Calculating cost of cloud: ROI and Total Cost of Ownership (TCO)

Cloud ROI (return on investment) is a measurement of how much money and time you save or make back from an investment in cloud technology. Cloud TCO (total cost of ownership) is the total costs associated with your new cloud technology—often compared to the total costs of your former server or data center deployment.

Both numbers are valuable not only after you migrate to cloud (when you likely need to prove value and keep costs optimized) but also before you migrate (when they can help you make a business case for migration, fully understand your options, and set expectations for cost, return, and the timing of those costs and returns).

Calculating total cost of ownership (TCO)

Before you can calculate cloud ROI, you need to identify all the costs associated with your current server deployment (known as total cost of ownership or TCO). This means identifying operational or hidden costs that you’ll no longer have to worry about after cloud migration, including:

Servers: With an average lifespan of 3 – 5 years, servers need to be regularly repaired and physically replaced.

Server support: Load balancers, climate control, server racks, replacement parts…in addition to the servers themselves, on-prem comes with some supporting hardware, parts, and physical assets that need to be purchased, maintained, and replaced in regular intervals.

Software renewal/licensing (and over-licensing): Over-licensing costs US and UK companies as much as $34 billion per year, according to one study. To avoid this common pitfall, companies either need to keep rigorous track of who needs which software, or they need to move to the cloud where the number of users can often be automatically tracked, updated, and viewed by admins in an instant.

Electric bills: If 80 percent of servers are overprovisioned, that means 80% of on-prem companies are using more energy than they need and getting bigger energy bills than they otherwise would.

Real estate/space: Physical servers call for physical space, which means a move to the cloud can open up existing space for other uses or remove data center real estate from your budget entirely.

Cooling expenses: Cooling units and the energy they require are yet another hidden expense of hosting on-prem.

Maintenance: Server maintenance often calls for temporary staff or contractors, which is a line item you can ditch when you delegate that responsibility to your cloud vendor.

Asset management time/audits: The more assets your IT team has (including physical servers, load balancers, and parts, as well as non-physical assets such as software licenses and databases), the more your asset management practice has to track. This means more time, resources, and mental overhead.

Calculating return on investment (ROI)

Once you have a better understanding of total cost of ownership, you’re ready to estimate your return on investment for a move to the cloud. The simplest way to calculate the return on any investment (including a move to the cloud) is:

Calculating return on investment

To figure out your own potential ROI, first, use the TCO you identified above to figure how much you’ll save with a move to the cloud (your profits/gains). Then calculate how much your migration from on-prem to cloud will cost by adding up the costs of:

  • Internal resources (IT and any other internal team time)
  • Software licenses used or forfeited in the transition
  • Cloud subscription or service fees
  • Professional services to support the migration (optional)

Once you have those numbers, you can use the equation above to understand your ROI both within a single fiscal year and as it (usually) increases over time.

Now, sometimes it makes sense to do this calculation based on a single year, but most cloud savings grow over time, since the up-front cost of a migration is a one-time expense and the savings on servers, software, IT, contractors, etc. are generally yearly savings. This means the ROI over time tends to chart up and to the right, and understanding your true savings often means a calculation that spans multiple years.

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For example, if you invest $60,000 in a migration from on-prem to cloud and you save $45,000 per year in operating costs, your ROI in the first year will be negative (i.e. the migration cost more than you saved). However, when expanded to a 3-year or 5-year model, the savings increase drastically.

In three years, you’ve more than broken even—and in year 5 you’ve almost tripled your investment.

Calculating 1-year ROI

  • Gain from migrating to cloud: $45,000 annual savings
  • One-time migration investment: $60,000
  • Calculating 1-year ROI: ($45,000 - $60,000 = -$15,000) / 60,000 = -25% ROI

Calculating 3-year ROI

  • 3-year gain from migrating to cloud: $45,000 annual savings x 3 years = $135,000
  • One-time migration investment: $60,000
  • Calculating 3-year ROI: ($135,000 - $60,000 = $75,000) / 60,000 = 125% ROI

Calculating 5-year ROI

  • 5-year gain migrating to cloud: $45,000 annual savings x 5 years = $225,000
  • One-time migration investment: $60,000
  • Calculating 5-year ROI: ($225,000 - $60,000 = $165,000) / 60,000 = 275% ROI

Organizations with a multi-year view of their technology investments tend to remain more competitive in the long-term and see greater returns. The gains can be further compounded when considering CapEx vs. OpEx.

CapEx vs. OpEx

Another key aspect to consider when reviewing costs associated with cloud vs. on-premise servers is CapEx vs. OpEx:

Capital Expenditures (CapEx) are assets purchased for long-term benefits that remain on an organization's balance sheet and depreciate over time (such as servers, upkeep, and insurance tied to asset use).

Operational Expenditures (OpEx) are expenses associated with purchasing services for a pre-determined period of time or pay-as-you-go (such as cloud and SaaS products, which usually include all costs required to run the software).

OpEx costs, such as cloud services, tend to offer organizations more flexibility in both the short and long-term. The pay-as-you-go model allows organizations to scale as they grow—rather than making a large up-front bet on future-year needs. When investing in CapEx, such as servers, the accounting team must account for how to amortize the assets as they depreciate over time and plan ahead for when the next large purchase will be required.

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