This would be a good time to test your cloud ROI

Enterprises have been moving steadily to the cloud for years, often paying for multiple cloud platforms — and the COVID-19 pandemic greatly accelerated that trend, as businesses closed offices and outsourced their on-prem operations. 

Now, as the pandemic seemingly winds down and workers are returning to the office, several questions arise: Has anyone on your team run an ROI analysis on your cloud use? Is your company actually saving money? Is the cloud-centric environment indeed more scalable and secure than your team can deliver internally? Has someone — anyone — recently done the math? 

David Heinemeier Hansson, the co-owner and CTO of 37Signals (maker of Basecamp and HEY), argues that many have not — and they need to. With 2023 just around the corner, and the need to support fully remote workers with cloud-based apps and software waning, this is the time to crunch some numbers. 

The role of accounting

Part of this ROI disconnect involves accounting categories. A CFO, for instance, can reject a request for additional IT staffing —and then approve a much larger expenditure for cloud investment. That can happen because IT costs could be considered Capital expenditures (CapEx) and cloud costs could be considered Operating expenses (OpEx), Hansson argued. That separation can make it more difficult to recognize whether the tradeoff makes financial sense to the overall enterprise.

Like everything in accounting, there is a lot of interpretation. Hyoun Park, the CEO and principal analyst for Amalgram Insights, agrees that accounting techniques could obscure the costs of the cloud. But it may not be an OpEx versus CapEx issue. 

“The (accounting) complexities can get pretty nuanced,” Park said. “CFOs start thinking about ratios and metrics that might not make sense for straight-forward profits. Cloud is considered cost of goods sold and IT hiring would be seen as an investment for a longer period of time. A lot of companies focus on revenue per employee, which is top-line revenue divided by the number of employees. That is a metric that is fairly common as part of CFO compensation.”

In short, this explains why shifting dollars away from IT to the cloud can appear to be advantageous to a CFO, even if it doesn’t necessarily help the business. 

Park argues that the key number to focus on is 30%: That’s what he is projecting is the profit margin from the major cloud companies. Absorb that number for a moment, then ask again how much cloud platforms make sense financially. 

When the cloud makes sense

There is a lot to be considered on the other side; the cloud can indeed make excellent sense for some businesses in some situations. It’s perfectly reasonable for smaller SMBs that have no IT teams. And, financial details aside, the cybersecurity capabilities can certainly help companies that do not have robust cybersecurity operations of their own.

Of course, there is also the single-point-of-failure issue, which the industry has seen repeatedly. If a cloud platform goes down, it takes a large number of companies with it. This forces a tricky calculation: Is your enterprise better positioned to fight off an attack than Amazon or Google? It’s a critical question and, sadly, it may be impossible to definitively answer.

There are many other reasons an enterprise might make a cloud investment beyond pure ROI. Again, take cybersecurity. For many enterprises whose focus on cybersecurity is, well, relatively lax, a large cloud environment can potentially deliver better security. 

The other perceived value of the cloud relates to a poor perception of a company’s IT operation. It’s the quintessential example of Shadow IT. A workgroup needs to scale up for a project. They put in a request to IT and they either don’t hear back or are told it will take quite some time to get to their request. At that point, some line-of-business manager just decides to whip out a credit card, buy the needed space from a major cloud platform, and expense it. 

Put another way, when IT moves too slowly and isn’t adequately staffed for a company’s needs, the cloud option looks mighty attractive to business units. That brings us to math crunching task No. 1: If a company could take all the dollars it spends on cloud — including the easy-to-miss shadow expenses — and instead use that money to hire more IT people and expand its on-prem server farm, would the company save money? Given Park’s cloud profit margin figure, there is an excellent chance you’ll do better financially by making that IT investment.

Hansson argued in a well-thought-out blog that the cloud may no longer make sense — especially in a 2023 context — for a lot of SMBs. (His arguments could just as easily apply to many enterprises.) 

