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OpEx vs CapEx: Why it's not a clear cut decision

OpEx-based IT consumption is growing in popularity - but don't rule out the old fashioned CapEx sale

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Colocation as a driver of OpEx

The growth and increasing availability of colocation facilities is aiding a shift from a CapEx to an OpEx model, according to Greg McCulloch, CEO of Aegis Data.

“The growth in data volumes coupled with the need for more flexible and bespoke IT capabilities, means committing CapEx expenditure over a significant lifetime is becoming increasingly more difficult to justify within the boardroom,” says McCulloch. “Instead, the rise in third party outlets, such as colocation facilities, and the flexibility of terms offered by these providers now means organisations no longer have to commit huge levels of funds upfront, supported by continued Opex expenditure over the life cycle of the infrastructure.

“By outsourcing their IT capabilities, the initial CapEx hit associated with building and managing their own facility is taken away – the third party provider has everything already in place and in doing so you can effectively budget for your usage based on the agreed terms with the provider. In doing so, this removes the risk of fluctuation within your financial forecasting process, brought about by unexpected IT changes or failings, allowing for greater accuracy when budgeting and defining long term expenditure.”

OpEx vs CapEx: Why it's not clear cut

The financial crisis of 2008 was a massive shock to the system. Unemployment across Europe over the next few years doubled, and a massive reduction in consumer demand, property values and investment had a knock effect across every aspect of the private and public sector.

For the channel, customers put major IT projects on hold or started to look for less CapEx-intensive (capital expenditure) solutions. Yet in many ways, the crisis arrived at a time when much of the IT sector was already gearing towards a more OpEx-based (operational expenditure) sell. From a technology standpoint, the evolution of virtualisation along with the rise of SaaS and cloud all stress an OpEx, or scale-out position.

The biggest OpEx champion is the rising number of managed service providers (MSPs) which not only serve demand based on scalable capacity but deals with many of the inherent skills shortages within the IT sector. For smaller customers, MSPs, combined with cloud, provide access to applications that in previous ages were often unaffordable due to high CapEx and constant refresh cycles.

More upfront

As we head towards 2016, the OpEx messaging that dominated vendor pitches is starting to lose its prominence. With the US, UK and much of Europe experiencing record employment and global interest rates at all time low, the reduced cost of credit makes the finance behind CapEx relatively cheap. In addition, technology shifts such as hyper-converged infrastructure, which uses a Lego-like approach to scaling compute, storage and connectivity is surging.

The assumption that switching to OpEx is a better deal is losing less of its shine in some quarters as organisations start to stabilise IT around this longer term scale-out model. For example, in the legacy world of storage where big filers ruled, when you reached capacity, it was time to upgrade. Dominant players like EMC with its Clarion range are not selling in droves and are in part losing out to a plethora of scale-out rivals. Recognition of this trend was EMC’s purchase of Isilon.

For channel partners keen to improve profitability, the MSP model and resale of OpEx-based third party services still offers many benefits but customers that are less financially stretched may well be looking harder at the longer term ROI. The tax benefits of investment in capital equipment, and in some cases bad experiences with outsourcing, are causing pause.

In addition, a number of vendors are nipping at the heels of channel partners with service offerings that in some ways compete. For example, HP’s instant Ink brings the end customer relationship closer to the vendor, although HP does have some rebate mechanism for channel partners.

Choice is crucial

What is clear is that the channel can no longer assume that customers will increasingly just want an OpEx deal. Especially if over a longer period that deal is far more costly. The channel needs to look at providing a variety of purchase methods and in some case even becoming the financier behind deals.

Although that may start alarm bells ringing for cautious FDs, a growing number of vendors, and even a few distributors, have mature financing models which help channel partners offer the benefits of spreading the cost of a CapEx deal into a financed purchase without carrying the risk. Another option is offering lease agreements. Although less utilised in the UK then the US with its byzantine tax laws, in essence, a lease allows the whole of the yearly amount to be offset against net profits within the financial year versus an outright purchase which can only have a partial offset followed by depreciation.

In an ideal world, both CapEx and OpEx deals would have the same levels of profitability for channel partners but that is rarely the case. In some areas like core networking infrastructure and HPC, structuring deals based on an OpEx/MSP model is challenging and not suited to smaller channel partners without the financial security to carry the up-front expense.

Higher up the stack towards software and SaaS, the higher margins and lack of physical hardware makes the ability to slice and dice contract terms much easier. In addition, software vendors are much happier to accept creative licencing terms that a partner may suggest if it get a foot in the door of a net-new customer.

Cherish transparency

The critical advice for every channel player is to consider how every portfolio product can be sold as both a straight solution sale, potential lease sale or delivered as an MSP model. If a preferred vendor does not offer the product as all three options than look at rivals as potential clients almost certainly will.

Another bit of advice is the adoption of transparency. The old model of closely guarded pricing and terms has been eroded by the power of the internet and is not coming back. If a channel partners intends to gouge a customer, eventually the customer will get wise to the situation and in the hyper competitive world of IT reselling, the longer term reputational damage is often terminal for the VAR.

In the OpEx vs CapEx debate there is no winner. But being able to offer a clear and credible choice will stand any channel partner in good stead with customers and ultimately deliver long term and profitable relationships.

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