For decades, the capital expenditure (CapEx) model was defacto model for acquiring and implementing new information technology. Companies were required to make large upfront investments in IT infrastructure like servers, software, and data centers that they would then own and depreciate over several years.
Also, In the traditional CapEx driven approach, companies purchased perpetual software licenses, storage hardware, and compute capacity based on projected peak demands.
As a result, This "buy and build" IT ownership model provided control but also carried substantial risks of overcapacity, technical obsolescence, and vendor lock-in. Vendor swaps were extremely difficult to due risk of sunk cost and had a huge entry barrier due to upfront capex commitment requirements to migrate.
The structural shift from CapEx to OpEx models for enterprise IT is often a recurring debate. While cloudification and Saas based services are becoming a norm for small scale applications, cracks have started to appear in large scale enterprise cloud migrations.
We've already seen few cases of companies rolling back to on-prem versions i.e. de-cloudification of their applications due to uncontrolled and difficult cloud cost management!
Yet still, Gartner projects the global cloud services market will reach $591 billion in 2023, up over 20% from 2022 levels. Within that, the fastest growing OpEx segments are IaaS (31% CAGR) and SaaS (17% CAGR).
Similarly stark trends can be seen within software expenditures. SaaS delivery models now comprise 70% of all software expenditures and represent the largest segment of public cloud services, per analysis from Gartner.
On the other side, on-premises data center spending is flatlining as workloads rapidly migrate off inflexible CapEx infrastructure. IDC forecasts spending on enterprise compute and storage infrastructure will decline at a -2.8% CAGR through 2026 as organizations opt for elastic OpEx capacity.
"It's clear that enterprises are rapidly reorganizing around recurring revenue relationships rather than big upfront CapEx commitments for IT," said Michael Corey, VP Analyst at IDC.
Few Examples of Capex to Opex Transformations
Some of the world's largest enterprises have executed sweeping CapEx to OpEx transitions:
1.) Banking leader Capital One completed one of the most ambitious cloud migrations ever by shifting all of its computing workloads off its data centers and into AWS's cloud between 2014-2020 at a cost of over $1 billion. The move eliminated CapEx refresh cycles while enabling the agility to rapidly spin up new digital services and divest technical debt.
2.) Insurance giant Allstate moved over 300 applications and two data centers into the AWS cloud for scalable OpEx-driven capacity. The company cited greater deployment speed and a $300 million reduction in IT run costs as primary benefits.
3.) General Electric spent billions transitioning over 9,000 workloads to a hybrid cloud model combining Microsoft Azure and AWS services. By migrating off CapEx infrastructure, GE reinvested savings into digital innovation while gaining the IT scalability to support future growth.
"Most procurement organizations we work with have identified the transition from CapEx to OpEx subscription-based solutions and services as a top strategic priority," said Julie Choo, partner at IT sourcing advisory Wavestone US. "CPOs recognize they need new capabilities to effectively manage this vendor ecosystem and radically different set of supplier relationships."
How To Manage Cloud vs On-Prem Negotiations as a Procurement Manager?
So, the question arises for procurement leaders on what kind of sourcing and negotiation tactics are required to manage this dynamic situation of Capex vs Opex .For procurement leaders, this CapEx to OpEx transition represents a seismic sourcing shift with profound strategic implications. We must rethink our governance models, realign our supplier management tactics, and reskill our teams to thrive in this new OpEx-centric IT economy. Any strategic refresh of this category will include indepth understanding of
Cloud economics,
Pricing mechanics,
and Supplier dynamics.
These can differ vastly in an sourcing transaction of a on-prem software purchase versus cloud based platform purchase and hence, Maintaining ROI and cost optimization in this landscape requires new negotiation tactics and cost models.
"In the past, tech procurement tended to focus sourcing criteria narrowly on features, functionality and integration," said Henri Lee, partner at procurement advisory Provalido. "
In the OpEx world, financial impact analysis and consumption scenario modeling become essential to determine which suppliers and pricing constructs will yield the best long-term value.
Also, the menu of options has expanded exponentially beyond traditional enterprise vendors like IBM, Oracle and Microsoft to include born-in-the-cloud players like AWS, GCP, Salesforce and ServiceNow plus niche specialists in databases, storage, integration and more. Procurement has to identify and qualify this diverse array of candidates and run tailored sourcing events.
"In the on-premises world, we worked with a shortlist of large established vendors like Microsoft and IBM," said purchasing manager Suketu Desai of industrial manufacturer PE Corp. "Today, our SaaS and cloud sourcing efforts might include 30+ providers across SaaS apps, cloud platforms, infrastructure, integration services and more many of which are new market entrants."
Few important factors to consider during Negotiations are:
1.) Consumption Analytics and Scenario Modelling: Procurement must conduct a detailed analysis on consumption analytics, benchmarks, total cost of ownership modeling, and service-level transparency must underpin all OpEx evaluations.
2.) Relying on a single-source cloud or SaaS vendor concedes leverage and forces you into forced renewal positions. Also, Negotiating multi-year subscription agreements with complex pricing tables, usage metrics, discounts and incentives requires specialized capabilities. Consumption commitments, auto-renewal provisions, price protections and termination rights differ greatly from perpetual license constructs and carry considerable financial consequences.
