What is the difference between capital expenditure and operational expenditure in Azure?

• Before: up-front cost in hardware and infrastructure to start or grow a business (CapEx)
  • With cloud: Use services without significant upfront costs or equipment setup time (OpEx)
• 📝Hybrid solution = combine both in cloud with using both on-premises (CapEx) and cloud (OpEx)
• Also possible to have CapEx in cloud with e.g. Azure Reserved VM Instances
• CapEx model is also sometimes use in cloud

Capital Expenditure (CapEx)

• Spending of money on physical infrastructure up front
  • and then deducting that expense from your tax bill over time.
• An upfront cost, which has a value that reduces over time.

Costs of CapEx

• E.g. server, storage, network, backup & archive, organization continuity and disaster recovery, datacenter infrastructure, technical personal.

Benefits of CapEx

• Plan your expenses at the start of a project or budget period.
• Your costs are fixed, meaning you know exactly how much is being spent.
• 💡Appealing when you need to predict the expenses before a project starts due to a limited budget.

Operational Expenditure (OpEx)

• Spending money on services or products now and being billed for them now.
  • There's no upfront cost: You pay for a service or product as you use it
• Deduct expense from your tax bill in the same year.

Billing of OpEx

• As soon as the provider provisions resources, billing starts
  • your responsibility to de-provision the resources when they aren't in use so that you can minimize costs.
• Cloud computing can bill in various ways e.g.
  • Number of users, CPU usage time, allocated RAM, I/O operations per second (IOPS), and storage space.
• Billing at the user or organization level.
• Pay-per-use (or subscription model)
  • Designed for both organizations and users
  • billed for the services used, typically on a recurring basis
  • E.g. when using a dedicated cloud service, you could pay based on server hardware and usage.

Costs of OpEx

• Leasing software and customized features
• Scaling charges based on usage/demand instead of fixed hardware or capacity.
• 💡Plan for backup traffic and disaster recovery traffic to determine the bandwidth needed.

Benefits of OpEx

• CapEx challange: Demand and growth can be unpredictable and can outpace expectation
  • 
• Companies wanting to try a new product or service don't need to invest in equipment
  • Instead, they pay as much or as little for the infrastructure as required.
• OpEx is particularly appealing if the demand fluctuates or is unknown
• Enables cloud agility
  • Ability to rapidly change an IT infrastructure to adapt to the evolving needs of the business
  • Manage your costs dynamically, optimizing spending as requirements change.
  • E.g. service peaks one month => pay more, demand drops next month => pay less

CapEx vs OpEx Models: This is the second blog of Topic 1: Cloud Concepts in the Microsoft Azure Fundamentals Certification Series(AZ-900)

In this blog post 1.2, we’ll cover the overview and difference between Capital Expenditure (CapEx) and Operational Expenditure (OpEx) models in cloud computing.

Check out the first topic of Cloud Computing: Overview & Benefits to understand cloud computing basics.

There are two ways of investing in the resources available on the Cloud:

1. Capital Expenditure (CapEx)
2. Operational Expenditure (OpEx)
   

Check out the key differences between Opex vs Capex model:

What Is CapEx?

CapEx is the spending of money on physical infrastructure upfront and then deducting that expense from your tax bill over time. CapEx is an upfront cost, which has a value that reduces over time and usually has no recurring cost.

Deploying your own data center and Azure Reserved VM Instances are a few examples of the CapEx pricing model.

Pros: With capital expenditures, you plan your expenses at the start of a project or budget period with a fixed cost. This is appealing when you need to predict the expenses before a project starts due to a limited budget. It is also beneficial in the longer run.

Note: Azure Reserved Instances (Azure RI) help Azure’s most active customers save on long-term VM usage by reserving VMs in advance at a discounted price by committing to one or three-year benefits.

