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How cloud costs can undermine your company valuation

28th November 2019 by 
Dr. Manzoor Mohammed Cloud Cost

There’s no doubt that cloud is essential for any organisation wanting to stay competitive and encourage innovation to flourish. And if managed effectively, it can offer significant cost-saving and efficiency benefits.

But when it comes to your company’s valuation, the cost of cloud could be doing significant damage to your bottom line.

That’s because valuations are based on a multiple of earnings before interest, taxes and amortisation (EBITA). In the pre-cloud days, capital investments like hardware and software were accounted for as capital expenditure – which doesn’t affect EBITA.

But cloud is classed as an operating expense – just like salaries and rent – which has a material impact on valuation calculations.

Why is it important?

EBITA equates to annual net earnings before any tax, interest or amortisation payments. Market valuations are typically in the 12x-15x EBITA range. The higher the EBITA, the higher the valuation – which is why investors and founders alike need to keep a close eye on the bottom line.

But cloud infrastructure and services can be one of the biggest outgoings for many organisations. So if your company is paying for cloud computing that’s not returning any value to the business, it will end up simply eroding the valuation.

Cloud costs are a complex issue

It’s a material issue. Research by Rightscale suggests up to 35% of cloud capacity is wasted because simple housekeeping tasks such as rightsizing and turning off idle instances aren’t regularly performed.

When you consider that the rapid growth of cloud-reliant technology and services means that global cloud spending is only set to increase, the problem of paid-for, but unused capacity will simply get worse if it continues to go unchecked.

The reasons for this are easy access, infinite scale, the pressure to deliver faster and more complex services, the attractive pricing models of cloud-based storage, and the availability of compute capacity. If you can pay for it, you can have as much as you want.

And that’s the trap many organisations fall into.

On the face of it, cloud’s “pay as you go” model can seem like a cost-effective way to reduce IT expenditure, and a refreshing alternative to traditional CAPEX models. But, as I discussed in an earlier blog, the reality is you could be paying for capacity, performance and services that you simply don’t need. Conversely, some senior leaders take the view that executive bonuses can suffer due to the devaluation caused by cloud expenditure. That means they’re at risk of withholding investment in cloud, and missing out on opportunities to innovate and generate value.

So, what’s the answer?

A cloud excellence “strategy” can upsize valuations

Being clear about the value cloud can deliver, and then optimising the way the whole business uses it, is key to bringing down cloud costs without impacting its ability to support growth and innovation.

It’s a discipline we call ‘cloud excellence’ – and it’s one that’s becoming critical for companies that want to scale and innovate without racking up huge OPEX bills. It’s a challenge we helped family history website Ancestry to overcome. We worked with them to identify a range of rightsizing and efficiency opportunities in their cloud infrastructure, saving the company around 40% of its total expenditure.

In our work with another business, we helped the company reduce its annual cloud expenditure from $60 million to $36 million, while still enabling it to grow by 20%.

This meant that its valuation increased by $500 million – a significant sum whichever way you look.

In businesses with tighter margins – such as retail where competition is fierce – reducing base cloud cost and incremental cost per user can make a huge difference.

Weighing cloud costs with EBITA: a critical balancing act

For reasons I’ve outlined in this blog, it’s vital that decisions around cloud strategy and usage are fully understood by senior leadership.

Crucially, that doesn’t mean cutting cloud use at any cost. For most businesses today, cloud is a positive driver of value. But if it’s not completely optimised, the benefits can be cancelled out by the negative impact to the bottom line – and to the company’s valuation.

Control the cost of cloud to deliver real value

You want your business to grow, and cloud is key to your development. But unmanaged cloud costs could also be holding you back. If you’d like to find out more about cloud excellence, visit our website or get in touch with one of our experts.