Telescope: You thought Cloud's Opex is risk free? Really?

MUMBAI, INDIA: Gartner has just come out with a report on ‘The Impact of Public Cloud Adoption on Working Capital’. The report highlights that - the key financial reasons driving many organizations to look at cloud offerings are better short-term investment options, lower upfront capex, better short-term borrowing rates and favorable capital structures. But, because they lack cash and other securities, small and startup companies taking loans to finance the adoption of cloud-based solutions expose themselves to greater financial risks. It also points out that - When planning a move to cloud-based solutions, working capital requirement changes should be an important point of reference, because they can have a direct impact on return on investment (ROI).

To translate these findings and recommendations better into a CIO’s syntax, we talk to Biswajeet Mahapatra - research director, Gartner, who helps us dig deeper into these spots of IT on Finance’s soil.

This report mentions a strong observation. By moving expenses from the capital expenditure (capex) to operating expenditure (opex) category, enterprises become more vulnerable to market risks, and, if the returns are lower than the risks, the entire proposition could rapidly lose viability. Can you elaborate on the 'risks' part?

As companies look at adopting Public Cloud they would be moving from an in house data center operations for those applications to services provided by external vendors or service providers. As in the case of any outsourcing or any services which we procure from external vendors we have to pay our monthly/ quarterly or weekly bills. If we are moving huge services on to the cloud, the bill amount may be high. We need to be ready to do those monthly or quarterly payments on time for which we may have to carry extra cash or be ready to pay by borrowing. Whether we carry extra cash or we borrow, we are now affected by the cost of capital which would cost of equity or cost of debt. With the kind of economic times we are in now, these costs are fluctuating and have only been increasing in inflationary economies like India. This means my cost of operations is actually increasing due to my decision to move to public cloud rather than the popular notion of it decreasing. And mind you, we are still not talking of increasing in service charges, increase in usage and so on. This means we are opening our operations to market risks which may not be so good in some situations, especially if the figures (in case of large enterprises) are very huge or even if the companies are small or start ups as if they miss a few payments their operations would be completely stopped.

Would (and how would) the same risks pan out in case of private clouds or hybrid alternatives?

The risks are much lower in case of hybrid and lest for private because you are not paying to an external agency in the private cloud. Not many companies have a Balance Sheet or Income statement at IT Operations levels and most of the time either there is no charge back or even if there is no charge back there is no actual money transfer so we are safer in case of private and hybrid cloud. Yes, it may have some impact in the case of hybrid cloud but in hybrid cloud you use only few services and in the worst case you can easily move these services back to in house.

Are there any areas/fine prints that vendors brush under the carpet when they pitch the Cloud platforms on the very proposition of opex vs. capex?

Vendors are correct when they say you are moving from Capex to Opex model but then one has to be clear what does that mean. The corollary is same as whether one should buy a house or rent it, or whether one should buy a car or rent it. If I have gone to a new city for say 15 days or a month is it wise for me to buy a car my paying 1000 or more rupees for 15 days or should I buy a car of four lakh rupees. In this case may it is better to rent, but If I have moved to a city for indefinite period or say 5 years I may think it is better to buy. That is a very layman kind of logic but that drives home the point.

So switching to Opex is good?

It is good to move from Capex to Opex as you do not need to invest upfront on IT and use that money in other ways, but then you have to be ready for points which we discussed in point one. If large companies are asked to carry say a million dollars more in their balance sheet just to pay for services, definitely people will question it, may be they are more comfortable buying and showing more assets. Also companies which are running at low Working Capital levels would have to be careful because by moving to an opex model you are increasing your current liabilities which mean more pressure on Working capital. The impact of this would be debt becoming costlier which is a worry for all. So these issues have to be kept in mind when someone discusses Capex to Opex issues.

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From a long-term strategy which Cloud direction would work best for an Indian enterprise? How would it change for a medium or a large enterprise?

This is difficult to say and there is no straight forward answer to this. There are surely benefits in terms of not investing on assets which you use once or twice a year, and it is a waste of money to buy such assets which virtually are 'Non-Performing assets' (if I am allowed to use that term loosely) for the rest of the year. Hence for any kind of industry certain things like back up, BCC, DR, Compute capacity, storage are something which they can surely look at in the public cloud (if they are convinced with the other issues). However for large enterprise especially the ones who have already developed their own expertise and data centers I would suggest they give a harder look and a more detailed financial evaluation before moving on any operations to the public cloud. They should do a good NPV calculation for the next seven years and also use techniques like Free Cash flow for Firms before adopting public cloud offerings.

So what so you recommend for a CFO and CIO to work together in aligning a smart ROI and ROCE strategy in this context?

First CIOs and CFOs should work out a plan how to measure the current operations, what should be the bench marks and how to calculate ROI. Many times what we see is people confuse ROTA as ROI and do all the calculations which is wrong or sometimes they take very small issues like turnaround time or faster provisioning as faster ROI which is again wrong. These are some of the components in ROI but not what ROI is all about. ROCE is very complicated and will not happen till the IT Operations do not move to an investment Center. Most of the time they are still seen as Cost Centers and not even seen as Profit Centers. Only when CIOs have the liberty to choose the kind of capital and source on their own and invest on their own decisions and then charge for their services can one say the ROCE calculations are correct.