CLOUD COMPUTING PRICING CHALLENGES

by Klaus Ehmke

The Cloud Computing service model, boarding (SaaS - Software as a Service, PaaS - Platform as a Service, IaaS - Infrastructure as a Service) it is challenging IT companies pricing departments. It is a great sales model that may increase sales of services and recurring service contracts, but requires an experienced pricing department. 

The Cellular companies implemented this sales model a long time ago. Cell companies deliver a mobile to customers, along with the provision of their services. You are buying your mobile as a service. 

Likewise, in the Cloud Computing model IT companies are delivering their services along with some hardware, software and infrastructure. This model removes the CAPEX – Capital Expenditure from customer’s hands and shares the gains of a shared infrastructure. 

It is the perfect setting for everyone. IT companies will increase sales, recurring revenues and increases services margins. Customers on the other hand no longer need to spend high sums in CAPEX (Capital Investments) and should receive an ongoing up to dated infrastructure paying a smooth monthly fee. 

Klaus Ehmke from Akurat Consulting warns that although it seems a perfect model for everybody, this model imposes significant challenges on IT companies pricing teams, and if all the risks are not properly considered, it may end up in future negative surprises. 

IT organizations must consider numerous financial variables that impact significantly on the final pricing and profitability.

The right level of equilibrium at those many pricing assumptions will determine whether you win or lose the contract against competitors and will avoid future negative surprises. Some examples are:

1. Availability of Capital and or funding - The initial investment ("CAPEX" - Capital Investment), that all your customers wants to avoid now it is on your companies hands. Tech companies must have available cash or bank funding to finance clients’ infrastructure investments.  Small & Medium companies will probably be out of big contracts per lack of funds to finance the required contract investments.
2. Contract term - Contract term significant influences the final price. A 5-year contract is going to dilute investments in 60 months, and of course, the monthly price is lower than a 3-year contract for example.
   
3. Termination Fee - Obviously, the contract term impacts on the final price, as mentioned above, but a long-term contract without a penalty for early cancellation, covering all investments may results in significant losses in case of early termination. Determining the right penalty for early termination is a major challenge in the Cloud Computing model. 
   
4. Hardware lifetime - The useful life of the hardware supplied in the contract is a determining factor in the pricing. In trying to win, the contract is a great temptation to include an additional year in the life of the hardware, but if you need a refreshment before the end of its useful life, for sure your company is going to face a contract margin reduction.
   
5. Shared Infrastructure - A basic principle of Cloud Computing is to share the infrastructure and this is another challenge in defining the price. How to make the correct apportionment of shared infrastructure? Who pays the idle infrastructure? How idle infra should be included in the price of each contract? In summary, another variable that can make final prices go lower, but may end up in significant losses if erroneously estimated. 
   
6. Cost of Capital - What is the cost of capital to be considered in the price? As contracts tend to be long-term, Tech companies must estimate the future rate of interest, consider the average rate of its capital funding, consider the country risk, inflation, etc (basically "WAAC"). A few percentage points of difference in the estimate interest rate may determine a lower price to win the bid, but can also end up in future losses.

When pricing a project there is always a dilemma: be more aggressive on some assumptions to have a more competitive price and win the contract, or be conservative, reduce risk and run the risk of lose the contract to your competitor. How to balance this dilemma it is the big challenge.

Sell ​​IT solutions in the new Cloud Computing model is becoming a financial challenge more complex than the technological challenge, and requires attention because the great contract closed today may became a big financial problem of tomorrow.

Author:

Klaus Ehmke

Partner and Director of Akurat Consultoria

Financial Executive at Technology companies

Associate member of IBGC

email: klaus@akurat.com.br

www.akurat.com.br