Also read: Everything you need to know on Azure SQL Database

CapEx Computing Costs

The following are part of CapEx Computing Costs:

• Server costs – All hardware components and the cost of supporting them are included here. While purchasing servers, one must ensure design fault tolerance and redundancy, such as server clustering, redundant power supplies, and uninterruptible power supplies.
• Storage costs – All storage hardware components and the cost of supporting it are included here. Note, based on the application and level of fault tolerance, centralized storage can be expensive.
• Network costs – All on-premises hardware components, including cabling, switches, access points, and routers are included here. This also includes a wide area network (WAN) and Internet connections.
• Backup and archive costs – This includes the cost to back up, copy, or archive data. Setting up a backup to or from the cloud might be considered. An upfront cost for the hardware and additional costs for backup maintenance and consumables like tapes are included here.
• Organization continuity and disaster recovery costs – Together with server fault tolerance and redundancy, one must plan for recovery from a disaster and continue operating with a plan of creating a data recovery site. It could also include backup generators.
• Datacenter infrastructure costs – The costs for electricity, floor space, cooling, and building maintenance are included here.

What Is OpEx?

OpEx is your operating costs, the expenses to run the day-to-day business, like services and consumable items that get used up and are paid for according to use. You can deduct this expense from your tax bill in the same year. There’s no upfront cost but has a recurring cost. You pay for a service or product as you use it i.e. pay-as-you-go pricing.

Pros: Demand and growth can be unpredictable and can outpace expectations, which is a challenge for the CapEx

Also check: Steps to register Azure Free Account

OpEx Cloud Computing Costs

The following are the part of OpEx cloud computing costs:

1. Leasing software and customized features – Using a pay-per-use model requires actively managing subscriptions to ensure users do not misuse the services, and that provisioned accounts are being utilized and not wasted. Resources that aren’t in use will be de-provisioned by the Cloud service provider so as to minimize costs.

2. Scaling charges based on usage/demand – Cloud computing can bill in various ways, such as the number of users or CPU usage time. Allocated RAM, I/O operations per second (IOPS), and storage space are also considered in Billing Categories. Plan for backup traffic and data recovery traffic to determine the bandwidth needed.

3. Billing at the user or organization level – The Azure subscription (pay-per-use) model is a computing billing method designed for both organizations and users. The organization or user is billed for the services used, on a recurring basis like we can scale, customize, and provision computing resources, including software, storage, and development platforms.

Accounting differences between CapEx & OpEx

Many IT goods can either be acquired as CapEx or OpEx, giving businesses more options to work with. Like, the software can be bought outright for indefinite use as a capital item or bought on a monthly subscription depending on what fits the financial goals of your company best because both capital expenditures and operational expenditures are accounted for differently when it comes to taxes and accounting and thus affects the overall value of the purchase in the long-term view of your business.
CapEx costs are considered an investment because it is believed that buying a long-term need all at once has great value and will eventually pay for itself as it benefits the company over a period of time. However, since a CapEx item will be used for a longer period of time, it must either be amortized or depreciated over its lifetime, rather than deducting its value in one tax year, for accounting purposes. So, although capital expenditures are a great investment for a business, they can sometimes be an accounting headache, and becomes difficult to pinpoint their actual cost and value to a company.
On the other hand, OpEx items are fully tax deductible and are subtracted from your revenue when calculating your profits and loss. Generally, this increases your profit margin. Operational expenditures more accurately reflect the cost of doing business as their benefits and value is immediate and easily recognizable.

The backlog of OpEx expenses is that these purchases don’t necessarily pay for themselves and are a notorious cause of business debt, but if the operational expenditure is too high for your organization, then you can quickly limit your spending. Also, if something isn’t working out for you, you can also switch to a different product easily as you didn’t invest much in the first place.

CapEx stability or OpEx flexibility

The primary benefit of the CapEx model is stability because you know exactly what the costs are on an annual basis. But that cost comes with unpredictable results attached to it. Your initial cost and how it will depreciate or be amortized over time is a certainty, but the true value of that investment to your company every subsequent year is not determined yet.
Here are some risks which you take when you take a CapEx approach to IT spending:

• Buying capacity which is not required today but purchased to meet tomorrow’s uncertainties. In the IT world, technology is constantly changing. An upfront push into establishing your own cloud might seem like an investment, but what if the equipment and skills of the workforce you invest in become irrelevant before there is a return on your investment
• The longer it takes to set up an item or infrastructure implies more money you lose. So, taking a very long time to adopt a new capacity, usually through a difficult process will result in late returns.
• Entering vendor contracts that create business dependencies you can’t break as you will be held hostage by those contracts. And left high and dry if the vendor doesn’t follow through.

