When Financial Factors Work Against the Cloud

Cloud financial factorsFlexible, consumption –based pricing models in most cases make cloud services economically and financially attractive to CFOs.  The ability to get IT “off the balance sheet” through subscription-based services is seen as a big positive for cloud migration from a financial point of view.  Despite this apparent advantage, there are cases where financial factors can actually work against cloud migration.  Here are some of the more interesting examples we’ve recently seen where accounting and financial factors can either significantly slow the adoption of cloud models:

  1. Fully depreciated IT environments – dev / test is one of the most popular cloud use cases around.   Migrating rarely used dev / test servers sitting in expensive Tier 3 enterprise data centers to public cloud IaaS models is widely perceived to be a financial no-brainer.  But what if those servers are fully depreciated?  What if anticipated IaaS subscription costs end up being higher than costs associated with operating and maintaining the existing environment?  Eventually of course the servers will need to be upgraded, and IaaS migration will be financially more compelling.   While over time it will make sense to migrate the test /dev environment to the cloud, the financial profile of the asset base provides a short term inhibitor.   While this example might be a bit of an oversimplification, there are enterprises hesitant to begin migration to private or public cloud IaaS models as the operational life of their servers extends past their depreciation basis.  While there may be sunk cost fallacies in play here, and enterprises may not fully understand the fully loaded costs of their environments, we have seen situations where this has become a short-term barrier to cloud migration.
  2. Private equity (PE) portfolio companies – on the surface cloud services would seem to be highly attractive to PE investors.  Ever on the lookout for opportunities to cut costs and improve profitability, the cloud would appear to provide investors another improvement lever to pull in their portfolio companies.  PE investors, though, are focused primarily on operating cash flow, or EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) which is often used as a close proxy.  What’s that mean?  Investors are very sensitive to increases in operating expenses (opex), less so when it comes to capital investments (capex).  While cloud services may offer the reduction or complete elimination of ongoing capex, this often comes at the price of increased opex.  This ends up making the cloud story difficult with PE owned companies, unless a compelling business agility or transformation story is present.
  3. Regulated utilities – electric utilities, natural gas distributors, telcos and other regulated utilities often have a strong disincentive to migrate to the cloud.  Public utilities are not just government-owned entities – they also include privately owned and publicly traded companies (think Exelon or ConEd).   Public utilities are permitted to earn a specified rate of return on their “rate base”, which determines the prices they’re allowed to charge the public.  As the rate base consists primarily of capital investments, a strong incentive exists to invest in assets (including IT).  The larger the rate base, the more money the utility makes.  Not surprisingly most regulated utilities would prefer to continue to make large capital investments in IT to increase their permitted rates, rather than shift those costs to an operating expense. 

While these are in some sense “corner cases”, it will be interesting to see if new pricing and contractual models emerge that provide operational flexibility, but coupled with different financial models.

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