The enterprise IT landscape has rapidly changed over the past decade, with organizations opting for the advantages of the cloud versus on-premises data centers. According to a report from Gartner, Inc., 40% of organizations in North America plan to spend the majority of new or additional funding on cloud.
With this shift, businesses are seeing an increase in OpEx and a decrease in CapEx. What does this change mean for your business? In this article, we’ll compare the two financial models, CapEx vs. OpEx, and provide key considerations that could impact your cloud cost management strategy.
What is CapEx?
Capital Expenditures (CapEx) are investments made by an organization for long-term benefits in the future. Computers, servers, and other hardware needed for on-premises data centers are all examples of CapEx. The business pays for these expenses upfront, with the expectation of the purchases benefiting the business for many years to come. Any associated maintenance costs are also considered CapEx since they extend the asset’s lifetime.
When it comes to accounting, CapEx is listed on the cash flow statement under the investing section. The value of CapEx depreciates over a number of years, so the full upfront expenses are not usually deducted from the business’ income statement all at once—only the depreciated or amortized amount is deducted for a given year in which the asset provided value.
What is OpEx?
Operational Expenditures (OpEx) are the ongoing costs related to day-to-day operations. A subscription fee for cloud services is considered OpEx—the cloud provider is making the infrastructure investment upfront, and you only pay for the resources you need as you need them.
OpEx show on a business’ income statement as either a cash reduction or accounts payable increase. The expenses are fully deductible in the year in which the expense is incurred. So if a business spends $100k over one year for cloud services, that business claims a $100k deduction on its tax return.
CapEx vs. OpEx for Cloud Cost Management
For any organization thinking about migrating to the cloud or expanding their cloud usage, there are key differences between CapEx and OpEx to consider before committing one way or another.
|Greater expense upfront means less cash for day-to-day operations or new investments||No large upfront expense, so businesses have more cash flow on a day-to-day basis and can invest in new services or products as needed|
|Businesses are locked into a long-term commitment and can’t make changes easily||The payment timelines are shorter, so businesses can pivot their investments easily as needed|
|Because CapEx usually incurs a significant cost, the internal approval process to purchase can take a long time||OpEx are generally smaller costs, so the approval process to purchase doesn’t take as long|
|Businesses have full control of their infrastructure, but internal resources need to be dedicated to running, maintaining, and repairing the infrastructure||External experts (cloud providers and/or MSPs) manage and upkeep the cloud infrastructure. Internal resources can focus on driving value for the business|
|Additional unexpected costs may be needed for infrastructure maintenance and repairs||The cloud provider is responsible for any maintenance or repair costs|
|CapEx is seen as an investment in improving the business that will return value in the future. This is usually a good sign for potential investors||It can be difficult for a business to show future value to a potential investor because they are paying as they go|
|With the rapidly changing world of technology, technology investments may become redundant or obsolete before the end of its lifetime||If changes need to be made, the business can adapt quickly by canceling, modifying, or upgrading their plan in a short amount of time|
|ROI is not usually realized until a long time after the purchase was made because the infrastructure needs to be set up and employees need to be trained||The business can achieve ROI immediately in many cases because the infrastructure is managed by the cloud provider|
|If a business wants to boost its net income for a specific year, it could invest in CapEx and only deduct a small amount of expenses that year||Businesses paying OpEx don’t have many options to make their income statements look different within a given year because expenses are deducted as they incur|
|Businesses often overspend to ensure they have enough resources for their needs (or they can underspend because they underestimated their needs)||The business can make more accurate predictions for the number of resources they need in the short-term. If they need to adjust, they can quickly make changes one way or another|
The ability to shift to OpEx for investments in IT infrastructure is driving many organizations to shift workloads from on-premises hardware to the public cloud.
Cloud providers offer various OpEx payment options to best meet the needs of their customers, both in terms of pricing and operations. These options are based on different variables, such as the type of cloud service, the service level, and the length of time for that service. However, with all the options available, it can be confusing to sort through in order to make the right decisions for your business.
To learn best practices for making those decisions and optimizing your cloud costs, see our guide: Building a Successful Cloud Financial Management Practice