Investing in the right systems, assets, and infrastructure is critical to business success. It can be the difference between profitability and loss. Businesses employ several methods to determine the value of a product or service before purchase or adoption. One of those methods is the total cost of ownership.
Total cost of ownership (TCO) is the sum of all costs involved in the purchase, operation, and maintenance of a given asset during its lifetime. TCO helps businesses understand the cost of a tool beyond the initial purchase price and is extremely helpful for understanding ROI.
What Is TCO In Cloud Computing?
The total cost of ownership in cloud computing refers to the total cost of adopting, operating, and provisioning cloud infrastructure. Organizations often find it necessary to perform a cloud TCO analysis when they are considering moving to the cloud because it allows them to weigh the cost of cloud adoption against the cost of running their current on-premise systems.
Since TCO is typically used to understand the lifetime cost and value of static or contained resources, however, estimating the TCO of cloud infrastructure — an inherently dynamic ecosystem — can be challenging.
When businesses calculate cloud TCO, they often make an apples-to-apples comparison of the costs of running an on-premise system versus the cost of running the same system in the cloud. That is, comparing the initial purchase price of hardware and software in an on-premise environment to the monthly subscription cost of cloud computing.
For example, a common starting point might be: “How much will it cost to run my on-premises system in the cloud?” or “If I have 3,000 traditional servers in my datacenter, what is the rack-rate for 3,000 compute instances of similar CPU, memory, and networking capacity in the cloud over x period?”
While this is a good place to start, you may not get the full picture. This is because a head-to-head comparison does not capture hidden costs or intangible costs of not switching to the cloud (i.e. the benefits of a cloud solution), such as faster time to market, increased productivity, and elasticity of demand.
To accurately calculate cloud TCO, you must capture not only the purchase price of on-premises vs. cloud solutions but also the intangible costs associated with either solution.
In this article, we’ll discuss the best approach and practices when evaluating the total cost of ownership for cloud computing.
Why Is Calculating TCO Important? 9 Benefits
Understanding the TCO for cloud computing is crucial. Your cloud cost allocations should align with business objectives, not just the expenditures. Below are the key benefits of performing a detailed TCO analysis:
1. Strategic decision-making and business alignment
Understanding TCO is necessary for strategic decision-making, offering a comprehensive view of cloud computing costs — from direct expenses like storage and compute resources to indirect costs such as training and support. This analysis aids in making well-informed decisions and ensures that cloud spending strategically aligns with overarching business goals.
2. Optimized cloud spending
Grasping the entirety of your cloud costs allows you to spot inefficiencies. Focus your cost optimization efforts to cut unnecessary spending and maximize cloud spending.
3. Enhanced budgeting and forecasting
Accurate TCO calculations improve cloud budgeting by considering all cloud expenses. Forecasting predicts future spending. It aids long-term financial planning and prevents cost overruns.
4. Clearer ROI analysis
TCO is essential for assessing the return on investment of cloud initiatives. Organizations can assess cloud investments by measuring all costs — including those detailed in cost allocation — against expected benefits, such as enhanced efficiency and faster market entry.
5. Competitive advantage
A deep understanding of your cloud TCO can give you a leg up on the competition. It allows quick adaptation to market changes. Smart resource allocation enables reinvestment in innovation and growth.
6. Risk management
A detailed view of all cloud-related costs improves financial risk management. This approach helps avoid unforeseen expenses that could affect your bottom line.
7. Cost transparency
Performing a TCO analysis simplifies cloud costs. It breaks costs into understandable components. This transparency ensures that stakeholders know where and how funds are being utilized.
8. Supports scalability
A precise TCO analysis helps scale cloud infrastructure. It ensures sustainable and viable growth.
9. Facilitates better vendor negotiations
With detailed TCO information, your organization can negotiate with cloud service providers. This knowledge may help you secure better terms for your cloud usage.
Steps For Calculating Cloud TCO
Below are some of the steps you should follow when estimating cloud total cost of ownership.
Step 1: Calculate your current IT infrastructure costs
Understanding the actual cost of your current IT solution is the first step. This means calculating the direct and indirect costs of running and maintaining your current system as well as estimating your current workloads, including servers, databases, storage, and network bandwidth.
Consider the following cost areas:
- Hardware and infrastructure – Identify the cost of the hardware that powers your on-premise application. These include physical servers, supplies, spare parts, etc.
- Datacenter – How much does it cost to power your data center? How much does it cost to meet your current cooling, power, and space requirements?
- Software – Calculate your current software usage, including the number of licenses and cost of these licenses.
- Personnel – Identify all the personnel involved in system, network, and database administration and how much it costs to payroll them.
- Disaster recovery – If you have a disaster recovery system in place, how much does it cost to maintain and manage that site?
- Maintenance – Calculate the cost of servicing, operating, and maintaining the system, including the cost of both in-house and outsourced maintenance.
- Upgrades – How much will it cost to upgrade the system if the need arises? Would you need to overhaul the system completely?
- Security – Estimate the total cost of securing your current system, from the cost of physical security to firewalls and security experts.
