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Understanding TCO Cloud Economics

By now, we all know that cloud computing eliminates the need to purchase, deploy, and maintain IT assets. The primary selling point of cloud services is that the cloud vendor takes on full infrastructure responsibility for running hosted applications.

Gartner Research underscores the total cost of ownership (TCO) advantages by estimating that the annual cost of owning and managing software applications can be as much as four times the cost of the initial purchase. All size businesses are moving away from the general mindset that these numbers are merely a cost of doing business. The new mantra entails the notion of slashing expenses and still improving the agility, competitive advantage, and profitability of an organization through the reduction of capital expenses (CAPEX).

However, arriving at an accurate TCO number is often difficult. When comparing Software-as-a-Service (SaaS) to on-premises' IT costs, it is difficult to arrive at an apples-to-apples comparison, especially when trying to calculate the ongoing internal operational costs with employees always being one of the biggest line items. Let's face it, companies do not jettison their entire IT staff just because they dip their toes into cloud services.

For a decade, studies have been conducted on the cloud’s TCO benefits. In 2009, Hurwitz & Associates completed an in-depth study comparing TCO of a cloud-based business application and equivalent on-premise solutions. Even in the cloud’s infant stages they found services yielded substantial economies of scale and skill and lower TCO. Additional findings from the Hurwitz & Associates analysis include:

Overall TCO for a cloud-based integrated solution suite is significantly lower than a comparable on-premise solution. IT infrastructure costs (hardware, software, and maintenance) account for about 10% of the total cost of deploying on-premise business applications. The cost advantages of cloud computing slowly taper off as the number of users increases beyond mid-market to larger enterprise companies. Application subscription costs account for two-thirds of the total solution cost in the cloud computing model, where the subscription fee encompasses underlying IT infrastructure and personnel costs required to manage a business solution. In comparison, business application costs comprise about 27% of total cost in an on-premise solution. Costs for internal IT staff and/or value-added reseller (VAR), consultant, or systems integrator (SI) resources required for application implementation and support represent a significantly higher percentage of total cost for on-premise solutions than for cloud-based business solutions. Pre-integrated front and back office functionality in the integrated business application offering contributes to reducing integration complexity and lowers application implementation costs.

 

What was true in 2009 still holds true today. In fact, Gartner reports that global spending on Infrastructure-as-a-Service (IaaS) was expected to reach almost US$16.5 billion in 2015, an increase of 32.8% from 2014, with a compound annual growth rate (CAGR) from 2014 to 2019 forecast at 29.1%. This notable growth rate is due — in no small part — to the cloud’s TCO and ability to:

Eliminate the ongoing operational costs of internal IT departments. Ensure organizations are always able to take advantage of the latest features and innovations.

 

If you need more motivation to adopt the cloud, here are more stats from International Data Corporation (IDC), Forrester, Gartner, Ovum, Wikibon and others, as reported by Forbes on September 27, 2015:

The global SaaS market is projected to grow from $49B in 2015 to $67B in 2018, attaining a CAGR of 8.14%. Global spending on IaaS is expected to reach $16.5B this year, an increase of 32.8% from 2014. The global SaaS market is projected to grow from $49B in 2015 to $67B in 2018, attaining a CAGR of 8.14%. Global spending on IaaS is expected to reach $16.5B this year, an increase of 32.8% from 2014. Cloud applications will account for 90% of worldwide mobile data traffic by 2019, compared to 81% at the end of last year.

 

A big part of eliminating the ongoing operational costs is retiring capital assets and their associated services. Another way of putting this is addressing information lifecycle management (ILM). ILM takes into account:

 

Hardware and software purchases Professional services administered by third-party vendors Software maintenance and upgrades Contract negotiations and new licenses

 

Every item in this punch list is absolutely necessary because no self-respecting IT person would allow their infrastructure to dissolve into obscurity and place the business at risk. ILM is a method of keeping the IT infrastructure aligned with a business so that it’s functional from the time it is implemented through its retirement. The ever present and constant specter of ILM does have the benefit of ensuring effective asset management, configuration, deployment, and disposal while setting up the technology standards and maintaining continuity. However, there are many assets — with varying dates of obsolescence to contend with. Consider this list as a mere microcosm of these IT assets:

 

Server hardware Storage device Switches, routers, firewalls, security appliances Facilities — HVAC, UPS, generators, security (cameras), video storage Backup — hardware (disks) and software Disaster recovery Operations — help desk software NOC — dashboards Security (IPS, IDS apps) Compliance

 

Many of these assets have a 36-month life cycle to the end of their maintenance contract, and nobody is going to pay maintenance on a device that is five years old. So the vendor research and proof of concept (POC) stage begins, which inevitably leads to a conversation with the finance department and more paperwork. In three to six months the buying process begins and once the new device is selected, the installation, racking, and migration from the old device and training staff on the new asset can take place. A well-coordinated IT person, friendly with his/her finance department, can get meaningful use out of the new asset within three to six months. All this time and effort must also be taken into consideration when evaluating TCO.

