Calculating the TCO: Cloud vs. On-premise Infrastructure
When it comes to investing in new hardware and software, companies choose between different types of infrastructure models. Which one is better – on-premise, virtual servers in the cloud, or hybrid? Many choose the first option because it is cheaper. They make a very simple calculation – compare prices for buying and maintaining equipment with the cost of services of cloud providers, and then conclude.
This is a mistaken approach. Cloud4Y explains why.
It is important to understand that TCO is not just a fixed value. It is the amount of money, that a company invests from the moment it buys the equipment until it gets rid of it completely. Thus, it reflects the economic impact during the whole life cycle of IT projects.
What is TCO
The Gartner Group officially introduced the term TCO (Total Cost of Ownership) in the 1980s. Initially, it was used in its research to calculate the financial cost of ownership of Wintel computers, and in 1987, it finally formulated the concept of Total Cost of Ownership, which came to be used in business. It turns out that the model for analyzing the financial aspect of using IT equipment was created back in the last century!
The following formula for calculating TCO is generally accepted:
TCO = Capital expenditures (CAPEX) + Operating expenditures (OPEX)
Capital expenditures (or one-time, fixed costs) imply only the cost of acquiring and implementing IT systems. They are called capital costs because they are required once, in the initial stages of building information systems. They also entail future operating costs:
- The cost of project development and implementation;
- The cost for external consultants;
- The first purchase of the necessary basic software;
- First hardware and additional software purchase.
Operating costs directly relate to the IT systems operation. They include:
- The cost of maintaining and upgrading the system (staff salaries, external consultants, outsourcing, training programs, certifications, etc.);
- Costs of complex system management;
- Costs associated with the active use of the information system by users.
The new way of calculating costs has become popular with businesses. The executives came to an understanding that besides direct costs (cost of equipment and staff salaries), there are also some indirect ones. They include the salaries paid to managers who are not directly involved in working with equipment (IT-director, accountant), advertising costs, rental payments, etc. There are also non-operating expenses: interest payments on loans, financial losses due to currency volatility, and payments to contractors. These data should certainly be included in the formula for calculating the total cost of ownership.
To make it clearer, let's list all the variables in our total cost of ownership formula. We start with the capital costs for hardware and software. Our total costs include:
- Server hardware
- Virtualization platform
- Information security equipment (Crypto-gateways, firewall, etc.)
- Network equipment
- Backup system
- Internet (IP)
- Software licenses (anti-virus software, Microsoft licenses, etc.)
- Creating disaster recovery plan (redundancy to 2 data centers, if necessary)
- Datacenter colocation / rent of additional space
Among the associated costs, we should take into account:
- IT-infrastructure design (specialist recruitment)
- Installation of equipment and setup works
- Infrastructure maintenance costs (staff salaries and supplies)
- Lost profit
Here are the calculations for one company
As you can see from this example, migrating to cloud infrastructure is entirely justified – cloud solutions are not only comparable in price with on-premise but also even cheaper. Yes, you have to calculate everything yourself to get objective figures. This is harder than simply evaluating the purchase price. Nevertheless, in the long run, a meticulous approach is always more effective than a superficial one. Efficient management of operating costs can significantly reduce the total cost of ownership of IT infrastructure and save part of the budget, which can be used for new projects.
Besides, there are other arguments in favor of cloud servers. The company saves money by eliminating one-time hardware purchases, optimizes the tax base, gets instant scalability and reduces the risks associated with owning and managing information assets.