Transcript:
A recent study of technology budgeting trends between 2015 and 2016 has revealed that year-over-year capital IT spending has remained flat, although IT headcounts are rising.
In other words, on a per-person basis, capital IT budgets are actually shrinking.
In order to provide some peace of mind around your IT spending, we’d like to share a few financial principles that might help.
First, let’s examine the following scenario:
Johnny’s Pizza Shop has done some market research, and they’ve found that — after gas, labor and other expenses – they could earn an extra $2000 per month if they offered delivery services to supplement their walk-in business.
When shopping around for a delivery van, they found that 2 options were available.
They could purchase the van up-front for $30,000.
Or they could make payments over 2 years, for a total cost of $40,000.</p>
Which option should they pick?
At first, the idea of saving $10,000 with the up-front purchase seems attractive. But there is another way of thinking of this scenario.
With the second option, they would pay $1,600 for the first month. After this, the van would earn $2000 per month for the company. In other words, the van would pay its own rent. In addition to this, the company would still have $28,000 of cash that would be available to other parts of the business.
The second option is a win-win for Johnny’s Pizza Shop. They win twice!
Let’s look at another scenario, which is partly based on a true story.
Kerry wants to start a high-end craft soda pop company. Her aim is to sell bottles at $2.50 each, and produce her soda for $1 per bottle. But in order to do this, she’ll need to purchase some equipment.
In her research, Kerry spoke with the Chris, CEO of another craft soda company. He told her that he’d purchased his bottling machine for $500,000, and it can produce 100,000 bottles per month. This is enough to meet 70% of his monthly demand.
Should Kerry purchase a bottling machine of her own? What would you do in this situation? Where would you get the money to purchase the bottling machine?
Based on their conversation, Kerry determined that Chris’s company has 30,000 bottles worth of unsold excess production capacity every month. Instead of buying a new machine, Kerry arranged a deal to purchase this excess capacity from her competitor.
This way, Chris makes more money, and Kerry can go to market quickly, without incurring significant startup costs. And since Kerry is debt-free, she’ll be profitable sooner.
Both of these scenarios illustrate a core concept of finance, which is especially relevant to IT.
In both of these situations, Kerry and Johnny were about to sink large amounts of money into OWNERSHIP of a piece of equipment. But what they actually wanted was the BENEFIT of controlling that equipment. By choosing to control these resources instead of actually owning them, they were both able to get the benefits they wanted, while also preserving their initial budgets.
When it comes to IT budgeting, it’s important to consider the differences between Cap-Ex and Op-Ex.
In finance, Cap-Ex — or Capital Expenditure — represents the business expenses incurred to create future benefit. By purchasing a sign, a store will attract customers and earn more money. However, it might take 2 years for the sign to make up for its initial construction costs.
Op-Ex — or Operational Expenditure — refers to the costs associated with operation and maintenance of the business. For example, merchandise has a high turnover rate, and can often produce revenue for the store within a month of being purchased from the wholesaler.
Capital expenditures can be problematic. This is especially true in Information Technology, where rapid change and uncertainty are a constant.
You may spend $5000 on a new tape system, and then a change in your infrastructure makes tape inadequate for your requirements. This is often called Capital Risk.
You might risk starting a project that could die during the implementation phase, as many IT projects often do. If you invest a large sum of money into one project, it would prevent you from investing in other projects that require your attention.
An emergency might come up, requiring a large unexpected purchase. This emergency will force you to cancel other plans that you’d had for this money.
In order to get the most out of your IT budget, you should find creative ways to turn Cap-Ex into Op-Ex.
When you turn Cap-Ex to Op-Ex, you take something that would’ve required a significant capital investment, and you try to make it available on a pay-as-you-go basis.
By doing this:
- You can help eliminate capital risk.
- You can force your IT systems to “pay the rent”.
- You deploy faster, and minimize the impact of failed IT projects.
- You free up capital that might’ve been locked up in other projects.
- You’ll be better prepared to deal with unexpected financial emergencies.
- You’ll find new ways to use wasted resources.
In other words, by shifting your IT spending from Cap-Ex to Op-Ex, you’ll squeeze maximum value from every dollar in your budget. And this will provide you with total peace of mind, by enhancing the value that IT provides across the organization.
So if you want total peace of mind for your IT spending, you should focus on turning Cap-Ex to Op-Ex.