December 14, 2018

Helping Your Customer Capitalize Cloud-Based Spend

In the course of working with our technology clients and their enterprise sales teams, we’ve noticed an interesting trend in the last six to twelve months.  Increasingly, I.T. buyers are expressing a preference (or sometimes a need) to be able to acquire cloud-based technology as a capital expenditure event rather than as operating spend.  That’s right, the buyer is asking for a CapEx offer vs OpEx.

CalculatorThis is contrary to the pattern of I.T. buyer behavior we’ve seen over the last several years, which has been toward buying technology with operating budget dollars rather than CapEx.  However, a recent pivot toward a desire for spending CapEx dollars shouldn’t be entirely surprising for a number of reasons.

First, as companies have moved to reduce large and costly capital technology expenditures in favor of SaaS (Software as a Service), PaaS (Platform as a Service), and IaaS (Infrastructure as a Service), I.T. operating expenses have ballooned while I.T. capital spend has often leveled off or decreased.  This means that many I.T. buyers now find themselves with available CapEx budget, but a lack of OpEx dollars.  So savvy buyers are trying to find ways to continue down the (X)aaS path and reduce on-premises infrastructure, but they want or need to do so out of the available CapEx budget.

Additionally, if an organization has a focus on near-term operating profit, particularly on EBITDA (earnings before interest, tax, depreciation and amortization), they are likely to favor a capital spend.  This is because capital expenses never hit EBITDA, and trickle to the bottom line over multiple years as the assets are depreciated (“hard” assets) or amortized (software, etc.), whereas operating expenses impact earnings in the period in which they are incurred.

So how can you, as a seller of technology, make your cloud solutions more consumable for your buyer when they prefer CapEx spend over OpEx?  Here are some use cases we’ve encountered where customers may elect to capitalize some or all of their cloud costs:

1. Cloud Implementation Costs May Be Capitalized

The FASB has endorsed a decision from its Emerging Issues Task Force (EITF) that will align the accounting for cloud computing costs with the accounting for the costs from developing or obtaining internal-use software.  The thinking here is that costs for implementation (which may include pre-production subscription costs), employee training, customization, etc. should be capitalized as long-term assets and amortized over the contract’s life.

2. Dedicated Hosting (vs. Multi-Tenant)

Customers have capitalized some or all cloud-related costs when they have a dedicated hosting environment (particularly on premises).  However, we have not seen this tested or reviewed formally by the accounting governing bodies.

3. Hybrid Licensing

In some cases, when a customer pays for a cloud-based, hosted solution, they are actually granted “hybrid” license entitlements, where they have right to consume the technology as a true cloud offering, or to deploy the licenses on-premises in their own data centers.  Depending on the customer’s deployment and usage, and the terms or duration of the contract, customers may treat some or all of the solution investment as a capital expense.

4. Cloud Licenses With Option To Convert To Perpetual

If the cloud license provides an option to convert to perpetual at “minimal” cost, then some customers are electing to capitalize the fixed, committed costs of the cloud license (less the conversion cost).

5. Long-Term Cloud licenses

If the cloud license term is longer than the term over which perpetual licenses are amortized by most customers, then an argument may be made that the cloud license costs may be capitalized.  This is a hypothesis put forth by several financial experts. However, like #2 above, we have not seen any formal review by AICPA or EITF.

HandshakeIf you keep these ideas in mind, you have a better chance of discussing and proposing your solution in a way that provides the solution model the customer wants, while making it consumable for the financial or economic buyer.