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Capex vs Opex: The changing trend in IT spend

Richard Kempsey Brennan Content Writer Linkedin Profile
Capex vs Opex: The changing trend in IT spend

With the rise of ‘as-a-Service’ delivery models, IT leads now face decisions beyond just placing the right technology bets. They have to determine how they’re funded.

The trick is to know which model – Capex or Opex – is right for your project, your budget, and your company. We explored both, and spoke with Steve Banfield, Brennan’s Chief Financial Officer, for his view on how to make sense of the numbers.

Expressed at its simplest, Capital Expenditure (Capex) is company spending that takes the long view.

Typically used for major investments and shown on the company’s balance sheet, capital is exchanged for an asset, one that can be capitalised and depreciated over its lifespan. Chosen well, these investments create long-term value to the business.

On the flipside, Operational Expenditure (Opex) spends in the here and now.

Commonly earmarked for ongoing expenses, Opex is shown on profit-and-loss statements (P&L) and isn’t exchanged for tangible assets. However, Opex is usually tax-deductible in the year it is incurred, which can offset the fact it doesn’t deliver a depreciating asset.

IT Capex in action

Used for the one-time purchase of fixed assets that benefit an organisation beyond the year of purchase (at which point it’s considered an existing asset), a few common examples of Capex in IT settings include:

  • Air conditioners
  • Computers
  • Data centres
  • Firewalls
  • Generators
  • Land for data centre facilities
  • Mobile devices
  • Network switches
  • Physical plants
  • Printers
  • Routers
  • Servers
  • Software licenses
  • Universal Power Systems

The CFO’s view: The time value of money.

It is important that decision makers consider the ‘time value of money’. Imagine having a choice of incurring Opex of $1.2 million over five years, or a one-time Capex investment of $1 million. That $200,000 discount may look attractive at first blush. But if you take into account the interest cost associated with paying upfront, it would likely make a difference to your decision. Not considering that ‘time value of money’ is a trap to avoid.

How about Opex?

Earmarked for recurrent ongoing costs that support an organisation’s daily business activities, one of the hallmarks of Opex is that they are typically consumed in the year they are purchased. Common Opex examples include:

  • Contracts (think domain registrations, hosting, maintenance, and service agreements)
  • Insurance
  • Marketing, advertising, and events
  • Office supplies
  • Rent or property taxes
  • Repairs and maintenance
  • Utilities
  • Travel and accommodation
  • Wages

The shift from Capex to Opex

With the explosion of digital solutions – cloud, automation, and ‘as-a-Service’ offerings – the cost model for a multitude of IT products and services that were once considered Capex have now switched code to be classified as Opex. Prime examples include:

  • Data storage
  • Infrastructure as a Service (IaaS)
  • Managed IT services
  • Managed security services
  • Platform as a Service (PaaS)
  • Software as a Service (SaaS)

Instead of depreciating (like Capex items), Opex purchases are recorded in an organisation’s P&L statements and deducted from the bottom line as they are incurred.

The CFO’s view: The Opex appeal

Technology is such a fast-moving space. But Capex investments tend to lock you in for the long haul. And the bigger the investment in a single Capex initiative, the higher the risk. Opex is inherently less risky. Because you’re not locked in, you can change course more quickly. That is certainly one of the key attractions for Opex and may explain why a growing number of organisations are increasingly becoming Capex-light.

The upsides (and downsides) to each

Every company needs to invest to succeed. And understanding the strengths, weaknesses and financial implications of Capex and Opex can offer strategic insight in when to use them and how to deploy them.

Capex offers several benefits to organisations, including:

  • Agency: The outright purchase of hardware and software offers total control of how you implement and use it, including the freedom to modify it as your needs or the market changes.
  • Certainty: Knowing the exact costs of a Capex purchase – both the initial cost and its depreciation schedule – offers certainty.
  • Continuity: Invest in your own equipment and you remove many of the blockers linked with subscription models. Servers are a prime example. You won’t need to deal with license renewals as you would if purchased on an Opex basis.
  • The long view: Capex items are investments that fill needs both in the now and the future. All things being equal, they should deliver value for years to come.

On the downside, Capex comes with several risks, including:

  • Crimped agility: The longer the commitment, the larger the investment. And these sunken costs – in money, time, and manpower – can create two unintended consequences. The first is to limit your hand in adopting newer, smarter technologies. The second is a reluctance to change course, even when the market demands it, or your competitors change tack.
  • Locked in for the long term: Purchasing hardware outright handcuffs you to the maker, which can create complications down the line if it can’t adapt to changing demands, the vendor falls short on their promises, or, in the worst-case scenario, folds entirely.
  • Maintenance pains: You’ve bought the assets outright. Now you need the in-house resources to manage them. You could solve that by reallocating existing staff or hiring new staff. But the first fix dilutes the focus on other business-critical issues. And both fixes eat into profits.
  • The future arrives fast: In trying to predict future needs, there’s always the risk you’ll buy more capacity than you ultimately use or invest in solutions that age faster than you’d like, making it harder to fully realise a return on your investment.

The CFO’s view: Does it merit capital?

An Opex vs Capex decision can also be informed by funding availability. A business may need to preserve capital or have an alternative higher priority use for the available capital, in which case Opex would become more attractive than Capex.

How about Opex? Here are a few key benefits

  • Greater freedom: Purchasing IT services and solutions as Opex tends to carry less risk than Capex. If technology advances (it always does) or the market evolves (it always will), your budget can flex accordingly. And if you’re not satisfied with a particular vendor, you’re free to vote with your wallet and switch to one that better meets your needs.
  • Maintenance managed: With the vendor handling most if not all of the network and equipment maintenance, it means your people are free to focus on the initiatives and activities that improve your products and services, lift efficiencies, and increase profits.
  • Delivered at pace: On-demand services can smash typical deployment lead times, down from months and years to days or even hours. The result? More productive workers. More satisfied customers.
  • Versatility: Things change quickly in business. And one of the key upsides of a subscription model is the ability to reconfigure services and architecture on a dime. And if a project is completed or aborted? You can retire the supporting services and their associated costs.
  • Greater budget flex: Pay-as-you-go services and other IT operational expenditures frees up cashflow for other needs.

The CFO’s view: Pricing in risk

Just as important as considering the time value of money is ensuring that risk is priced into an investment decision. When deciding to invest, the projected returns from the investment are rarely guaranteed. Using a target return rate that prices in both the inherent risk in the investment as well as the time value of money will help ensure that capital is deployed wisely.

And here are the common challenges associated with Opex:

  • The stealth cost: Smaller recurring subscription costs may look attractive on paper. But those smaller expenditures can prove to be a false economy when calculated over longer timeframes, often costing more than outright ownership.
  • Fraught forecasting: While there are considerable fiscal upsides to pay-as-you-go models, they can complicate long-term forecasting if your consumption see-saws dramatically from month to month.
  • Lack of control: A reliance on third-party services means less direct control over solutions and technology.

Maximising capital potency.

In today’s dynamic tech landscape, businesses with an astute understanding of Capex and Opex can maximise the potency of capital, leverage it in ways that boost innovation, productivity, and efficiency, and ultimately create a significant and lasting competitive advantage.

The first step is to gain full visibility on all IT-related costs, both the obvious and the hidden. Only once you understand those costs in totality can you make an informed call on investments – be it on-premise infrastructure that calls for Capex, or a cloud service provider funded through Opex.

As always, the final call will align with your company’s goals, strategy, requirements, and budget. And in an ideal world, shrinking Capex and Opex – without sacrificing availability, usability, output, or service – will always be the shrewdest investment.

This article does not constitute financial advice.

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