Everything As a Service

Transition from Capex economy to Opex Economy

World is in a transition from Macro to Micro. Granularity is on a seismic shift, and this started around a decade and half back with evolution of internet and its reach to the masses. Success and failures were defined and underlined by its reach. Traditional business models are challenged every now and then by the garage breeding models. Traditional businesses are running transformation/s to match up the pace and be relevant with new emerging business models.

To be relevant tons of business cases are up for approval in board rooms for technology transformations with expenses and costs against revenue or profit is bold and underlined. Technology transformations relatively take some time maybe a year or more to be in production line, expense keeps getting released during the course. Released expense is fundamentally reflected in accounting books as fixed asset or a liability to be assumed or consumed within the financial year. Now post the payments starts systems get triggered to calculate the P&L and summary of it in balance sheets.

Most of the organizations have faulty methods to determine the overhead of running the organization. Business cases get developed around Capex and Opex to be amortized or consumed in a particular year and final output is EBITDA.

Organisations in erstwhile were happy creating assets and almost all the assets were depreciating assets over a period. If you wrap asset annual or regular maintenance over period of years, it was almost equal to the price of asset added up which was Opex.

Let’s illustrate this.

Illustration 1

(All illustrations are currency neutral)

From an income tax perspectives, businesses typically prefer OpEx to CapEx. For example, rather than buy IT hardware say laptops and desktops outright for 800 apiece, a business may prefer to lease it from a vendor for 300 apiece for 3 years. This is because buying equipment is a capital expense. So even though the company pays 800 upfront for the equipment, it can only deduct about 250 as an expense in that year. Capex is another form of Opex but applied only on the depreciated value of that particular period.

On the other hand, the entire amount of 300 paid to the vendor for leasing is operating expense because it was incurred as part of the day-to-day business operations. The company can, therefore, rightfully deduct the cash it spent that year.

The advantage of being able to deduct expenses is that it reduces income tax, which is levied on net income. Another advantage is the time value of money i.e. if your cost of capital is 5% then saving 100 in taxes this year is better than saving 104 in taxes next year.

However, tax may not be the only consideration. If a public company wants to boost its earnings and book value, it may opt to make a capital expense and only deduct a small portion of it as an expense. This will result in a higher value of assets on its balance sheet as well as a higher net income that it can report to investors.

Illustration 2

Let illustrate another at an individual person level: This illustration excludes inflation as well as time value of money.

Let’s assume A buys a car for 100000 (currency neutral) and the moment the car is bought it is depreciated by an average 20%, so by basic mathematical logic it will be 0 value and residual value of 20000 and sold off and buyer gets 20000 (it may be higher).

Let’s assume an average 10000 is maintenance is (including regular maintenance and insurance). So, total cost of the vehicle over a period of 5 years is 150000. So, buyer lands up buying it for 130000 (negating the residual value). This is capex model which is primary acquisition of assets.

Now let’s assume the same car is on lease or rented an average rent would be around 2000 per month (including all charges) and yearly rent 24000. Over a period of 5 years it adds up to 120000 (with all expenses covered). So, end customer will save around 10000 upfront. Plus, the customer will have the power of choice to change the car as and when required or upgrade in case customer income allows. This is Opex model. No assets no commitments and power of choice to change service provider or subject matter.

Same can be checked on other personal assets with maintenance and excess cost on acquiring the assets, rather than leveraging on pay per use.

Uber, AirBnB, Netflix and so many unicorn’s have unleashed the potential of Opex as a fundamental model to run their respective businesses and carve out a new business model on revenues, expense and costs. They have ‘Explored the unexplored’.

Customer behaviors are on extreme shift from owning assets to pay per use products and services. On demand products and services supplies are now been discussed in board rooms and fulfillment is been carried out basis on demands. Entire supply chain is on the verge of getting revamped or getting modelled around the demands based ecosystem.

Technology world is shifting the enterprises and individual customers to cloud which is a classic Opex model of Demand services. Demand economics are being worked out at enterprise levels to manage costs and expenses and finally procurement of services on demand basis is been worked out to eliminate waste and make operations more lean.

World has paid a heavy price on acquisition of asset, maintaining it plus not deriving full potential and value of asset. In turn created lot of wastage in cost which goes underutilized.

There is transitional shift in procuring anything and everything as a service and manage cost and expense On Demand. This is making availability as high which is anytime anywhere.

Setups and frameworks are being developed and created to develop even Industry- as- a- Service as well as Human-as-a service.

Above hypothesis needs to be examined before they are applied on any setup, articulation is completely on author’s views basis the experience as practitioner as well as research across industries.

  • Anshul Srivastava
    Anshul Srivastava
    Chief Information Officer, Union Insurance

    Anshul is a global technology leader who has been instrumental in driving technology transformations for businesses in the range of multi Billion USD as revenues.  He has several notable career accomplishments, wherein he has led, created and launched the key ecommerce, mobile and business intelligence initiatives for world's #1 insurance brand AXA in the fastest growing emerging markets of Asia.

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