CapEx vs OpEx
“No one is rich whose expenditures exceed his means, and no one is poor whose incomings exceed his outgoings.” — Thomas Chandler Haliburton
Suppose you have ever been involved in any discussion about cloud computing. In that case, if you argue that cloud computing reduces costs more than traditional data center-based computing, it is very unlikely that you would be challenged.
However, when it comes to ROI on cloud computing, comparing capital expense (CapEx) of running IT infrastructure in a traditional data center with operating expense (OpEx) in the cloud reveals that the cloud is an effective way to switch to IT infrastructure — it reduces CapEx cost.
When it comes to IT spending for businesses, there are typically two financial models: Capital Expense (CapEx) and Operational Expense (CapEx). Let's explore these two financial models of IT expenditure.
Table of Contents
Capital Expenses (CapEx)
CapEx is defined as business expenses to gain long-term benefits by buying assets such as buildings or equipment. CapEx examples of IT infrastructure are an office building, data center, physical servers, desktops, laptops, storage, printers, scanners, generators, software, and other related assets. In the CapEx type of business expense, you invest once, and you can reap benefits of that business expenses many years in the future. The question is, what are the maintenance costs of these assets? The charge related to the maintenance of these assets also falls under CapEx as the price extends the lifetime and usefulness of these assets.
Since expenditures are long-term investments for many years, CapEx expenditure is spread in amortization or depreciation in accounting books over many years. Thus, the CapEx form of investment is not a straightforward deduction for tax or accounting purposes. It is also a little challenging exercise to find out the company's actual direct and indirect value proposition from the investment over the years.
Operational Expenses (OpEx)
Operational expenses are expenses to run day-to-day business operations like services and consumable items that get used up, and you need it again to run the business. Examples are stationery supplies, printer cartridges, utility bills, monthly office rent, domain name registration and renewal, website maintenance, etc. The main idea is that these things are needed to run the businesses, but they are not considered long-term investments like items in CapEx.
From the business accounting perspective, operational expenses can be deducted from the revenue, thus decreasing your tax liability and increasing your profit. Another advantage of OpEx is that if it is not working as intended, you can stop using it or replace it with another alternative, which is tricky in CapEx. On the other hand, one potential drawback of OpEx is that sometimes it is challenging to gauge value proposition because of the short-term nature of OpEx – which is typically a year from the business accounting perspective.
CapEx, OpEx, and the Cloud
In the above discussion for OpEx and CapEx, it's clear there are steep differences in OpEx and CapEx both from the accounting perspective and gauge of value proposition provided in both of these financial models of IT expenditure. The question is what their use cases are. In other words, when to use one over the other.
If you are tight on capital expenditure or want to start very quickly as what you are looking for is already available on the public cloud, the public cloud's pay-as-you-go model could be the right choice –that would be the OpEx financial model. On the other hand, if you would like to have complete control of IT resources, you would instead prefer to build a private cloud — this would be the CapEx financial model. In this private cloud case, your organization will be responsible for all expenditures.
The current trend is using the public cloud as this is where there are actual multi-facet advantages of the cloud. However, organizations with tight, unique security and regulatory requirements tend to think critically about public cloud adoption.
In some cases, these organizations adopt a middle ground of hybrid cloud where they migrate those applications which are non-essential and not in the tight security and regulatory requirements realm. But keep critical and essential applications on private cloud or on-premises data center as it is.
CapEx Approach to Spending
CapEx approach to spending provides stability as expenses are known over the years in amortized value and assets depreciation. The usually grey part is about an uncertain value proposition – it may or may not. In the technology field, the degree of uncertainty is more as technology is changing very fast. So let's discuss what the risks in the CapEx financial modeling are.
Buying resources for future
One of the CapEx model challenges is an upfront investment for the future. Technology is changing very fast. And this fast change poses a significant risk in investing today in building something or training staff for something that may be needed in the future.
Redundant or obsolete resources
This is another type of risk in CapEx. If the technology changes, those resources such as staff, software, or machine could become obsolete or redundant. Another example is supposing a business builds a private cloud, but the need for the cloud services doesn't grow as you expected, then you risk losing money on your investment in building the private cloud.
Long-term business contract
This is another type of risk in CapEx, where you set up a long-term contract with a vendor but technology or requirement changed, but you stuck with this vendor contract.
Maintenance staff salary
This is another type of risk in CapEx, in which the organization pays to the maintenance staff to maintain servers or equipment which are redundant or not utilized.
Longer buying and setup time
Some projects take much longer to complete, and they have a risk of not bringing fruitful results as, by the time the project completes, the technology or business has changed. Thus, causing that entire project to be a waste of CapEx investment.
OpEx approach to financial modeling has fewer risks to expenditure compared to CapEx.
Purchase IT Resources and Services
This is the most crucial feature or sweet spot of the OpEx approach to spending. The OpEx approach to expenditure makes each purchase temporary and helps reduce its risk. If a vendor fails to make its commitment, or if technology changes, your business requirements change to changing market demand, or your IT budget changes, you aren't locked into one cloud vendor and IT infrastructure.
Overseeing Over Maintenance
With the OpEx approach, in other words, migrating to a cloud provider for IT infrastructure or IT resources needs, your maintenance staff will have to oversee the resources instead of maintaining them. However, that staff time can be utilized as other meaningful work to meet the organization's objective.
Improved Lead Times or Quickly Availability of Resources
Straight from one of the advantages of cloud computing, the OpEx approach helps improve lead times as there is a high possibility that you can quickly find available resources on cloud providers and start working on your project. Thus, the faster time to time market, which many times is a top priority for businesses.
Agility and Flexibility
The OpEx approach to IT spending provides agility and flexibility. Trying out something new is much faster and less risky. If the POC isn't working as you intended, you can try out something else. The reason is that recourses can be readily available and quickly terminated. And with the pay-as-you-go model of OpEx, you will only pay for the use of services.
SK Singh is the founder, a software, cloud, and data engineer. He has been involved in the software industry for around 25 years. He has a bachelor's degree in computer science and engineering from India and a master's degree in software engineering from the Pennsylvania State University. SK has been involved in a wide range of software projects for many governments, private, start-ups, and large public companies in various software engineering roles. He has many professional certifications such as AWS, Hadoop, Kafka, Oracle, Unix, Java, Java-related frameworks, and many others related.