Land of the dinosaurs: Is CapEx IT about to go extinct?

For many years now, cloud service providers have been engaged in a relentless marketing effort designed to get their customers to move anything and everything to the cloud. Over time though, three things have become increasingly clear.

• Cloud services are more than just a fad, and they aren’t going to go away.
• Most software vendors greatly would strongly prefer that their customers use cloud services, as opposed to on-premises resources.
• In spite of the cloud’s ever-increasing popularity, some workloads are better suited to be run on-premises.

Before I tackle the issue of whether or not CapEx IT is about to become extinct, I want to delve a little bit more deeply into my second bullet point from above. Based on my observations, there are three main reasons why most software vendors greatly prefer that their customers use cloud resources rather than running software on-premises.

Why the cloud is so attractive — to vendors

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First, by forcing customers to run their software in the cloud, software vendors virtually eliminate the problem of software piracy. While some might be quick to point out that software piracy has been greatly reduced through the use of Internet-based software activation, software companies are still losing money through intentional or unintentional license violations. After all, some software licenses can be complicated or ambiguous, and there have been numerous examples of companies that have unintentionally violated the terms of a license. Cloud services eliminate this problem for the software vendors by tying a subscription fee directly to the license.

A second reason why software companies prefer that their customers operate in the cloud is because doing so has the potential to greatly reduce a software vendor’s support cost. When an organization purchases software to run on-premises, the software vendor has no control over the environment within which the software will be installed. The software vendor also has no way of guaranteeing that the customer will install the application correctly, or keep the application up to date.

When an organization uses software in the cloud, the software vendor has complete control over the infrastructure within which their product is running. In doing so, the software vendor can eliminate technical support calls related to things like misconfiguration, inadequate or incompatible hardware, and resource consumption issues such as low disk space. While software companies are quick to point out that allowing them to handle installation, configuration, and maintenance of their product provides an optimal experience, the reduced volume of technical support calls likely saves them a fortune.

The third reason — and this is the big one — why software companies prefer that their customers operate in the cloud is because a subscription-based licensing model generates recurrent revenue. When a customer purchases a software application to run on-premises, they pay a flat fee for the license and may not incur any additional costs. A software vendor’s only hope for deriving additional revenue from that customer rests on the possibility that the customer will eventually need additional licenses or will eventually upgrade to the next version of the software.

In the case of software-as-a-service, however, the customer pays a subscription fee each month, thereby creating a steady revenue stream for the software vendor. Over time, the cumulative subscription fees far exceed the cost of purchasing the software outright.

So as you can see, it is clearly in a software vendor’s best interest to get their customers to subscribe to a cloud-based product. Doing so lowers the vendor support costs, eliminates losses due to piracy or license violations, and creates a steady, ongoing revenue stream. For a software vendor, this is nothing short of a dream come true.

What about hardware?

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Even though this is a great time to be in the software business, life hasn’t been so great for the hardware vendors. Over the last decade, hardware vendors have suffered from a one-two punch. First, organizations started using technologies such as server virtualization and containerization to consolidate workloads, thereby reducing the amount of hardware that was needed. More recently, organizations have been migrating more and more of their resources to the cloud, which has also hurt hardware vendors.

It is easy to assume that hardware vendors haven’t really been hurt all that much by the mass exodus to the cloud. After all, cloud providers need hardware. At the same time, however, the larger cloud providers purchase so much hardware that they are almost certain to be receiving a huge volume discount from the hardware providers.

Even if you were to put the issue of declining sales aside, hardware vendors suffer from some of the same issues that plagued software vendors a few years ago. More specifically, a piece of hardware is a one-time purchase. Sure, hardware vendors have tried to improve their bottom line by selling maintenance contracts, but at its most fundamental level, a piece of hardware does not generate recurrent revenue.

Earlier this year, HPE announced that it is going to adopt consumption-based pricing for its entire portfolio of products within the next few years. What this means is that a cloud-like pricing model will apply to the hardware that is running inside of an organization’s own datacenter. Rather than purchasing datacenter hardware at a flat price, as has been done in the past, enterprise customers will be billed based on how much of the hardware’s capacity they are using.

In many ways, this new pricing model is similar to a car lease. Leasing a car tends to be less expensive than purchasing a car because you are only paying for what you use (mileage, depreciation, etc.). Of course, the downside to leasing a vehicle is that regardless of how much you might pay, you never actually own the car. In the case of datacenter hardware however, the issue of ownership will be a moot point since the hardware cannot be used without paying a fee to the manufacturer.

So, is CapEx IT about to go extinct?

So let’s revisit my original question. Is CapEx IT about to go extinct? The short answer to the question is that I honestly do not know. My guess is that right now there are a lot of hardware vendors that are watching HPE very closely to see if they can get away with switching their entire product portfolio to a consumption-based pricing model. If HPE can make the idea palatable to their customers (which does seem likely), then it will only be a matter of time before the other vendors follow suit and switch to a consumption-based pricing model. At that point, CapEx IT will truly be extinct.

In a way, I can’t help but be reminded of the airlines. About 15 years ago, one of the airlines began charging passengers for their checked bags. (Before that, the idea of paying to check a bag was unheard of.) When that change went into effect, passengers were justifiably upset, but not so much so that they stopped flying. When the other airlines realized that passengers were continuing to fly in spite of the new fees, they too began to impose fees on checked bags. Eventually checked bag fees became the norm.

I think that the same thing will happen within the IT industry. Initially, there will be those who oppose having to pay a usage fee for the hardware residing in their own datacenter. Eventually, though, everyone will adopt consumption-based pricing and it will become the accepted way of doing business.

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