The Cloud

Their Business, Your Risk

As the cloud market matures, it’s important for CFOs to understand the cloud-provider business model and track their business risks. If your provid...
Rob LivingstoneOctober 17, 2012

Security, privacy, location of data, total cost of ownership, lack of standards, and vendor lock-in are just a few of the well-understood risks of cloud computing. A less understood, but no less important, risk is your cloud provider’s business model. By understanding your provider’s underlying business model, you can gain a better understanding of how its problems can quickly become yours should it be unable to maintain its ongoing (and necessary) investments in the people, processes, and technologies that keep its product suite secure, robust, and current.

At the technical level, there’s nothing terribly mysterious about cloud computing. At the end of the day, we’re still talking about operating systems, software applications, and database systems running on IT infrastructure in data centers, supported by a mix of technologies and a daisy chain of IT providers.  But at the heart of a cloud provider’s offering lays its business plan, investment strategy, technology, and innovation road map. And that can be less transparent.

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If you’re running your business’s critical systems in the cloud, you’ll want to be the first to know if your vendor is having problems. Exiting the cloud on anything other than your own terms is traumatic, expensive, and risky. So let’s go behind the scenes and look at some of the key issues cloud providers face as they develop, market, and support their products.

No Capex for You; Plenty for Them
The core of the cloud’s value proposition is its pay-as-you-go model.

The benefit of shifting from paying for IT with capital expenditures to accounting for it as an operating expense is a generally accepted mantra in the cloud marketing world. In fact, the reality is that someone in the cloud provider’s ecosystem is taking on financial risk by laying down serious capital: signing multiyear service contracts with data centers (or building their own), taking out leases for staff and back-office services, purchasing hardware, implementing networking technologies, and contracting for other professional services. As CFOs know, there’s no free lunch.

The provider’s risk lies in balancing its customers’ demands to pay for cloud-as-a-service (preferably without any long-term commitment) against the long-term financial liabilities it incurs to meet those demands.  How can CFOs best identify and quantify that risk?

Is knowing whether your provider’s funding is based on private equity, a joint venture, or a future initial public offering likely to affect your selection process?  If a foreign entity holds a majority share in your provider, would that concern your organization?

As a CFO, you’re well equipped to do your own due diligence on the funding structures behind your provider’s business. And doing so is a good idea. It could yield surprising results.

For Providers, Cash Is King
Cash-flow management is far more complicated in the cloud-provider world than it is in the cash-up-front conventional software-licensing universe. Factors such as the cost of customer acquisition, customer payment terms, customer longevity, and the structure and timing of sales incentives for sales teams can have a dramatic impact on cash flow.

The largest determinant of the ongoing profitability of the cloud provider’s business is customer retention and the subscription renewal rate. A flight of customers to a competitor could cause serious problems for the provider’s cash flow and could pretty quickly threaten its viability.

Regularly monitoring the financial performance of your provider is a worthwhile exercise. Fundamental changes in earnings, the size or composition of its customer base, market share or ranking, and product mix and key staff movements can all be warning signals that something is up. Monitoring these indicators and others like them is important, especially if your business is dependent upon their offerings.

A Crowded, Commoditized Market
As cloud services increasingly drift toward becoming true utilities (as e-mail and file storage already have), maintaining margins on these services becomes ever more difficult.  Add to this increased competition, plus the maturation of the customer’s ability to buy wisely, and you get an extremely challenging market environment. If most of your cloud provider’s revenue is derived from one service, and that service is becoming a commodity, should that concern you? Imagine your business in a similar position. How good would you feel about that?

The Cloudwashing Argument
Almost every traditional IT vendor is now offering a cloud service of some sort.  Not all of these services will have all the attributes of true cloud offerings, such as automatic upgrades, pay-as-you-go pricing, or dynamic workflow scalability. However, whether these are genuine cloud services or a traditional hosting or managed offering with cloudlike pricing is a bigger deal for cloud vendors than it is for you. Let them argue about it. A well-known provider with a long pedigree may offer you some comfort from the perspective of its long-term financial viability, but even that comfort may be illusory. How committed is it to the offering you’ve signed up for? Is it central to its business? That may be more important to you than either its balance sheet or the cloud credentials that come along with its service.

In all cases, the key is for CFOs is have a clear understanding of what props up their cloud provider’s business. If you need its services to run your business, you need to have your exit plan mapped out, tested, documented, widely understood, and up-to-date.

These plans will be crucial to your business should your provider’s business model and funding arrangements be unable to withstand the increasing turbulence that will precede the cloud market’s maturation and inevitable rationalization.

Rob Livingstone, a former CIO, is the author of Navigating Through the Cloud. He runs an IT advisory practice and is also a Fellow at the University of Technology Sydney (UTS), Australia, where he teaches strategy and innovation in UTS’s flagship MBITM program. Visit Rob at or e-mail him at [email protected].