- Hidden costs – How much does downtime cost you? Review log files to determine server downtime frequency, hours lost, and the cost implication of those hours.
Step 2: Estimate the cost of a cloud solution
Next, calculate the cost of operating your applications in the cloud. Keep in mind that many of the cost areas considered for on-premises infrastructure will not apply in the cloud because they will be offloaded to the cloud service provider.
However, it’s important to note that a cloud solution is not inherently cheaper than on-premises infrastructure.
When businesses switch to the cloud, they often assume that their cloud bill will be automatically cheaper. But the on-demand nature of cloud services means your cloud bill could quickly spiral out of control as developers deploy instances and move at the speed of the cloud.
Understanding the major cost areas in the cloud is key to optimizing your cloud cost and ensuring a lower TCO.
Two of the major cost areas to consider for the cloud are migration costs and the monthly cost of your selected cloud services.
1. Migration costs
Moving your applications and data to the cloud is a key step when switching to the cloud. Your current applications may require modification to function properly in the cloud. Gartner identifies the five ways to move applications into the cloud, namely:
- Rehosting applications without making any changes to their architecture
- Refactoring or running applications on a cloud provider’s infrastructure
- Revising the application, i.e. modifying or extending the existing code base
- Rebuilding or rearchitecting the entire application for the cloud
- Replacing the application with commercial software delivered as a service
Each application migration method has its cost implications and you need to determine the costs associated with the method you choose. In addition to application migration costs, estimate data transfer charges that will accrue when moving your application.
2. Monthly cloud cost
Your monthly cloud cost will depend on your workloads, and the specific cloud services consumed and method of purchase. The goal here is to estimate your potential monthly cloud bill based on your current workloads.
Since this calculation differs considerably for each organization, major cloud platforms provide pricing calculators that make it easier to estimate your monthly cloud bill. The AWS pricing calculator, for example, allows you to estimate your infrastructure cost based on the retinue of AWS products and services selected.
Two of the major factors that will affect the size of your cloud bill are:
Type of cloud services consumed
Commodity services, such as storage or raw compute power, are relatively less expensive compared to more specialized services, such as machine learning.
Amazon, for instance, offers Rekognition which does image and video analysis, and Polly, which is a text-to-speech service. These services have higher workload costs than storage. The total cost will depend on the types of services your business needs.
Cloud consumption model
The on-demand model, where resources are deployed as needed, is the most popular cloud usage model. However, it is also the most expensive cloud consumption model. The other way to consume cloud services is to use a savings plan or prepaid option (reserved instances).
You could also opt for a hybrid model. Your cloud costs will differ depending on the consumption model your business adopts.
3. Consultation and training costs
If your team lacks the expertise required for the migration process, factor in the cost of hiring consultants for training.
Step 3: Consider the intangible benefits of the cloud
Beyond comparing the monetary implications of on-premise versus cloud solutions, there are opportunity costs associated with not switching to the cloud. You need to quantify what this means for your business.
- Innovation – The cloud offers hundreds of services you can access on demand. By continuing with an on-premises system, you sacrifice the ability of developers to move fast and respond quickly to market changes.
- Elasticity – Handling demand in an on-premise environment is always a challenge. The solution is usually to maintain redundant infrastructure in anticipation of peak loads. In the cloud, however, you could easily deploy instances to take care of the additional peak without any downtime.
When the peak is over, you go back to operating at your normal capacity at no additional cost. While you may incur a larger monthly cloud bill at peak, you will experience no downtime nor would you need to maintain redundant infrastructure when the surge is over.
Comparing On-Premise TCO To Cloud TCO: Key Things To Keep In Mind
At the end of your cloud TCO analysis, you should have specific numbers that can help with your decision-making. A few things should guide understanding of the results:
- Cloud computing is not inherently cheaper than an on-premise model.
- Cloud adoption is rarely about pure cost savings. Often the end result is a larger ROI and better business outcomes, not lower TCO, even though it could be both.
- Comparing the business value and opportunity cost of switching to the cloud versus using an on-premises model is just as important as comparing head-to-head costs.
- Identifying cost savings and efficiencies is critical when performing a cloud TCO analysis.
Lowering Your Cloud TCO
Ensuring a lower TCO in cloud computing, in the long run, means applying cloud optimization best practices to ensure that your cloud costs stay within control.
Companies often move to the cloud with the notion that it’s going to be cheaper. However, the on-demand nature of cloud services means your cloud bill could easily spiral out of control, so your monthly bill could be the same or more expensive than your on-premise costs.
CloudZero is a cost intelligence platform that enables a deep understanding of your cloud unit economics and provides a continuous feedback loop to your engineering team while you migrate.
Once you have made the decision to switch to the cloud, CloudZero is a tool that allows you to connect your monthly cloud costs to key business metrics, providing the visibility you need to understand where your investment is going. You can read more about how CloudZero can help during a migration here.
To understand how CloudZero can help you manage your cloud costs and lower your TCO, 
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The Cloud Cost Playbook
The step-by-step guide to cost maturity
