The Financial Implications of Cloud Computing

by Tim Langley-Hawthorne, Director, Financial Analysis, TPI

My colleague Kevin Smilie wrote last month about the need, when evaluating a Cloud Computing offering, to understand how the services are priced and how that price compares to your current costs.

The general perception of Cloud is that it follows a simple P-x-Q (price times quantity) model, that is, you pay for only what you use. What could be difficult about that, you ask? Well, just take a look at the pricing structure for Microsoft’s online collaboration offering (dedicated vs. multi-tenant implementation, volume discounts, existing Enterprise Agreement discounts and end of year discounts) or Amazon’s Elastic Compute (EC2) offering (On-Demand, Reserved or Spot instance pricing, anyone?).

Detailed financial models still need to be developed to give an accurate comparison of Cloud pricing vs. traditional approaches and what really happens when your expected volumes change. Total Cost of Ownership analysis is another important consideration: Technical support, incremental bandwidth and initial set-up, integration and data migration can all add costs in the Cloud.

IT outsourcing agreements typically contain forward pricing provisions where the price paid falls over time to reflect the declining costs of hardware, maturing of offerings and expected efficiencies and economies of scale for the service provider. But a close look at some of the standard subscription agreements for public Cloud services finds mention of only price increases, which can generally take effect automatically after 30 days notice. An IT service provider willing to offer firm unit-based pricing that declines over time may not seem as cutting-edge but could end up being the lower-cost option over time.

Finally, don’t overlook termination costs. Clients can typically cancel public Cloud agreements at any time with limited notice and no penalty. Given the provider has no client-specific investments to recover, that makes sense . For private Cloud agreements, however, termination provisions tend to look like traditional outsourcing arrangements, where the service provider needs to recoup stranded costs from assets purchased for dedicated client use.

If the assets are generic, an argument could be made that the Cloud provider could re-use them for other clients, but in my experience, very few are willing to step up to that risk. Therefore, it is unrealistic for clients to expect the same no-cost termination rights offered for public Clouds.

Cloud computing might seem intuitively quite simple, but have you thought through all of the financial implications of these new offerings?