Virtualization and cloud computing bring costs down by enabling the reuse and sharing of physical and application resources leads to a more efficient and higher degree of utilization for that particular resource.
Most IT organizations today are under enormous pressure to keep their budgets in check. Their costs are going up, but their budgets are flat to decreasing as illustrated in the figure below. This is more true than ever in this period of economic and financial crisis. The situation is not sustainable and eventually leads to unpleasant conditions such as slower technology refresh cycles, reduced expectations for IT value delivered and layoffs. The service re-use inherent in cloud computing promises long lasting relief from the cost treadmill.
Conceptually, a portion of IT budgets is used to maintain existing projects. It's the portion dedicated to maintain office productivity applications help desk or the organization that provides telephone services. This portion is important because is the part that “keeps the business running” (KTBR). In most IT organizations, the KTBR portion takes the lion’s share of the budget. The downside is that the KTBR is backward looking, and it’s only the leftover portion that can be applied to grow the business. There is another problem: the KTBR portion left unchecked tends to grow faster than IT budgets overall, and the situation can't stay unchecked forever.
A number of strategies have been used in IT organizations to keep the KTBR growth in check. Perhaps the most oft used in the past few years is the outsourcing of certain applications such as payroll and HR applications such as expense reports and the posting of open positions in the corporation. When outsourcing (and perhaps off-shoring) is brought in, costs actually go up a notch as reorganizations take place and contracts are negotiated. Once the outsourcing plans are implemented costs may go down, but still have the problem of sustainability. Part of the initial cost reductions comes from salary arbitrage, especially when the service providers in lower cost countries. Unfortunately the cost benefit from salary arbitrage tends to diminish with time as these countries advance technically and economically.
A third alternative comes from technology refreshes as shown below.
The introduction of a new technology, lowers the cost of doing business, seen as a cost dip. Costs can be managed through aggressive “treadmill” of technology adoption, but this does not fix the general uptrend, and not many organizations are willing or even capable of sustaining this technology innovation schedule.
Finally, the adoption of cloud computing will likely lead to a structural and sustainable cost reduction for the foreseeable future due to the synergies of reuse. As in the outsourcing case, there is an initial bump in cost due to the upfront investment needed and while the organization readjusts and goes through the learning curve.
Cloud computing reduces both capital and operational expenses through multiple factors:
- Economies of scale: The service provider becomes an expert in the field and can deliver the service more efficiently at lower administrative costs than any other provider, possibly at a lower price than the cost of implementing the same service in house. (OpEx)
- The infrastructure is shared across multiple tenants. (CapEx)
- Application software licensing costs are shared across tenants.(OpEx)
- The environment is virtualized allowing dynamic consolidation. Servers are run at the most efficient utilization sweet spot, and hence fewer servers overall are required to deliver a given capability. (CapEx)
- The traditional IT infrastructure is highly siloed. Once these silos are broken, there is no need to overprovision to meet peak workloads. (CapEx)
- Expensive and slow capital procurement processes are no longer necessary. (CapEx)
- The IT organization can defer server purchases and decommision data centers as in house capabilities are phased out in favor of cloud services (CapEx)