capex vs opex costs Revisited

In a previous article I discussed article by Bernard Golden on CIO.com called “Capex vs. Opex: Most People Miss the Point About Cloud Economics“. My understanding has broadened since then a little and I just wanted  to highlight a few further thoughts.

First definitions:

  • Capex – stands for Capital Expenditure. Incurred when a business spends money to buy assets. For example a server or a desk. One of the benefits is that the asset’s lifetime is normally longer than the current tax year and therefore the budget cost an be spread over a number of years.
  • Opex – Operational Expenditure. Ongoing costs incurred by businesses enabling it to operate.

Wikipedia explains the difference simply by using the analagy of buying a printer: the capex cost is the printer itsself and are written off over the lifetime of the printer (say 3 years) where as the opex costs are those of the paper and ink – they are ongoing and vary depending on how many pages you print.

So what’s all the fuss with Cloud Computing about?

Well there are two reasons this is being discusse, firstly if you are in a position to take advantage of the fact that putting your servers in the could means (in theory) that you can add and remove servers quickly and depending on usage, then your costs will vary in direct proportion to your revenue (well traffic actually, but I think the simplification is credible).

If we lay this over our printer analogy it means that instead of paying £3,000 for the printer plus whatever per year for ink and paper, we pay the ink and paper cost plus a proportion of the £3,000 dependent on usage. So if only print one page we pay very little and if we do a lot of printing we pay more. The key benefit of having your servers in the cloud is that the costs are proportionally relevant! The £3,000 that would have traditionally been Capex-ed has actually been Opex-ed.

Now, one can argue whether the costs are greater or not but the point is that they are proportional to usage.

The second advantage is that once you have bought Capex goods you are stuck with them – and the printer company still want their monthly payment regardless of how much you are using your printer(s). An important point if your budget forecast boundaries are wider than you would prefer!

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Finally, and the point which I noted in my previous article and that Bernard Golden discussed, is that Capex expenditure can be limited by the funding that can be raised where as Opex costs can be more easily increased – as long as this increase is a direct and proportional representation of revenue and therefore profit! Put another way, when Amazon moved from 10,000 customers to 1million customers they needed to quickly increase their capacity. The cost of this was offset by the additional revenue generated by those extra customers – or at least that’s the theory!

I accept that this is a simplification of real life business models and I am certainly not claiming to be an expert in finance, however I have been trying to work out what the real world differences are, why  this is such a hot topic and whether or not this whole business is a red herring or not. In my opinion I think this is a valid topic – particularly for startup tech businesses, which is actually one of the most important target customer groups for hard-core cloud usage!

Hopefully this article will be useful to you when forming your own views. Comments and opinion please!