3.) Risk Mitigation Provisions: Refine contracting playbooks to align incentives, enforcement mechanisms, clearly defined obligations/SLAs, and favorable termination/exit rights. Avoid one-sided vendor paper built for lock-in.
4.) Continuous Optimization Framework: OpEx cost efficiency requires vigilance and active management versus static perpetual licenses. Establish oversight processes monitoring utilization patterns, resourcing mix, service quality, and financial levers to course correct.
5.) Consumption-Based Pricing Expertise Unlike CapEx's basic unit prices, cloud and SaaS fees involve complex consumption tiers with diverse per-use pricing metrics (IaaS compute cycles, database I/O, data transfer volumes, SaaS active users, tiered storage, etc). Incremental changes in resource allocation and usage patterns can trigger material pricing impacts. Hence, it is key to establish consumption and billing hygiene in place to avoid cost overruns.
6.) Scenario Planning to Optimize Costs: Strengthening financial modeling and scenario planning abilities is essential. For example, re-evaluating deployment patterns can optimize costs by 40%+ by aligning workloads with the cheapest infrastructure type.
In-depth modeling and optimization of resource mixes and deployments is now part of the core procurement process. Incentive & Commercial Creativity To counteract increasing supplier leverage, procurement must get creative structuring discount schedules, incentive bonuses, service credits and other commercial deal terms incenting cloud vendors to minimize OpEx costs for customers over time.
7.) Annual or multi-year consumption commitments can help qualify for substantial discounts. But leading teams complement these with layered incentives, such as:
Cost optimization bonuses based on reductions in a customer's year-over-year cloud spending
Fee rebates or credits for migrating or deploying additional workloads
Refunds based on minimum service-level guarantees on uptime, performance, security
Staff augmentation support for implementation and cloud operations at a fixed monthly cost
No-cost advisory consulting and managed services to drive adoption
8.) Relentless Tracking: In the OpEx model, billing is intrinsically usage-based, so overpaying for underutilized resources becomes a risk without rigorous tracking and optimization. Procurement must develop analysts to audit cloud billing, identify cost-saving opportunities through rightsizing workloads, spot overprovisioning, and optimize hybrid workload placement.
9.) Vendor Management Oversight: Under CapEx, asset ownership meant tracking software upgrades, patches and infrastructure refresh cycles. With OpEx services, procurement must closely govern performance, cost, security and compliance across a dynamic vendor mesh including cloud hyperscalers, SaaS providers, MSPs and more
How Leading Organizations are managing their Cloud Migrations
Leading enterprises have developed Cloud Centers of Excellence with personnel skilled in:
Cloud pricing intricacies and modeling across hyperscale platforms
Custom forecasting algorithms using historical data
Workload profiling and hybrid/multi-cloud optimization
Managing vendor compliance and cost assurance audits
"Cloud's pricing complexity has exponentially increased the need for hands-on technical and financial analysts upskilled in consumption patterns, workload attributes, and service rate cards," said Mike Cullen, VP Cloud Strategy at AWS consulting partner Dati Cloud
Cheat sheet on IT Cloud Opex Negotiations
Here are some top negotiation strategies to effectively negotiate IT OpEx agreements like cloud, SaaS, and managed services:
1.) Leverage Consumption Data Unlike perpetual licenses, OpEx agreements are based on usage metrics like active users, data storage, compute cycles, etc. Having accurate historical data on your actual consumption patterns is critical leverage. Use this to rightsize commitments, benchmark against market rates, and avoid overprovisioning.
2.) Employ Multi-Sourcing Tactics
Don't sole-source large, must-have OpEx services - divide requirements across multiple vendors. Use real RFP competition, benchmarks, and optimization tools to pit providers against one another and avoid excessive lock-in leverage.
3.) Insist on Transparency
Demand simplicity around pricing models, metrics definitions, auto-renewal controls, and any hidden fees. Make vendors outline utilization reporting and optimization processes. Ambiguity favors vendors over time.
4.) Pursue Hybrid Deployment Options For many workloads, a combination of public cloud, private cloud and on-premises infrastructure may be optimal. Reserving ability to repatriate workloads provides negotiation leverage.
5.) Align Incentives and Penalties
Structure incentives rewarding vendors for continuous cost optimization and adoption growth. But also implement weighted penalties around performance, security, compliance, etc. to transfer risk.
6.) Enforce Future-Proofing Protections Cloud technologies evolve rapidly. Lock in contractual price protections for new services/features added to your footprint as well as discounting for consumption growth over time.
7.) Negotiate Opt-Out Provisions
Avoid auto-renewal traps with stringent opt-out notification periods and termination rights. Also reserve offboarding process and data portability requirements.
8.) Secure Cost Optimization Resources Demand that vendors provide continuous cost monitoring, optimization services, and designated procurement resources incentivized to manage your declining OpEx spend.
9.) Embrace Managed Services Options Leveraging consumption-based managed services for activities like cloud operations, application management and cybersecurity can optimize costs versus runaway internal hiring.
10.) Push for Most-Favored Pricing Unless transfer pricing rules prohibit, ensure all contractual pricing matches the most favorable negotiated rates the provider offers any similarly situated customers.
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