Tip

Opex vs Capex: Maintaining the right balance

Sitting in the conference room with his team discussing a roster of upcoming, heavy-duty investments in IT, a CIO has to constantly ponder over one important question: Which model would be in the best interest of his company, the operating expenditure-based (opex) model or the capital expenditure-based (capex) model?

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The changing signals

Over the last few years, a shift has taken place with respect to CIOs’ outlook to opex vs capex debate. Large enterprises today prefer opex to capex for long-term projects. The reason is understandable. The in-house software development projects, such as ERP, involve high sunk costs. In today’s times, investing big money in a long-term project that doesn’t assure quick returns can be risky. Moreover, given the increased maturity and reliability of branded tools, opex model can be a wiser option in such cases. Lastly, getting approvals for large capital expenditures is a challenge faced by CIOs, especially in the government departments and the PSUs. Even that attaches a greater value to opex than capex.

At Konkan Railway Corporation Ltd (KRCL), a typical ratio in the past was 80% capex and 20% opex. But this year, with a major project like KR-Net under way, there has been a dramatic shift with 70% of IT spending being through opex model and only about 30% as capex spending. A lot of organizations, including KRCL, that are currently using in-house developed systems, are now moving to outsourcing options to reduce maintenance cost and to assure scalability.

How to stay on track

Whenever troubled with the opex vs capex debate, I follow a thumb rule. I ask myself: Is it a core business investment or is it meant for some non-core function? While investing in any new asset for the company, if you can add value, optimize it, distribute costs over multiple businesses and locations, control it from centralized location, then capex is the sensible choice. Once such investment is made, we can leverage it for many years as its associated costs diminish. Some of the proprietary applications which are critical to KRCL’s operations, such as the RDBMS, have been procured under the capex model and managed by the organization in-house.

On the other hand, if the particular asset or service is long-term in nature, and you cannot add value to it by managing it within your organization, then going for opex model may be a better option. The simple formula can be: growth in business should be directly proportional to the growth in operating expenses (opex). At KRCL, assets and services like hardware and maintenance, where we don’t have expertise and have to depend on OEMs anyway, become ideal candidates for opex.

Further directions

The decision about capex vs opex should also be taken based on the level of competition amongst the suppliers of a particular product or service that you are looking for. When the market has several competent suppliers, it may be wise to opt for opex model. For non-core applications, you can switch between the vendors if and when required. This ensures that you get the best features for the best price, always.

In case of products where the market is controlled by one dominant vendor, opex vs capex may not always be a valid debate. The terms may largely be controlled by the vendor.

On the other hand, certain requirements are business specific in nature. An example can be the customized ERP at Konkan Railway. Developed in J2EE, the application is peculiar to KRCL as it conforms to the PSU-norms laid out by the central government. So, it was developed and maintained in-house and hence capex was a more suitable model for it.

Traction with vendors

For commodity products where the level of traction required with vendors is minimal, opex can be a good option. Commodity products need to be replaced every now and then and do not require high vendor traction for their smooth running. At Konkan Railway, the items such as hardware provisioning and maintenance come under opex category for these reasons. There may be some applications where vendor-traction may be recommended. Such items, if business critical, can go under the capex header.

All said and done, the opex vs capex debate will continue. Much like fashion, there will be changes in the market outlook with organizations shunting from one route to the other. There are four ways in a CIO’s business: the right way, the wrong way, the vendor’s way, and your way. Know your destination, and plan your itinerary well before the journey begins.

About the author: Vijay Devnath is the chief IT manager at Konkan Railway Corporation Ltd (KRCL). He has varied experiences in managing maintenance, technology, personnel, and materials in areas of electric locomotives, traction distribution, traction OHE construction, and IT.

(As told to Anuradha Ramamirtham)

This was first published in July 2011

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