The OpEx model, on the other hand, provides flexibility and addresses all these needs:

• Since the OpEx services are provided instantly and on-demand, the lead times for deploying new and improved products shorten to days and hours, versus years and months, which again increases profits.
• If architecture or service turns out to be misconfigured or misfit, you can easily & quickly reconfigure it and there is minimal amount wasted.
• The OpEx approach to IT expenditure gives modern businesses the agility and flexibility they require to stay relevant in these constantly changing markets and meet their clients’ needs more appropriately and quickly. Better product & service delivery means higher profits for your company.

Benefits of OpEx IT Expenses

The primary & most significant benefits of OpEx IT expenses are cost savings for your business and the ability to quickly change ways to meet market demands.

• With operational expenditures, you can buy on an as-needed basis, so technically you never make an investment in something that can’t be used profitably immediately.
• You won’t find yourself stuck with the capacity you don’t need because you won’t have equipment that is not used or over-complicated systems that your business just never grew into need.
• OpEx purchases do not require any strict, long-term business contracts. For example, with pay-as-you-go cloud services, a subscription or service term isn’t for more than a year usually and the contract terms aren’t very hardbound. So if a vendor fails to satisfy your expectations, it is easy to break the contract and sign on with someone new.
• OpEx services are not owned by your company (probably owned by a vendor or third party), so you are not responsible for keeping them up and running.
• OpEx purchases are quick deliverables, which means that you never have to waste time and money coordinating a whole new IT setup. You don’t have to look after space, equipment, or manpower. You just have to sign up for the service and the vendor has all of that on their plate.

If you haven’t already deduced that all of these benefits related to procuring IT services as OpEx expenses guarantee your business a degree of flexibility and agility which is not possible up until recently. And as you know, in this constantly changing & growing world of business, the more easily and speedily you can respond to the latest market trends, the better you can serve your customers and grow your profits and overall value.

Review of CapEx vs OpEx

Capital expenditures (CapEx) are major purchases a company makes designed to be used over a longer period of time while on the other hand, while Operating expenses (OpEx) are the day-to-day expenses a company bears to keep its business operations.
There is an inherent difference in the way management approaches these two expenditures: CapEx is often more expensive and labor intensive often requiring greater patience to get rewards. OpEx is often cheaper and flexible to incur.

Sample Questions

Here are a few sample questions from the Microsoft Azure Fundamentals Certification Exam [AZ-900] that you should be able to solve after reading this blog.

Q 1. HOTSPOT: For each of the following statements, select Yes if the statement is true. Otherwise, select No. 

NOTE: Each correct selection is worth one point.  

Q 2. HOTSPOT: For each of the following statements, select Yes if the statement is true. Otherwise, select No. 

NOTE: Each correct selection is worth one point.  

Correct Answer: 

Explanation: 

• The cost of an Azure VM depends on various factors like its size, OS, and region. Even though we create two VMs of the same size and OS they incur different charges if they are in a different region.
• We will be charged for the OS, public IP, disk, and other resources even if the VM has been stopped. In order to avoid paying for any non-functional resources, they should be deleted.

Check out the next topic in the module Cloud Service Model to understand SaaS, PaaS & IaaS in detail.

Related/References

• • [AZ-900] Microsoft Azure Certification Fundamental Exam: Everything You Must Know
  • Learn how to create a Free Microsoft Azure Trial Account
  • [AZ-900] Microsoft Azure Fundamentals: Cloud Computing – Overview & Benefits
  • Azure Fundamental Certification For Beginners: AZ-900 vs AI-900 vs DP-900
  • [AZ-900] Microsoft Azure Architecture: Region, Availability Zone & Geography

Next Task For You

Begin your journey towards becoming a Microsoft Azure Solutions Architect Expert. Just click on the register now button below to register for a Free Class on Microsoft Azure Solutions Architect Expert Certification [AZ-305], which will help you to understand better, so you can choose the right path and clear the certification exam.

What is capital expenditure and operational expenditure in Azure?

What is the difference between capital expenditures and operating expenditures?

What is CapEx and OpEx in cloud computing?

What are the Azure expenditure models?