 

TAKING THE FIRST STEP: NOT AS BAD AS YOU THINK

For some IT folks, entering the cloud can cause stomach pains. To avoid this, IT personnel can take facilities offline bit by bit until they get comfortable with someone else housing their equipment as well as providing power and security. As devices near the end of their useful life, conversations often take place around leaving the rack and spinning virtual disks in the cloud. This “walk before you run” scenario gives IT personnel the opportunity to establish a comfort level with the selected third-party cloud provider and build a TCO baseline.

In addition to accepting the fact that an IT department’s livelihood is under someone else’s control, knowing the cloud provider can securely protect IT assets brings even greater comfort. When you think about it, a public cloud offering is no more risky than the server sitting in a closet — at one point, data still needs to transverse a public communication line. The added benefits of a public cloud also brings redundancy, high availability, and a suite of security products that many organizations could not afford if they attempted to implement themselves. For those who are still paranoid about the security of their data, there is always the private cloud option. But even here, there is often one point where data travels over a shared access medium — at the end of the day, all data is typically mixed and combined at a major telco provider.

Once IT personnel get past the fear, doubt, and uncertainty, the TCO benefits of adopting the cloud begin to become apparent. Consider that cloud vendors have built their services from the ground up to specifically run in the cloud. These services are architected to be consumed by multiple customers at once or, in other words, a multi-tenant model. By running in this environment, cloud providers are able to service thousands of customers on a single database and application software. The SaaS solution is optimized for a shared environment to achieve efficiencies throughout the lifecycle; something that is often impossible for on-premise IT departments to achieve.

 

DON'T IGNORE THE INTANGIBLE TCO BENEFITS

Aside from the tangible TCO benefits mentioned, there are other business advantages specifically derived from cloud services. These advantages are scalability on demand, enhanced security, easier software integration, and the ability to quickly customize virtually any application. Although sometimes difficult to quantify, the soft costs are as much a part of the TCO equation as retiring servers.

Still another way to pinpoint the intangible TCO benefits is to focus on outcomes. It's essential to understand the legacy environment before adopting the cloud so a full baseline assessment can be made. After the cloud environment has been adopted, a full comparison can be made that details the before and after results. This is a challenge for many organizations as most businesses are measuring some metrics, but few are measuring them in the in-depth manner needed to realize a true TCO analysis.

Some of the key intangibles organizations must take into account when evaluating the cloud's TCO involve an analysis of the risk migration, security features, flexibility, and of course opportunity cost. Everything we do in business carries a risk, the challenge is to predict any negative probabilities before hand, to arrive at the best possible TCO analysis. Using this simple formula below can help derive a more accurate TCO.

 

Risk Value = ∑ (Probability of Event x Cost of Event)

 

In addition, downtime cannot be ignored in this evaluation of intangibles. Related downtime costs include the loss of productivity, the time required for remediation, as well as loss of revenue, SLA liabilities, and of course the inevitable goodwill tarnishing.

 

CONCLUSION

The inevitable conclusion is that the cost comparison between cloud services and traditional, on-premise IT infrastructure sways towards the cloud as the more cost-effective solution for any size organization. The most significant component of the TCO evaluation is indeed ILM. The infrastructure support, maintenance, upgrades, and never-ending license fees continue a vicious cycle of costly renewals. When compared to cloud services, the cloud vendor assumes all responsibilities for the aforementioned ILM headaches and also administers the benefits of scalability, compute-on-demand, as well as disaster recovery and IT security services. Perhaps one of the most powerful motivators in the cloud TCO consideration is this: Should IT personnel be consumed with application and hardware maintenance or should they be devoting their time to innovation and R&D? When viewed from this perspective, there is no mathematical formula or industry analysts’ statistic to derive the correct answer — cloud services win. 

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