Capitalizing on the Cloud

by Dave Michels

It is easy to look at technology from a technical perspective. Unfortunately, technology decisions are rarely based on technology alone. There are three perspectives that commonly determine how an organization makes its technology decisions: technical, financial, and strategic. Technical perspectives are the default approach, and examine each product, service, or vendor in terms elegance, efficiency, features, and capabilities. Financial constraints are, however, a reality and sometimes old tech needs to be stretched or less expensive tech needs to be purchased. Strategic decisions rely on relationships or perceptions (the boss’s son is a vendor). When I worked at a distributor, we didn’t purchase Dell since they weren’t channel friendly.

In this post, I want to discuss a “feature” of the cloud which sometimes isn’t a feature at all. The so called benefit in question is the reduction or elimination of capital expenditures. Allow me to back up a bit with some terminology. In organizational budgets, there are two kinds of dollars: expense dollars and capital dollars. It isn’t uncommon for one of these wallets to be full while the other empty. Once the dollar is spent, it becomes someone else’s revenue. Revenue dollars are just dollars, the expense/capital designation is strictly an internal accounting nuance.

A dollar really should be just a dollar. But then what would we do with all those CFOs and CPAs? These people get paid ‘the big bucks’ to understand that a dollar isn’t a dollar and spend countless hours debating what mere mortals find absolutely obvious – my favorite topic is when to recognize revenue (revenue recognition is a surprisingly complex topic). Nothing is obvious or simple when it comes to the books – and when people insist something is simple and obvious, they are very likely trying to sell you something. Such is the case of cloud providers insisting expense dollars are better than capital dollars.

Expense dollars are very simple. When you spend an expense dollar it’s gone. It requires no explanation because its so simple. I trade you a dollar for an ice cream cone and I no longer have the dollar. I then eat the ice cream cone and it’s gone too. Should someone ask, the answer is the dollar was eaten. Services, including circuits, are generally expense dollars or opex (operating expenses) because there is no long term value.
Capital dollars are not so simple as they buy things that keep some value, at least for a while. If I buy something that will last three years, through the magic of accounting, I only account for a third of its cost each year. Of course, that’s just internal math. I actually did pay for it and spend the money. This clever concept is known as ‘depreciation’. Accountants love this stuff. Sometimes they love depreciation, sometimes they hate it, but they always love the notion of it. I for one feel we should always show our depreciation for accountants.

Expense or capital dollars, or more simply depreciation and how it is treated, is a financial question which should be left to financial experts. The treating of depreciation has numerous ramifications including stock performance, bonus pay-outs, and taxes. From a technology prospective, I am happy to leave the matters of what dollars (expense or capital) to use to someone else. This is where things get cloudy.
With a traditional PBX acquisition, I collect user requirements, evaluate the vendors and their products/services, and make a recommendation. I might end up recommending the Acme PBX 5000 – technology decision done. If the CFO determines it is best to use expense dollars, then the CFO may decide to do an operating lease. Or if it’s capital dollars burning the proverbial hole, then the CFO may opt to pay cash, finance it with a bank loan, or do a capital lease. This model of separate decision making works well, I – a telecom, IT, and UC Super Genius made the technical decision and the CFO independently determined the financial model.

But if the technical recommendation was to go with Acme Hosted Voice – the CFO doesn’t have the capital depreciation option. The technical recommendation dictated the financial model (expense dollars). Going to the CFO and explaining the good news that IT made the financial model decision may not get the desired reaction. It is ‘billed’ as a huge benefit, but removing options isn’t. It’s like a 2 flavor ice cream parlor insisting it’s better not having all those distracting choices.
There are several reasons why it may be preferable to spend capital dollars. The simplest example is sometimes these capital assets last longer than their book values – effectively becoming free. Phone systems commonly do just that. I can’t tell you how many times, as a dealer, I’ve seen really old phone systems in place. The oldest was a 30 year system we pulled out, probably off the books 25 years ago. That means these products/assets are nearly free while in use after depreciation. A hosted service won’t give you 25 years of free service no matter how hard you smile.

Taxes are a complicated topic, but can result with incentives to spend money on capital assets. The federal government often provides spending incentive thru accelerated depreciation programs. Right now The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (H.R. 4853) signed into law by President Obama does just that. The legislation allows taxpayers to deduct 100% of the cost of equipment acquired from Sept. 8, 2010 through Dec. 31, 2011. This legislation creates an incentive to purchase expensive big ticket items such as a telephone or UC solution. The purchase shows up as a giant lump sum – reducing “profit” and taxable income in the current year, and provides years of near-free service. The goal is to stimulate spending and it will likely do so, but it won’t help cloud service providers (unless of course they purchase equipment).

There are ways to capitalize cloud based projects – implementation costs, project planning, even training – but capitalizing the actual service is far more difficult.  
The cloud has a number of significant benefits and I believe it will continue transforming the communications scene. But when cloud providers tout cost, be suspicious. In the recent Verizon announcement to offer hosted UC, the company says “In one sample configuration, involving a hypothetical 1,000-employee company with one site buying a three-year contract, Verizon estimates that UCCaaS will cost $34.53 per user per month, compared with $43.15 for a do-it-yourself system.” This is likely comparing capital dollars to expense dollars which isn’t reasonable.

The cloud will increasingly win more and more technical arguments – but the cost comparisons will be very difficult. It isn’t like a PBX where the financial questions can be delegated – but rather an integral part of the evaluation and needs analysis. The cloud requires consideration by both IT and finance. All the talk about trading capital for expense being a great thing is hype – based on ideas and aspirations – not reality. An organization’s requirements need to be understood – including financial objectives.