The New Normal:
Opex instead of Capex
Today’s CIO is confronted with a shift in thinking about expenses: look for ways to move expenses from the Capital Expenditure (Capex) budget to the Operational Expenditure (Opex) budget.
The Chief Financial Officer will look at ways to spread large costs over time to take advantage of amortization and depreciation. CFO's manage those expenses separate from the day-to-day operational expenses of the organization. Generally, big-ticket items like telephone systems, servers, software and, in some cases software development resource costs for products or internal application development, are capitalized. The Capex budget is determined annually, and investments made against it become locked in. Capital expenditures also appear on the Balance Sheet.
In contrast, the Opex budget is used for the day-to-day costs of running the business and are managed on a monthly basis. These expenses appear on the Income Statement simply as "operating expenses". These expenses fluctuate with the business and can go up or down from month to month. Examples include rent, utilities, payroll, and other expenses the are typically paid monthly.
CIO's must do two things at the same time: manage expenses and deliver high-quality, high-availability and robust applications for the business to grow. How you manage this balance will define you in the organization. Add in the need to ensure data security, quick response along with integrating software architecture that is getting more complex makes your job both more difficult and harder to translate.
The New Normal (continued)
Because Information Technology expenses can be high, if consumed all at once, today’s CIO must look hard at spending to determine if it makes sense to build infrastructure or simply buy it as it is needed. The difference comes down to who owns the technology and how it is financed.
Enter Cloud Computing, Software as a Service (Saas), and Managed Hosting. Each of these services offer attractive pay-as-you-go structures. That can make the process of getting a small company's infrastructure started, or quickly spinning-up a solution for an internal application a cinch; but walking away from any one of these services is not always an easy proposition. These services offer new ways to move an expense from what might typically land on the Capex budget to the Opex budget.
In the last few years, your options for asset acquisition have broadened. As recently as five years ago, if you needed to acquire 4 servers to augment your infrastructure, you had only two options that required you to manage the full cost of the equipment:
- Buy the 4 servers (either expense them, or capitalize them on your own).
- Lease the 4 servers through a third-party leasing company. Choose either an operational lease (leasing company owns the assets) or a capital lease (company owns the assets). This is the same if you use a hosting company to provide the equipment, but are forced into an operational lease structure.
Today, you have four more options:
- Buy (or lease) one server and spin up 4 virtual servers on it.
- This option may make the purchase a good candidate for Opex, rather than Capex. Since you are buying one server and virtualizing the other servers on it, your overall cost is significantly reduced.
- Remember that operating system, software and the other costs related to each virtualized server may remain as they were with individual servers. In this scenario, you're reducing the overall asset cost by three servers.
- Use Amazon Elastic Compute Cloud for all 4 servers.
- This option is attractive for short-term needs, such as development, conversion or temporary relocation of services while you re-purpose existing equipment (e.g. move from Windows Server 2003 to 2008).
- You're renting space and computing power on a monthly basis, so it's naturally Opex.
- Use a hosting company to provide a virtualized set of 4 servers for you to rent (shared hosting).
- Similar to using Amazon's Elastic Compute Cloud, but you may have a bit more control over resourcing and mix.
- Typical agreements span months and may lock you in for a short term.
- Use a hosting company to provide a dedicated virtualized environment with 4 virtual servers.
- This is a mixed option where the use of the equipment is essentially an operational lease.
- Not to be confused with co-location, where you own the servers but rent power, pipe and ping from the hosting company.
Did that just get complicated? In the sense of finance, actually, no. It got simpler.
Just make sure you read the fine print. Each of these options comes with considerations. For example, a hosting company will let you rent time on a "shared server" platform, but if you want a dedicated platform, it begins to sound a lot like an operational lease (the hosting company owns the asset). And, don't forget the hidden costs for using any cloud- or hosting-based solution. These include things like how much data you pass across the Internet and sometimes how much CPU you are using. That can cause your monthly bill to fluctuate. Finally, for any of these services requiring access to the Internet (SaaS and hosting), security and a fast link are essential.
How to Choose
Choosing what to move from Capex to Opex is ultimately the CFO's decision. He or she will want to keep a good balance between the two budgets. Whether to capitalize depends on the tax year, future anticipated earnings, availability of credit, cash flow and other factors that are of particular interest to the CFO. Your job here is to help the CFO understand how the asset will be used, its expected lifetime, potential for renegotiating pricing, and options such as dollar buy out on a lease.
You have several questions to answer, before you can make a solid recommendation. Here some basic criteria to get you started:
Candidate criteria for moving to Opex:
- Short-term and relatively low-cost assets.
- Trial applications. An example might be something like a sales forecasting system. Using Software as a Service (SaaS) such as Salesforce.com is a monthly expense, and the service can be dropped anytime in favor of a competitor or in-sourcing your own sales forecasting system.
- Networking and desktop computers that you plan to refresh on regular intervals (e.g. every 3 years), because you can lease the equipment on-site with an operational lease structure.
Candidate criteria for Capex:
- Long-term, expensive assets that form a substrate for the business (you plan to keep the asset beyond its useful life).
- Networking and desktop computers where an operational lease is not an option.
- Purchased package software.
- Internal development costs for infrastructure applications and integration.
Today's CIO is a partner with the CFO in helping to determine the best way to finance assets and computing resources. Your unique understanding of technology, its evolution in the company and your ability to predict the need for close integration among differing platforms can be invaluable to the CFO.