There’s a rent or buy dimension to infrastructure decisions, and the direction you go has significant long term implications for a company, so it’s important to know the difference between the two.
You can think of it like a car. Should you buy or lease? There are reasons why you’d do either. It’s a similar question when you’re looking at infrastructure.
Do you want to buy, and maintain all this yourself, or do you want to rent?
RENT OR BUY? (Capex vs Opex)
Note for readers – this short introductory article is oriented towards a typical IT professional, and it includes the language of finance, which is useful to get familiar with, in case you find yourself in the position of needing to discuss long-term, significant infrastructure investments.
This is the traditional model from an IT standpoint, also known as “capital expenditure”, which is a fancy way of saying “cash”. When you needed a solution, you had to go out and buy everything. For example, if a CFO wanted a new accounting system, they’d say “we need a database server, an application server, you’ll need those two things, each one of those will cost you x amount”.
In the CAPEX scenario:
– the company buys equipment
– you write a check upfront
– the equipment goes into a company’s own data center or a colocated space
– cost of ownership: upfront cost
For financial professionals, here’s a description of CAPEX:
“In financial terms, when you are buying the equipment, you’re spending all the cash upfront; from a financial perspective, it’s all happening on your balance sheet. Cash goes down, assets go up. And then ultimately the way that is expensed is there’s depreciation on your P/L statement. So if you have 3 or 4 years of life on the equipment, you’d depreciate that 4400 by spreading it over 26 months, and that’s the cost on your P/L,
But when a business is being valued, you don’t look at depreciation, you use a metric called EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). So under the CAPEX model, it’s more of a cash flow analysis, more than a P/L analysis. And there are reasons why businesses may want to consider placing more prominence on EBITDA — if so, OPEX can make a difference.”
This is the rental option for infrastructure. OpEx = “operating expense”; it occurs over time.
For example, instead of going for a 4400 purchase cash down for a couple servers, you sign up for a monthly charge. In simple terms, from a cash flow perspective, now you’re not putting out the 4400.
CFO Chris Locke on OPEX:
“That monthly charge actually is going to be on your P/L. It will be a “Server Rental Expense,” an infrastructure expense, will actually be in your EBITDA, and it will lower the EBITDA.”
A general “pro” of going with rental is that it improves cashflow, and a “con” might be that it lowers earnings.
So what are the other hidden benefits of rental that need to be considered?
In order to uncover them, you need to dig into the concept of “total cost of ownership”.
TOTAL COST OF OWNERSHIP AND OPERATIONAL RISK
So in our data center scenario, if I’m buying the equipment, I’m either paying for my own data center and the people required to maintain it, or I’m renting space out to colocate the servers.
In either case I’m taking operational risk – a common scenario is that the IT department or person will buy the servers, put them in a closet, without the infrastructure to provide full security, continuity or high availability. There is the real possibility of something catastrophic happening.
Operational risks include:
- Legal exposure from data loss or data breach
- Interruption of business
- Loss of brand equity
- Loss of customers
- Lost revenue
Or you can offload the risk to an expert who has the right infrastructure.
OFFLOADING: THE MONEY-SAVING ALTERNATIVE
IaaS providers (IaaS = Infrastructure as a Service) have achieved the intense growth in cloud computing through helping hundreds of thousands of everyday businesses to offload their infrastructure.
CONCLUSION – “FOCUS ON WHAT YOU DO THE BEST, HIRE OTHERS TO DO THE REST”
In the end, hundreds of thousands of IT professionals and small to mid-sized businesses have circled back to the age old principle of focusing on what you do the best, and this has helped to fuel intense growth in the cloud computing industry. The tools are there for offloading infrastructure, reducing risk, saving money, and IT professionals can harness them to help their business run more efficiently, with more focus.
Updated: January 2019