Tuesday, January 29, 2013

Could the cloud talk get (even) more loud?

Why the cloud will gain traction with business faster than you think.

Try this question: What’s the single largest capital expenditure item for companies? Buildings? Plant and machinery?  The answer will surprise most people: It’s Information Technology !

This is evident from the US Census Bureau's 2008 Annual Capital Expenditures Survey released March 2010, which shows that US companies spent $233 Billion on “Information Processing equipment” (a category that includes capitalized software, computers and peripherals, and communication equipment) out of a total capital expenditure of $1.33 Trillion. I verified (as you can too) that this was the largest single item, other large items being transportation equipment ($185 Bil), buildings ($164 Bil), and industrial equipment ($152 Bil).

What has driven this surprising development?

Duly surprised by this unexpected discovery, I set out to figure out why this is so. A few moments’ reflection, however, suffices to show that this fact need not sound as outlandish as it does at first blush. Over the past several decades, most forms of corporate capital expenditure have moved to “subscription-based” models such as leasing:

-          Land and buildings have long been leased or rented as a less-capital intensive alternative to purchase;
-          Heavy machinery and transportation equipment are also increasingly being leased. For example, airlines today rarely buy aircraft, preferring to lease them instead.

To be sure, IT too has begun to be subscription-based in the past few years but this trend has not yet penetrated deeply. Hence IT has emerged “by default” as the single largest capital expenditure (Capex) for companies.

This development is potentially disruptive for the IT services industry

As the single largest capex item, IT will attract increasing attention from cost-conscious CFOs in every company. As outlined above, they have become accustomed to reducing up-front costs on most other capital items thru “subscription-based” models such as leasing. Thus, pressure for reducing capex on IT will mount *, accelerating the move towards subscription-based IT models such as cloud computing, utility computing and SaaS.

As corporate IT increasingly moves into the cloud, big brands will seek larger chunks of the cloud pie, including thru alliances / acquisitions of IT services players. This trend is already visible and, driven by the above, is likely to accelerate in coming years. As large branded players gain a stranglehold, standalone players in the corporate IT market may run a risk of being marginalized. To derisk, IT services players must start combining with a leading global technology brand thru alliances / joint venture (preferably by starting subsidiaries dedicated to provision of cloud services).

The best IT services companies will thus position themselves to capitalize strongly on the immense opportunities that cloud-based computing will present as it takes off. The rest? They’ll be among the majority who’ll get “consolidated” away over the next 5-6 years, as I wrote in my last post. As for who falls into which category, time will tell.

* Thus far, the primary means of IT cost saving has been via Outsourcing / Offshoring. However these savings were essentially confined to the services stack. Now subscription-based  IT is available across the entire IT stack -  hardware, software and services.
Also while IT outsourcing has been available for some years, its attraction was limited as it did not change the fundamental cost structure of corporate IT.  Now subscription-based IT sharply reduces cost structure for many reasons including multi-tenancy.