The Cost Advantage Controversy of Cloud Computing

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Here's the thing -- for every opex user there is a capex investor. For every user who delights in only paying for the resources used, there must be a provider who stands ready to provide resources and offer them on an as-needed basis -- someone must own assets.

For that asset holder, a key variable in offering prices is utilization -- what percentage of total capacity is being used. To go back to that crude pricing formula, an example of cloud utilization is what percentage of a servers total available processing hours are sold. The crucial factor is to sell sufficient hours -- i.e., generate sufficient utilization -- to pay for the asset.

This means that IT organizations need to become much more sophisticated about managing load and shaping use. This is typical of any capital- intensive industry -- think of airlines and the sophisticated yield management measures they implement.

I have heard some people assert that utilization won't be much of a problem because most applications are not very volatile; that is, their resource use doesn't vary much. Therefore, high utilization rates can be achieved in private clouds by building a cloud to support typical use plus some spare capacity to support occasional spikes in demand.

I think this misreads likely experience and extrapolates the past inappropriately. This belief underestimates outcomes as application groups absorb the capability of cloud computing. For one, now that highly variable loads can be supported, application groups will begin creating more of these type of applications; heretofore, because it was extremely difficult to get sufficient resources for these type of applications, people didnt even bother thinking about them. Now that a highly variable load application is possible, people will start developing them.

A second way this perspective underestimates future outcomes is that it fails to understand behavior changes as organizations learn that they can reduce costs by squeezing application capacity use during low-demand periods. James Staten of Forrester characterizes this as "down and off," meaning cloud computing cost is reduced as ways to scale applications down or turn resources off. This cost reduction benefits uses, but causes problems for providers.

Finally, the perspective that the cloud will be like past infrastructure use -- mostly stable and low growth -- fails to understand how price elasticity will affect demand. If cloud is cheaper, people will use more of it. This is why we at HyperStratus predict a coming explosion of applications. Again, this will affect utilization and capacity planning (I discussed the challenge of capacity planning in a cloud world here). Not everyone agrees with us -- just read the comments to the capacity planning post, but the evidence is right before us, and is the problem staring us in the face -- data centers bursting at the seams. No one would have predicted that when the first client-server applications were installed in a departmental computer sitting under someone's desk that we would live in a world with corporate data centers running out of capacity -- but we do. Cloud computing will result in the same explosion of demand. Count on it.

What are the outcomes of this shift to opex and utilization risk? Here are a few:

1. Yield management will become a core IT skill. If users no longer bear utilization risk, the organization that does will have to carefully manage use to ensure sufficient utilization and financial viability. Buying equipment on behalf of someone is vastly different than buying equipment and selling it to someone and carrying the risk that insufficient sales occur. By the way, the historical 5% - 15% utilization rate of IT is scandalous; in 2009 people were decrying the historic low manufacturing utilization rate as evidence of an economy in deep trouble? -- and manufacturing utilization was at 69%! IT must do much, much better.

2. We can expect some examples of high-profile IT disasters as cloud initiatives implemented on the basis of 70% utilization struggle to achieve 25%, with accompanying financial bloodbaths. Of course, high-profile IT disasters are nothing new in the industry (witness the debacle of New York's CityTime system), so perhaps this won't raise a ripple in an industry seemingly inured to failure. The important point is that pricing is directly related to utilization, so low utilization rates can pose one of two unpalatable outcomes: going back to users and asking for much higher rates, or absorbing a large writeoff for spare capacity.

3. IT financial talent will be crucial for organizations operating private clouds. Being able to track utilization, set prices, market to raise demand, and implement pricing (and collection!) are skills most IT organizations do not currently need. That will change in short order. One might say that with the oft-predicted move to IT operating like a business, it will need to put all of the elements associated with running a business into place.

4. Risk management will be in a category of its own. The risk exposure of operating a capital-intensive business with financial exposure based on utilization is high -- very high. Figuring out a way to manage that risk will be vital for IT organizations in the future. I recently ran across a startup called Strategic Blue that provides the equivalent of insurance swaps -- protection against utilization risk by paying a fee to an intermediary. Just the fact that an entrepreneur has focused on this area indicates that the issue is present, perhaps more so than most appreciate. It's too early to tell how the company will do, but it's safe to say that cloud computing presents more risk to IT than traditional one application, one server ever did.

As always, I continue to be fascinated by this development in technology, and convinced that more change -- and benefit -- lies ahead of us than we've seen over entire history of computing. In a sense, IT is moving to its next stage, where it operates as a core capability of companies, rather than a backoffice support function. That, however, will require it to operate with the same discipline and financial management of other core groups, so the issue of utilization risk is entirely appropriate for a more important IT role.

Bernard Golden is CEO of consulting firm HyperStratus, which specializes in virtualization, cloud computing and related issues. He is also the author of "Virtualization for Dummies," the best-selling book on virtualization to date.

Follow Bernard Golden on Twitter @bernardgolden. Follow everything from CIO.com on Twitter @CIOonline

This story, "The Cost Advantage Controversy of Cloud Computing" was originally published by CIO.

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