Why CFOs and Cloud Computing Have a Love-Hate Relationship

As I’ve noted a number of times, cloud computing promises both greater IT agility and reduced costs. No one disputes the agility issue. Compared to traditional resource deployment that can drag on for weeks or months, cloud computing offers the enormous improvement of a timetable measured in minutes.

On the subject of cost, however, there is no consensus. I discussed the subject a couple of weeks ago. The other perspective made itself known last week with this opinion piece in InformationWeek. The author evaluated the historical price changes in AWS S3 storage vs. on-premises, disk-based storage and concluded that AWS isn’t cost competitive. Moreover, he asserted that AWS storage isn’t realizing (or at least, isn’t passing on) the benefits of Moore’s Law, since its prices aren’t dropping as rapidly as on-premises storage pricing.

I don’t want to get into a debate about the article, as I believe there’s ample evidence that, for a broad range of uses, cloud storage is more cost-effective than on-premises alternatives. One has only to look at the enormous growth of Amazon S3 to confirm that a very, very large number of organizations have come to the same conclusion.

The CFO View of Clouds

However, the question of cloud pricing is an interesting one. The reason for this is clear: While agility is primarily an IT-focused topic, pricing brings in financial analysis, the province of the CFO. How CFOs evaluate cloud pricing will have a large impact on adoption. If CFOs are convinced that cloud computing offers financial benefits, one can expect that there will be significant impetus toward adoption, particularly since, in many companies, the CIO reports to the CFO.

Today, CFOs have a love/hate relationship with cloud computing. With time, their stance will inevitably shift toward a preference for cloud computing and away from on-premises installations such as those described in the InformationWeek column.

Why CFOs Hate the Cloud

Let’s start with the hate part of the equation, as it’s relatively easy to understand. Cloud computing services that are priced according to resource consumption carry costs that vary over time. If you use a lot of resources one month, the bill will be higher than the bill for another month when resource use was light. Variable, unpredictable pricing messes up financial forecasting, including the all-important cash flow projections. CFOs are instinctively uncomfortable with financial commitments that cannot be estimated ahead of time.

One way to solve this, of course, is to purchase what are often referred to as “external private cloud” services. In this approach, the customer commits to a certain level of resource availability from a cloud provider. This offers the benefit of a fixed cost. On the other hand, this model also poses the problem of requiring a forecast of resource use, with the associated risk of under- or over-provisioning. Amazon offers a variant of this approach with its reserved instances — by pre-paying a fee upfront, the buyer obtains a lower cost per resource unit used. As an example, by pre-paying $69 per year, one can obtain a small virtual machine price of 3.9 cents per hour, a 51 percent savings compared to the standard eights cents per hour for an on-demand machine.

This approach has the virtue of reducing the cost variability, although it still requires some element of forecasting. For applications with a predictable base level of demand and only occasional unforeseen spikes, this approach can reduce the overall cost and decrease the risk of cost variability.

My own belief is that if finance departments save significant amounts of money compared to traditional methods of funding IT, they will learn to deal with any uncertainty. I also expect a number of businesses like Strategic Blue to spring up. Strategic Blue applies financial techniques to enable its customers to achieve predictable pricing while still enjoying the benefits of on-demand use. Many of these sorts of futures-oriented financial intermediaries will come into existence to address this issue and mitigate the uncertainty of variable pricing.

Why CFOs Love the Cloud

Now that we’ve addressed hate, let’s look at why CFOs love the idea of cloud computing.

It’s important to recognize a critical role CFOs play in acting as the arbiter among all the competing demands for corporate capital investment. Every corporation has an ideal level of capital investment that is often dictated by a necessary balance of debt versus equity and reinforced by the discipline of the capital markets (read: Wall Street). And every corporation typically has more demands for capital investment than it has financial capacity to support. The task of deciding which of these demands to satisfy falls to the CFO.

Consequently, anything that offers the capability to shift spending from capital investment to pay-as-you-go is inherently attractive to a CFO. That frees up capital investment for other purposes. This is nothing more than the “CapEx vs. OpEx” topic that is common to financial discussions relating to cloud computing. The fact that this issue is well known and widely discussed does not negate its value or importance, however. Excising one type of capital investment from the group of demands is extremely valuable.

But there are additional benefits available from cloud computing from the CFO’s perspective. These primarily relate to the pattern of spending on cloud computing compared with traditional infrastructure.

Essentially, paying for on-demand cloud computing enables businesses to avoid making a large investment at the commencement of a project. In other words, a company has no need to make a large computing investment in the early phases of creating an application. As we’ve just discussed, the uncertainty of how much the monthly bill for a cloud computing application will be disquiets the CFO. In my view, the ability to avoid a large capital investment trumps the uncertainty associated with monthly charges. Put another way, there is more uncertainty associated with making large capital investments than there is in the monthly variation of application costs.

There are three types of uncertainty that cloud computing can reduce:

1. Application Scale Uncertainty

One of the greatest challenges during the early phases of creating an application is the uncertainty associated with it. Will it be successful at all? Will it grow gradually? Might it experience skyrocketing adoption?

Traditionally, the need for capital investment in kit required a forecast in a period of uncertainty. That meant that one had to make a bet before knowing what the payoff might be. Even worse, if the application is placed into production and then, some period later, experiences a very heavy load it will require an “emergency” capital investment that can disrupt subsequent capital planning. As I discussed in a recent blog post on the consumerization of IT, applications are going to experience much higher levels of load variability, exacerbating this longstanding problem. The ability to match capacity to load and pay for only what is required significantly reduces uncertainties of the application’s scale, offering significant benefits from the CFO’s perspective.

2. Company Uncertainty

While mergers, acquisitions and downsizings have long been a feature of the business landscape, the pace of change in this area seems to be accelerating — a lot. All of these organizational changes disrupt many aspects of business activity, but one prime area is in IT. The number of users for an application can quickly grow or shrink based on events driven by company strategy. Trying to assess the IT impact during the post-announcement, pre-implementation period of a major corporate change is difficult.

From the perspective of a CFO, the uncertainty associated with corporate maneuverings is large. Being able to respond to corporate changes without having to address computing infrastructure reduces the challenges of company uncertainty. It seems likely that the flexibility offered by pay-as-you-go will outweigh the uncertainty of fluid monthly fees.

3. Economic Uncertainty

Looming over all other types of uncertainty is that of the overall economy. Who can confidently predict what the economic situation for any country will be in 12 months’ time? If you’re a CFO, knowing that the storm tides of the global economy may crash upon your company is disquieting, to say the least. Making capital investment decisions in such an environment is extremely risky.

It’s easy to see the result of what happens when capital investment decisions are made in a period of economic uncertainty. The total level of investment plummets. Since the onset of the financial crisis in 2008, corporate profits are up, but private-sector investment is significantly lower.

Taking advantage of the on-demand model of cloud computing would make the risk of IT decisions during such a period much lower, and foster increased use of IT. In fact, one could argue that, given such a troubling economic climate, companies might launch more IT projects due to the need to find new areas of growth and innovation.

In sum, uncertainty and its attendant risk are associated with every choice we make. For CFOs, the choice is whether to accept modest levels of uncertainty to avoid higher levels that other choices might entail. We are in a period of transition, with financial organizations still learning how to manage in a world of variable costs. There is little doubt in my mind that, in the long term, CFOs will develop comfort with the new financial model of on-demand payment and will also develop techniques to reduce the payment variability associated with that framework.

Bernard Golden is the vice president of Enterprise Solutions for enStratus Networks, a cloud management software company. He is the author of three books on virtualization and cloud computing.