“The cloud excels at two ends of the spectrum,” Hansson wrote. “The first end is when your application is so simple and low traffic that you really do save on complexity by starting with fully managed services. It remains a fabulous way to get started when you have no customers and it’ll carry you quite far even once you start having some. Then you’ll later be faced with a Good Problem once the bills grow into the stratosphere as usage picks up, but that’s a reasonable trade-off. The second is when your load is highly irregular. When you have wild swings or towering peaks in usage. When the baseline is a sliver of your largest needs. Or when you have no idea whether you need 10 servers or a hundred. There’s nothing like the cloud when that happens, like we learned when launching HEY, and suddenly 300,000 users signed up to try our service in three weeks instead of our forecast of 30,000 in six months.”

Hansson argues that the cloud at one point made sense for his business, but no longer does.

“Yet by continuing to operate in the cloud, we’re paying an at times almost absurd premium for the possibility that it could (be needed). It’s like paying a quarter of your house’s value for earthquake insurance when you don’t live anywhere near a fault line,” Hansson wrote. “We’re paying over half a million dollars per year for database (RDS) and search (ES) services from Amazon. Yes, when you’re processing email for many tens of thousands of customers, there’s a lot of data to analyze and store, but this still strikes me as rather absurd. Do you know how many insanely beefy servers you could purchase on a budget of half a million dollars per year?”

He then addressed the “but you need to pay people to manage those servers” issue.

“Anyone who thinks running a major service like HEY or Basecamp in the cloud is simple has clearly never tried,” he said. “Some things are simpler, others more complex, but on the whole, I’ve yet to hear of organizations at our scale being able to materially shrink their operations team just because they moved to the cloud.”

In an interview, Hansson reiterated that how accounting calculates and categories costs plays right into the marketing hands of the large cloud vendors. The idea of renting instead of buying delivers “an accounting advantage that might look much better to investors,’” he said, adding that the problem is worse for companies “where the IT is so dysfunctional.

“Run the damn numbers. How does it cost you to rent the computers from Amazon? What if you just bought them yourself?” Hansson argued. 

Hyoun made much the same argument. “Many enterprises have not calculated the ROI of what brings value to the organization. They have a $50 million cloud contract. Think about what else you could get for that $15 million.” 

That $15 million figures refers to what a 30% markup would be on a $50 million contract.

But this can get messy when plunging into the practical realities of enterprise operations today, Hyoun said. “You have to show growth, capabilities and roadmaps that help show a good future for the company. But too many enterprises have overinvested in public cloud computing because they believe it shows their that they are a future facing company, even though they could often get similar results by using on-prem resources and existing talent.”

There is also the perception problem. “Server management is boring and everyone overestimates the time in spinning up a new server,” Hyoun said. “Companies are screwing their day-to-day operations because there are other metrics in play that make it worth it for them. There is a financial incentive to avoid visibility so you don’t have to categorize the costs and perhaps increase your expected cost structure. It doesn’t hurt F500 companies to sometimes be ostriches for longtail IT costs.”

And there is a perceived people shortage issue. Some enterprise execs believe they can’t hire sufficient talent to manage their own operations, so they feel justified in paying a cloud platform a lot more money to make the problem go away. The issue is less about a lack of IT talent, and more about companies that still pay what they did years ago. (The inflation they complain about needs to hit salaries as well; and for skillsets that are highly valued, companies needs to pay far more.)

There’s also an ongoing psychological factor. In 2020, when COVID-19 first hit, companies had to close offices and make a lot of emergency cloud purchases. Many CIOs and CISOs forced into those decisions — paying whatever the cloud vendors asked for — felt burned and don’t want to go through that again. 

Truth be told, it might happen again. And no one is saying all cloud investments should be taken back. SaaS applications still make a lot of sense. But run the numbers and fight back against CFO accounting sleight-of-hand that makes spending $80 million to avoid investing $30 million look like a good financial move. Find out the salaries you’ll have to pay to attract the on-premises talent you need and drop the numbers into a spreadsheet.

If the cloud ends up cheaper, great. But I think a lot of enterprises will run the calculations and discover it may not.