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Pay-as-you-go IT: Implications for Organizations

Co-Authors:   Deepak Seth       Ashwin Pingali

Note: A version of this post has been published under the title Pay-as-you-go IT: CFO’s dream and a CIO’s nightmare. This version has a few extra graphs that are not in the other article.

Introduction

As the nature of business becomes more “digital” a pay-as- you-go Consumption based IT cost model is likely to emerge as a major disrupter to the traditional view of IT as a Capital Expenditure. The authors investigate some of the drivers for this shift; how it is likely to play out in the board room and the approaches which can be used to make this disruption a positive one for the corporation.

Synchronicity of IT Spend with Corporate Revenue

As we look at the IT–Business interaction from a strategic perspective esp. as it relates to the cost/funding dimension (manifested in the annual and long term budgeting exercises and periodic cost-reduction initiatives) we see one of the basic issues as “synchronicity” – How can IT spend be more closely aligned with the ebbs and flows of the business revenue stream?

In many large corporations this issue also impacts the IT long term vision of transitioning to a simplified, streamlined end-state architecture (vis-à-vis the convoluted mish-mash of legacy applications which generally exists) as thebusiness becomes increasingly wary of making the large investments required to drive the necessary changes as their own revenue projections fluctuate. In fact in some cases the large IT investments seem to be paying off at least initially but as time progresses the IT cost increase is far more disproportionate to the revenue increase.

Pay-as-you-go (Usage Model)

From a CFO perspective, then, a pay-as-you-go model seems very attractive. In the most simplistic configuration all applications will be hosted in the cloud with business users being charged based on the actual consumption of resources.

Rather than implementing any major platform initiative in-house with its associated fixed costs (Capex), technology vendors will be required to provide the desired capabilities as a consumption based service (Opex). Technology products if built in-house can be done so using the pay-as-you-go resources from a cloud vendor. These capabilities can also be leveraged to evaluate the feasibility of the product from a business perspective and to pilot risky projects without significant budget commitment. This shifts the initial fixed investment outlay into smaller outlay paid every month based on the usage.

Another key premise is that since the vendor will be leveraging economies of scale over a larger user base they will be able to drive the costs down significantly more than if the company would be able to do hosting applications in-house.

IT Supply Chain – Digital Products

The nature of the products and services offered by corporations are also dramatically changing with the “digital” component becoming a key part of the offering and value proposition for the customer. For example a traditional product may now be bundled with a digital service enabling customers to access and store content. IT processes and infrastructure will play a role in securing the digital files, storing them and enabling access to these files.

As a result the IT infrastructure component of the cost of the offering needs to have a more direct alignment to the total cost rather than just be an allocation of a fixed charge. In essence since IT infrastructure is essentially becoming the digital supply chain for the offering and as for any conventional product, the supply chain costs have to be in alignment with the revenue for the product.

The CEO’s Viewpoint

Couple this with the growing CEO perspective that most of IT spend is“non-differentiating for the business.” They also realize that as their business becomes more “digital” creating and securing their digital assets is critical to maintaining the corporate reputation. As IT spend is growing CEOs would like to demand more out of it. And they would definitely like more accountability and transparency about the burgeoning expenses. A granular Pay-as-you-go cost model creates more transparency in what the “non-differentiating” portions of IT are costing on a per transaction or a per user basis.

The CIO’s Dilemmas

Not many CIOs have climbed this bandwagon though. Some of their wariness comes about because of the security implications of moving everything off-premises and also from the viewpoint of looking at the historical investments in-house IT infrastructure and data-centers as a sunk cost. Economists would argue that the sunk-cost dilemma is moot, per the “bygones principal” only the “extra” or “marginal” costs and benefits of every decision need to be evaluated. Ideally the past costs should be ignored and the future costs and benefits taken into consideration when making such a decision: A hard-headed calculation of the extra costs one will incur and weighing them against extra advantages. But this is most easier said than done. Also, what many times gets ignored is that while the one-time cost of implementing an application or building an infrastructure may have been “sunk”, there are associated recurring costs – licensing, electricity, manpower etc. which are very much real and need to be factored in.

CIOs are also not yet fully sold on the idea of a pay-as-you-go or Consumption based IT cost model being as “variable” as it is touted to be. The likelihood of vendors introducing some “fixedness” ((start-up charges, launching charges, termination fees etc.) to the mix looms large. In some cases vendors have begun allaying the fears by agreeing to abstain from any “fixed” components in their cloud offerings. They also fear that their organization may not have the clout to motivate vendors to move to such an opex model. But that is likely to change as increasingly larger number of companies demand something similar.

CIOs have to worry about their in-house legacy applications too. The ones that cannot be hosted outside for a myriad of reasons. They can be though moved to private clouds – changing from “fixed charge allocation to business” cost model to consumption based usage charges. And then, what about the vendors who are not able to offer their capabilities as a cloud hosted subscription/usage based solution? Multiple vendors collaborating to resolve this is an option – one provides the application and other the cloud access.

Driving the Costs Down

This brings us to another very important point. While organizations may not be ready to move to a pay-to-go-model yet there is still a considerable opportunity to leverage the model to drive IT costs down. In theabsence of a consumption based “tariff”, a “Tragedy of the Commons” kind of scenario plays out where a shared common resource is inefficiently or sub-optimally utilized, somewhat like the scenario where free electricity or water leads to more waste and a lesser incentive to conserve. Currently IT cost reduction initiatives are generally periodic percentage cost reduction targets emanating from Corporate Finance or Business Leadership. IT generally responds by chipping away at cost elements to the best it can.

Transactional Cost Modeling for a Pay-as-you-go Approach

If organizations choose to move to the cloud or embrace a public cloud vendor or have everything on an in-house cloud, it is essential that they embed transactional cost modeling into the design of the IT solution or product. In this approach the IT architecture is used as a basis to model all the cost elements associated with the application. Even legacy applications can be modeled as if the applications were hosted on a private cloud and then can be benchmarked against the rates quoted by cloud providers like Amazon Web Services or Microsoft Azure for the same capabilities. Business users can be exposed to this cost comparison as an element of a “Go Out vs. Stay In” decision making.

The rigors of such a cost modeling exercise will also expose the business to discrete elements of IT costs which have hitherto remained hidden in larger silos. For example the cost associated with an IT solution or an application is not just the cost associated with the Production infrastructure. Even the Development and Test infrastructure that is used needs to be counted towards the operational cost of the application. If the company doesn’t have an offshore team or only works in two shifts then the development instances can be operational only during the actual hours of working reducing the number of hours in a year from 8760 to 2008 hours a reduction of over 75%.

Even production applications do not have to necessarily operate outside a time window and by building a flexible downtime capability within the application, one can schedule downtimes to minimize the costs outside the window of operations.

Conclusion

Failure to recognize the pay-as-you-go IT model as a platform disrupter can be very detrimental for organizations. The successful ones will leverage the trend to drive down costs and will reap the benefits. Adoption of the model does not need to be a revolutionary change as organizations can follow a more evolutionary approach by first focusing on it as a mechanism to get a better understanding of their own IT costs and endeavor to make them more “variable”, truly reflecting the demand patterns.

 

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