It’s about Cap-Ex to Op-Ex first (with “Cloud Transformation”)

If you are in the business of selling reasonably large and complex on-customer-premise systems, either as just software or bundled with hardware as an appliance, then you are probably aggressively building a cloud option for your customers as well. Your technologists are excited discussing modern methods of virtualization, scalability, security, hybrid-clouds, orchestration, AWS or Azure and aiding in the preparation of mobility Kool-Aid sales pitches where your customers can control their business using a tablet wearing sandals, sipping margaritas on a beach!

However, what technologists should realize is this: as a business owner, it is not about all that, it is first and foremost about having a simplified view of my numbers.

Capital expenditures obscure reality.

Let’s take the simple example of a home mortgage. If you have an amortized loan, you pay a constant mortgage amount each month. However, only a portion of that is technically expense – the interest portion. The other portion is merely a conversion from liquid assets of cash to illiquid asset of real-estate (principal reduction), and that’s not expense. If you have a reasonable or aggressive term, then the expense portion (interest) rapidly decreases. However, that decrease in expense does not allow you to make any meaningful decisions about what your monthly income has to be – that’s because you are still obligated for the full mortgage amount each month. So income minus expense is not sufficient (or even useful) information.

That’s just with amortization of the loan. Then there’s depreciation of the asset, which most resident home owners don’t care about due to simplified tax treatment. However, just one capital asset with one or no amortization loan schedule can spawn many depreciable capital assets, each with its own schedule and expense. Again, with our simple example, your dishwasher depreciates faster than your Acme brick! These depreciation expenses offset tax liability thereby impacting overall cash position/net income.

Then, for each depreciable capital asset, prudence dictates that there has to be deferred maintenance or capital improvement reserves. This is just a fancy way of saying stuff is going to break.

All this for just one tangible capital asset: your home. Business owners contend with several tangible and intangible capital assets generating several lines of amortization, depreciation and deferred maintenance/reserves into their reports. These capital expense treatments are subjective and worse can be manipulated. If you have an aggressive depreciation schedule without a balanced deferred maintenance put-away it probably means your finance manager wants you to be happy now and he knows he’s looking for another job in two years! Or, it’s a new law that suddenly declares that things depreciate faster – to help the economic climate! Either way, it might not reflect reality.

Any significant piece of purchased software – typically for operations, control systems, communications, accounting or storage – either as a separate piece or along with hardware as an appliance is subject to such confusing and tedious capital treatment. Often these capital assets are not core to the business. They may be essential but are still only supportive. They may be appreciated but certainly don’t appreciate. So businesses are better off just using them, not owning them.

Operating expenses on the other hand are real. If I paid $27 to get a lawn mowed, that money is just simply consumed and is gone. It doesn’t jump from one statement to another. It is not awaiting some kind of event to be realized. It’s just gone. Having a list of such operating and real expenses enables businesses to then start analyzing, shaping or eliminating them, thereby creating a path to improve operational efficiency – and that is the real ask:

To gain control of business operations using real and absolute numbers with less subjective treatments.

(Btw, removing subjective treatments enables you to remove the cost of arriving at those treatments as well; an automatic start to operational expense shaping.)

With the ask of clarity of numbers in mind, technologists should think of cloud transformation more broadly. Even if your technical solution will be delayed, retain your customers by offering the financial simplification first.

Offer a leasing model: In this model you continue to locate your equipment and software on customer premise, but you shift the complexity of capital treatment from their books to yours. Note that this is not achieved by offering the customer a financing model or a deferred purchase model – it must be a true leasing model. To do this however, you must be prepared to do two things: 1. possibly buy back or equivalently discount any asset of value on-premise you might use in the new solution/feature set and 2. get financing for your R&D – perhaps backed by determined contract revenue rather than projected sales revenue.

Offer a “Cloud-Feel”: Complex appliances (H/w and S/w) often have core pieces that must remain on customer premise for providing high quality of service. Climate control/building management solutions, communication systems, systems supporting complex customer operations may all fall under this category. Even in this situation a system has several ancillary functions that can and should be migrated and hosted. These are often customer provisioning, license/feature management, system monitoring, software installation and configuration, faults and alarms reporting, performance dashboards, usage/billing functions and the like. Move these ancillary functions off customer premise, host them and create secure interfaces back to the core through customer firewalls. This not only allows the customer to operate them as they would a cloud solution, but it also gives you better visibility into how the customer is using your solution. Note that this also provides an insurance (a default plan) if the customer stops paying as recovering “dead-gear” from customer premise is often not possible.

Try not to shock your ecosystem of partners: If you are in the complex software/appliance sales business, it is very likely that you are well supported by an array of partners: factory/assembly, transportation, distribution, third-party sales, installation and service partners. A significant portion of your revenue could be attributed to motions that include these partners. If they are shocked and decide to exit you before you are ready to exit them, you may not be able to fund your cloud ambitions. Using the above methods gives you breathing room to re-cast your partners where they play different functions in your new go-to-market model: A transportation partner might have a solid logistics function; a distribution partner often has a vibrant sales funnel.

Be-Fluid: In going through this transformation, it is often tempting to host solutions for your customers in your own in-house data-center. Perhaps it’s just business as usual or perhaps it’s an apprehensive infrastructure team. However, consider this: Will you stay fluid, not become a bottleneck and grow as your customer’s demand grows? – and do you really want to keep solving the same challenges? What is your buying power when it comes to hardware, platform software, networking and thick-pipe bandwidth compared to those who do this for a living? Will they have better methods to intelligently shift loads between sites to serve your customer better than you? Why acquire and carry all that capital instead of going op-ex where you can? What else is your customer hosting? Will there be an advantage to them down the line if they host with the same provider – either as discounts or otherwise? A manufacturer can reward a repeat customer today regardless of who the distribution or retail partner was for each sale. Similarly, it is conceivable that a hosting provider can reward a customer regardless of who the software/solution maker is. If data-center is not your business, why make it your business?

As a technologist you may feel your plate is quite full handling just the technical challenges of cloud-transformation, but understanding the broader value you are creating for your customer and appreciating the overall challenges involved should help you create the correct solution (in content and time).