the capital expenditure at the organisational level, and allocate operational budgets to lower level business units. Anything that increases the operational expenditure of that business unit will probably be viewed negatively. Business unit X is unlikely to go for a project that will be solely funded from its operating budget as opposed to one that is funded from the central pool of capital funds.

In some situations (and in some jurisdictions) capital expenditure may qualify for Research & Development tax credits. If the capital expenditure on ICT is part of a research or development effort to come up with a new product for instance, some governments give tax relief on that expenditure.  The same is unlikely to apply to opex spent on cloud services. This can mean that such capex is more effective (i.e. it is worth more) than equivalent money spent on opex. So, this in turn may be a disincentive to use cloud services.

Capital costs are also usually depreciated over time. Depending on the organisation and the asset that might be over three, five or even ten years. Any initiative that moves cost into operational expenditure before the asset it is replacing has been fully depreciated is likely to mean an increase in the financial costs to your organisation (unless the cost savings are so substantial as to outweigh the depreciation amounts). Particular cloud initiatives therefore need to be carefully aligned to the investment and refresh cycles of existing ICT assets.

In short, if you are considering a programme of cloud adoption you need to understand your organisations funding, cost and expense models to ensure that there are no financial or management disincentives to the adoption of these services. It would be a great shame if a fantastic cloud initiative that could deliver costs savings and improvements to business agility and effectiveness foundered on the way that operational budgets and costs were allocated.

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4 Comments to “Financial Disincentives for Cloud Computing”

  1. Excellent post, Doug. I’ve read many articles, white papers and more about the Cloud, but you bring a fresh, different perspective concerning how to think about the Cloud and great points to think about. Most importantly, you put the discussion in the right context. It’s not about investing in technology for the sake of technology, but you force the reader to think about the business logic first. Well done! Cheers, @MonicaCZN

    • Thanks Monica, one of the things that I am coming to understand in my current position is how important wider business (non-technology) considerationsa re to the successof IT initiatives and projects. This is part of gaining that understanding.

  2. Great post Doug. Like you, I’m not anti-Cloud; but it’s important to understand how things work in the real world, and analyse the touted benefits to see if they measure up.

    It might interest you to know that in the telco space we’re seeing faster adoption in regions where there hasn’t been such heavy investment in IT – eg LATAM. ie they can leap frog directly to this kind of model because they don’t have so much legacy to squeeze ROI out of. This backs up your point about investment – ie that few have the luxury just to bin everything and start again from any kind of “ideal IT architecture” point of view. In telco, change is now business-driven and customer-driven and far more pragmatic, rather than some grand scheme to create an “ideal” technical infrastructure.

    I also think there are some instances when Cloud simply isn’t appropriate for a variety of reasons. We have to view this pragmatically as one of a number of options and rationally analyse if it is the most appropriate in a given circumstance – rather than being overly dazzled by all the hype and often wild promises (from the vendors) as to its worth.

    Other models that we are employing in telco are full outsourcing of business processes and managed services (ie out-tasking). I recently wrote a paper describing how these three models (Cloud, outsourcing, managed service) differ and what they are most appropriate for. They all have their place in the mix, as does on-premises. Mail me if you’d like a copy.

    The other thing that’s interesting is that Cloud has stimulated an evolution in business models amongst vendors. Thus even if a company decides that Cloud infrastructure is not appropriate, the “rent rather than buy” model is often now an option. Another factor to consider is that if what you’re really interested in is cost saving then there are scenarios when buying is cheaper in the long run (it can also be more expensive, you just have to do the maths based on the circumstances). However, usually cost is not the only factor and that’s why large enterprises such as telcos often now need help and advice to work through an ever-increasing number of options to find the most appropriate solution for them.

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