While few will dispute the hard cost savings of cloud, there is always a need to create a compelling business case that clearly defines the value of agility and other soft benefits.

Cloud Economics

Every company has its own ideas on how best to determine cloud ROI. For many, it’s capital expenses (CapEx) versus operational expenses (OpEx). Cloud computing shifts IT spending to a pay-as-you-go model, like utility billing; you only pay for what you use, when you use it. For startups or new applications, this well-established argument is sound. Why purchase hardware, data centre space, power and supporting software when they can be rented by the hour at a higher utilisation rate? For enterprises, however, the decision is not so simple.

Enterprises have invested in data centres and equipment that is already bolted into racks and partially depreciated. For these organisations, identifying and making the right economic decisions requires additional investigation into the detailed costs and benefits of enterprise cloud.

Thinking Beyond Capex vs. Opex

Most enterprises have hardware utilisation rates significantly below 20% because of the excess capacity required to handle peak demand. As such, many companies carry up to five times the required hardware, networking, and data centre space during steady state business cycles. If their computing demand is spiky, utilisation rates outside of peak cycles are commonly below 10%. As a result, enterprises are spending much more on compute and storage than is required. Figure 1 depicts the traditional model where cloud shifts fixed Capex expenses to variable Opex expenses. To understand the full value of cloud for your enterprise, you must look beyond the Capex vs. Opex benefits and assess the other value drivers at play.

Challenges of the traditional IT purchase model
Figure 1 shows the challenges of the traditional model. The blue line depicts hardware purchases which are completed periodically to increase capacity ahead of projected utilisation. The red arrow indicates the cost an enterprise bears in excess capacity while the red shaded area represents the danger of underestimating utilisation.

Closely associated with utilisation is IT infrastructure’s ability to scale up and scale down to support business agility. Traditionally, high utilisation reduces IT spend, but limits agility and negatively impacts innovation and business growth. Conversely, the cloud can provide significant savings (near 100% utilisation) and nearly infinite agility. The value of this agility is challenging to calculate so we have a tendency to ignore it. That is a big mistake.

Are you quantifying agility?

The business value of cloud is more about agility and utilisation than any other cost consideration. Consider that the cloud provides us with the ability to provision and de-provision nearly unlimited resources as needed with complete control. Moving from 20% to near 100% utilisation provides significant cost advantages and even greater value in the ability to quickly solve business problems without waiting for software and hardware procurement and installation. With the cloud, businesses can enter into new markets, accommodate new customers, avoid compliance penalties, or just move fast when they need to move fast, all while concurrently maintaining fully-utilised hardware and networking resources.

What’s more difficult to quantify is the value of countless ideas and projects that are started, only to be stalled or placed lower on the priority list because by the time the resources are provisioned 3 to 6 months later, other initiatives have taken priority. With the agility of the cloud, projects can be conceived, provisioned, and deployed within 24 hours – allowing for real-time planning and execution.

Uncovering the Real Costs and Benefits of Cloud

Most cloud ROI calculations don’t factor in agility or fully capture the costs of poorly utilised hardware. While charts illustrating the differences between Capex vs. Opex are relevant to the potential value of cloud, a more complex assessment is necessary to reveal the full picture.

In this article we go beyond simple Capex vs. Opex decisions and explore how leading enterprises are calculating their true value of cloud.

Defining ROI and TCO in the Cloud

Return on Investment (ROI)The financial gain from an investment in cloud divided by the cost of that investment.

Let’s first look at cloud ROI. While businesses often discuss their “cloud ROI,” more often than not they’re missing the bigger picture. Most cloud ROI calculations are focusing around IT cost savings and how they affect the bottom line. Instead, cloud ROI should be more about the value that is returned to the organisation.

Value drivers that are often overlooked in typical ROI calculations include accelerated time to market, improved developer productivity, decreased provisioning time and many more intangible benefits of cloud.

Total Cost of Ownership (TCO)The sum of all direct and indirect costs of the IT estate including all application development, maintenance and support, operations, data center, network, and BC/DR.

Cloud TCO defines what will be spent on the technology after adoption – or what it costs to ‘run the engine.’ Typically, a TCO analysis looks at the costs of the “as is” on-premise infrastructure and compares these costs with the costs of the “to be” infrastructure state in the cloud. TCO analyses are much simpler to calculate than ROI analyses, however they only give the stakeholders a narrow view of the total financial impact of moving to the cloud.

So, the difference between a TCO and an ROI analysis is that a TCO defines the spending and savings, whereas the ROI determines what value is generated, while taking spending and savings into account. It’s critical that you understand both, and their differences, in order to effectively define the full value of cloud for your business.

Identifying the Types of Savings

Start by defining the hard benefits of cloud in terms of direct and visible cost reductions and efficiency improvements. These costs are typically easier to identify and easier to assign a clear value to.

Soft savings are those value points that are more challenging to accurately quantify, but can be as valuable, if not more valuable, than cloud’s hard savings. Any holistic cloud economics evaluation should have a thorough analysis of both hard and soft savings.

Hard vs. soft savings

How much does human error cost you?

A key savings that is often overlooked is cost avoidance. You may notice that cost avoidance is not listed in the grid above. This is because cost avoidance can land in either hard or soft savings. Some mistakes are easier to quantify (such as having your e-commerce platform go down for an hour on Black Friday), but others, such as an impact to your reputation, are much harder.

The cloud’s ability to help enterprises avoid costs is extremely powerful. For example, many of our clients are using various levels of cloud and DevOps to improve uptime and make operations, development and deployment much more efficient.

If you do not take the time to understand how much a lack of automation (and ensuing human error) is costing your company, you are missing a major opportunity to reduce future costs.

