Let’s revisit CAPEX vs OPEX

Last few weeks I have had the opportunity to meet and hear from different IAAS vendors as I look for partners to enable their solution delivery.

Recently I had the fortune to talk to an Inside Sales rep (SR) who tried to reason why their cloud based IAAS was great for the clients.

He said:

a)     Imagine having only OPEX and no CAPEX

b)    Total Cost of Ownership (TCO) is reduced by 35%

These two arguments got me fired up:

I asked: So what if ‘costs’ move from CAPEX to OPEX? What’s the IRR? What is the run rate required to break even and what is the break even period? What is the NPV of having these costs occurring year after year?

The SR just had a blank look. For him it was crystal clear – I moved into OPEX world, how could I question such a brilliant solution in today’s environment of lean budgets!

Then I asked, so how do you measure TCO, what metrics do you use? What about cost of retirement? How do you standardize training and transition costs? What about operational cost? What is the service period? What is the cost of downtime?

Again a blank look, he thought I was clueless and needed a bit more guidance. His reply:

a)     Imagine having only OPEX and no CAPEX

b)    Total Cost of Ownership (TCO) is reduced by 35%

Clearly our conversation didn’t last long after that, we exchanged the formal pleasantries and hung up the call.

So let’s revisit the Opex Vs Capex statement.

What does it mean to move from CAPEX to OPEX?

How to play this card when one wants to have a strong business case for IAAS or any XAAS setup?

Capex Opex
Definition: Capital expenditures are expenditures creating future benefits. A capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value of an existing asset with a useful life that extends beyond the tax year. OpEx (Operational expenditure) refers to expenses incurred in the course of ordinary business, such as sales, general and administrative expenses (and excluding cost of goods sold – or COGS, taxes, depreciation and interest).
Accounting treatment Cannot be fully deducted in the period when they were incurred. Tangible assets are depreciated and intangible assets are amortized over time. Operating expenses are fully deducted in the accounting period during which they were incurred.

As seen in the table, CFOs and CIOs get excited about OPEX as it stretches the budget.

One doesn’t need to have an upfront ‘capital’ investment to buy an asset but pay operational charges based on usage.

Another benefit is the tax deduction based on the operational costs which can claimed in the same tax year whereas in CAPEX one cannot realize the full tax deduction in the same tax year (normally depreciated).

This is an important financial metric, useful when preparing a business case around XAAS(anything as a service). But pay attention to the company objectives, does the CFO want a leaner balance sheet with better ROI(OPEX) or does the CFO want to have a bigger balance sheet with larger assets and a greater Net Income(CAPEX).

Also do the due diligence: know what is the cost of capital to the company? In the case of a big corporation with a AAA bond rating, they can raise capital at nearly risk free rate? So the cost of capital is quite low. Can the proposed service return a similar return or greater savings? Can the proposal have a positive NPV with the company’s cost of capital?

How many years will the asset be under service?

It’s very similar to leasing a Car Vs Buying a car.

If the intended usage is not for long periods or for intermittent usage, it makes financial sense to have the car on lease (OPEX) but if one needs continuous use for next 6-10 years, it’s better to buy the car (CAPEX).

Just thinking a bit beyond the Opex Vs Capex divide will help the XAAS Vendors or the CIOs to make a better business case for the Business stakeholders.

In the next part I will revisit the Total Cost of Ownership and make a more holistic case of moving onto the next generation of cloud based services.

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