Topiary for Technologists – a guide to cloud hedging – Part 1

Topiary for Technologists – a guide to cloud hedging – Part 1

Anyone who has to compile a budget, a firm price bid or any other kind of financial projection has been asked to predict the future in a chaotic world.

Some people are lucky enough to operate businesses with such fat margins that budgets can be finger-to-the-wind guesswork.   Other businesses care deeply about some costs, and couldn’t care less about other costs.  As a rough rule of thumb any cost that is larger than your profit margin, is worthy of attention, and should not be left to chance.

So for me, I don’t care about the cost of my postage.  The profit on our deals is many multiples of what we spend on postage stamps!  For anyone in a business that ships a lot of merchandise, that probably isn’t true, and they should probably be talking to – one of our fellow Techstars companies!

There are some companies that accept the risk of large uncertain costs because they are relying on the average of those costs across all the deals they do will be less than the revenue.  An obvious example is an insurance company.  However, almost any service industry faces this.  The cost of dealing with one dissatisfied customer often consumes more than the margin that customer contributes.  Manufacturers adopt so-called six-sigma quality programs to avoid the high cost of even occasional quality slip up requiring warranty work.

But there is a third type of cost which follows a law of averages but just cannot be left to average out over many deals.  These are costs that are large enough to cause major swings in company earnings but which, unlike for insurance companies, can be locked in well ahead of time.

So why aren’t CIOs locking down firm prices for their future IT projects in the public cloud?

Well, mainly because it is not possible to do this directly with the cloud providers.  At time of writing, I can only think of one cloud provider that offers pricing for time periods that do not start immediately.  And that cloud provider, last time I looked, wasn’t giving you a discount for a future starting deal, even though everyone believes the price of public cloud is falling.

However, it is possible to lock down firm future cloud prices – this is known as “hedging” – through our Cloud Options service.  Try our demo, if you haven’t already had a play.

Why should CIOs hedge the price of their future cloud usage?

Certainty.  In a chaotic world, it is reassuring to know what the future will hold, and a bird in the hand is worth two in the bush.

If a really low price for your future cloud usage is offered to you now, why would you not lock down that price now?  By the time you get to the time of delivery, the price may not have gone down as much, or at all, or heaven forbid, there is nothing contractual to stop the price from going up instead.  Better yet, you can put that price into your budget, and it isn’t an estimate to be corrected later on – it is a firm number.  One less thing being chaotic and your costs of financing benefit greatly

Now you may be concerned that you may lock in a low price that doesn’t turn out to be as low as the on-demand price, when you get to delivery.  That is possible, but in a situation where you are delivering a service at a fixed price, you wouldn’t have locked in a loss-making price for your cloud.  Missing a small windfall is a small price to pay for protecting yourself against making a loss.  And an unexpected windfall also attracts unwanted scrutiny from investors and lenders who are only too aware that such things can go both ways.

Averaged out over time, however, hedging is likely to be cheaper overall, at least in the current world of falling cloud prices…this is because those hedges provide usage forecasts to cloud providers, allowing them to plan their capacity, and at least part of the reason for the lower price is a reflection of the removal of risk for the cloud provider, rather than a projection of the expected future price.

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