How cloud starts

Agility – Cloud’s Most Undervalued Benefit

Cloud agility is the ability to rapidly change an IT infrastructure in order to adapt to the evolving needs of the business. This is becoming increasingly important in today’s disruptive markets and the reality is that many enterprises are plagued with IT infrastructures that are so poorly planned and fragile that they are limiting business growth. Cloud agility provides a huge strategic advantage and significantly increases a business’ chance of long-term survival.

To help quantify the value of agility for your organisation, start by breaking down its four components:

1) Your degree of change over time.

The degree of change over time is the number of times that the business reinvents itself to adapt to market demands. While a pulp and paper production company may only have a degree of change of 5% over a 5 year period, a technology company may have an 80% change, and a company in a downturn market may have a 40% change over this same period.

2) Your ability to adapt to change.

The ability to adapt to change is a number that states the company’s ability to react to required change. For instance, a large manufacturer may need to rapidly pivot in order to take advantage of a new market opportunity, but may not have an IT culture that can change at the rate required. Thus, they don’t have the ability to adapt to change, so, no matter what you do to promote the use of disruptive technology, like cloud computing, they won’t be able to take advantage of it.

3) Your relative value of change.

The relative value of change is the amount of money made as a direct result of changing the business. For instance, a retail organisation’s ability to rapidly establish a frequent buyer program to react to changing market expectations, and the resulting increases in revenue from making that change.

4) Your individual perspective on agility.

Finally, it is also important to take into consideration how different individuals at the same company view the benefits of agility. A CIO’s perspective will vary widely compared to how a Head of Infrastructure or Head of Engineering values their organisation’s ability to change. This is a key nuance that greatly affects investment decisions. The most successful companies focus on the overarching business agility the cloud provides, a strategic perspective that is generally in line with how CIOs view their organisation’s ability to change.

What We’re Seeing

The value of the cloud scales with the value that its agility brings to your business. In other words, the faster an industry needs to change, the more value cloud brings. No matter the industry, achieving financial maturity during cloud adoption is challenging and requires exploring all the economic considerations we’ve already discussed.

We see that a company’s cloud financial maturity on their cloud investment follows a consistent flow as the company matures. Companies early on in their cloud journey are focused on identifying hard costs and other clear cloud value drivers, which are easier to identify but provide a limited perspective to total ROI. Figure 2 depicts these considerations in light peach at the beginning of the spectrum. As companies mature through their economic analysis and cloud adoption journey, their financial maturity increases as they start to understand the value of agility and other soft costs, which are depicted in a darker shade of red.

Achieving Cloud Financial Maturity
Figure 2: Achieving Cloud Financial Maturity

Market Snapshot

The table below compares enterprise TCO savings for financial services, technology, manufacturing and communications companies. In general, we see average TCO saving of around 40% regardless of industry. For retail and other sectors that experience large seasonal or cyclical changes, savings are often greater. These sectors were not included in our analysis.

TCO savings by industry
TCO savings by industry

Case Study

 
A multinational software and manufacturing firm faced rapidly growing IT operating costs tied to its legacy IT outsourcing provider. With a monthly IT spend of $14.5M, the company identified cloud adoption as a key driver for cost reduction. To determine the potential savings, CTP conducted a TCO study comparing the current environment to target cloud endpoints. In the graph below we show the company’s 18-month TCO. In this case, the TCO compares using an IT outsource model vs. a hybrid cloud (public cloud services + an IT outsource provider). This TCO model calculates a payback period of 6 months for a hybrid environment, with savings growing to $4M per month (25% reduction) at month 18.

Monthly TCO: IT Outsource vs Hybrid (Cloud + Outsource)

18 month TCO for an enterprise manufacturing and software company
18 month TCO for an enterprise manufacturing and software company highlighting growth to a 25% savings.

The graph below shows the company’s total run rate comparison between lift-and-shift vs refactoring vs colocation for a single enterprise application. Note that the run rate for co-location is lower, at first, in this model. However, it goes up significantly over time, relative to the cloud run rate which does not grow at the same rate, and in many cases shifts downward as the cost of compute and storage declines over time.

For this application, payback is at 6 months if the application is lift-and-shifted, or at 18 months if the application requires a major refactoring. Of course the cost of migration, whether it be lift-and-shift or refactoring, impacts the savings and when they are realised. Keep in mind that you need to consider the existing and future run rates of each approach prior to making your final decision.

Total Run Rate Comparison for a Single Enterprise Application

Application-level analysis for a single enterprise application
Application-level analysis for a single enterprise application. We see that this type of application-level analysis enables granular and data-driven justification for additional investments in cloud.

Cloud provides the perfect opportunity to change the way your organisation runs IT. With cloud, IT has a much more positive influence on the business and is better aligned with strategic goals. IT will no longer be a drain on company resources, and many enterprises will find that the newfound efficiency and agility of cloud adds huge value to their bottom line. After all, IT is there to serve the business, not the other way around.

While few will dispute the hard cost savings of cloud, there is always a need to create a compelling business case that clearly defines the value of agility and other soft benefits. While it is important to remember that there are rare scenarios where cloud does not make economic sense, generally, you’ll find a strong ROI and reduced TCO. Ultimately, you won’t know the full costs and benefits until you define your business case and run the models.

Calculate The Value of Your Cloud

As part of our Cloud Adoption Programme, we’ve developed a comprehensive roadmap focused on accurately quantifying the holistic value of cloud for your organisation.

This article was originally published in The Doppler, published by Hewlett-Packard Enterprise. Reprinted with permission.


Sign up to the Primer newsletter

Keep your finger on the pulse with monthly news, insights and tips on technology, innovation and transformation