Watering down the cost of IT financing

IT firms need to stay on top of new technology, but how do you afford the latest kit? Julia Vowler looks at the real price of IT...

IT firms need to stay on top of new technology, but how do you afford the latest kit? Julia Vowler looks at the real price of IT financing

With all the focus of IT directors on business strategy, skills resourcing and dynamic personal leadership, it can be easy to overlook the tedious detail of how best to pay for all the kit and caboodle in the IT department. But at some point the bills have to be paid.

But who should they be paid to, and for what?

Whatever the IT budget, a fundamental equation every IT director has to make is how best to finance what he needs to deploy. In terms of skills resources, the three options are permanent staff, contractors or buying in professional services, whether that means spot consultants or perpetual outsourcing. When it comes to everything else the choice is buy or hire.

Entire books have been written, pored over by student accountants upwards, over how organisations should fund their capital assets, from stationery to factories. All sorts of equations are applied and all sorts of models, each with its own set of acronyms, can be selected, depending on the financial management of the company and the economic and fiscal environment it operates in.

Cash, of course, has its own costs - not least the opportunity cost a company faces by spending its money in one way rather than another, as it evaluates corporate-wide return on investment - and those costs change over time, as does the price of what that cash can buy. For IT, the most salient variable is the rate of technology change - today's hot box is tomorrow's heap of junk. Knowing exactly when that metamorphosis will occur, what the residual values of expired boxes will be, is what makes doing the IT sums tricky.

The IT financing industry is also busy doing the sums on the costs of IT acquisition. The industry has been around just about as long as IT itself, originally dominated by the manufacturers themselves as a way of getting their boxes out of the door, and these days accounts for some $30bn (£19bn) in Europe.

That figure is set to grow, according to a new survey carried out by Bloor Research on behalf of IBM Global Financing. By 2002 80% of the l77 respondents (nearly three quarters of which spend over a million pounds a year on IT) "expected to be using or considering financing for their IT acquisitions," found the survey. That represents a l3% growth in financing over the next two years and a l5% growth in rental.

The drivers for the increase, says IBM, are the increasingly short lifecycles of hardware, making it more imperative than ever to avoid obsolescence, and the rush into e-business, as well as the emergence of application service provision.

But the financing industry itself is changing.

New financial models such as price-per-seat and, perhaps the most fundamental ground shift, the shift away from hardware-only leasing. With software rather than hardware becoming the key item of expense on the bills, finding new ways to pay for licences is a growing trend.

"We can purchase the licence from the supplier on behalf of the customer, and transfer the licence in perpetuity to them (for which the customer pays us back over a period)," says Ivor Coleman of IBM Global Financing. "Or we can buy the software, pass it to the customer charge them for it monthly, and when they've finished paying they will own the licence."

In either case, the user's licensing contract is with the supplier, but IBM either lends the user the money to buy the licence up front, or buys the licence itself and rents it on to the user until he's paid enough to own it.

"The trend to finance software is increasing," says Coleman. "About a quarter of business IT software is financed."

Services are also being financed externally, whereby financing companies lend users the money to pay for services as disparate as maintenance and consultancy.

"In key growth areas of IT financing, 26% of respondents are already using or considering financing for software compared with l8% of respondents already using or considering financing for IT services," concludes the report.

For all the market growth the survey finds that, compared with their finance directors, IT directors themselves remain cautious about financing as a method of paying for the IT they need.

"IT people perceive financing to be relatively complex and potentially inflexible - they have a rather conservative view of its overall value to their business and are concerned about potential lock in to a solution and its supplier," says the report.

Nevertheless, "IT people have a good understanding of the benefits of financing - conservation of capital and spreading costs - are perceived to be the top advantages (over 80% of respondents) followed by protection from obsolescence (over 75% of respondents," the report says.

How to pay for what you want may not be the world's most exciting subject, but for IT directors it remains an essential item on their permanent agenda.

IT managers on financing

At what stage in the acquisition process is the financing decision reached?

  • Business case - 50%

  • Procurement decision - 30%

  • Request for information - 11%

  • Invitation to tender - 9%

    Main advantages of IT financing:

  • Capital spend can be conserved for other projects - 81%

  • Costs can be spread over time - 81%

  • Protection from obsolescence - 75%

  • Lease is off balance sheet -71%

  • Payments can be tailored to meet budget requirements - 73%

  • Leasing offers a lower cost of borrowing - 60%

  • It is relatively easy to upgrade/extend a lease - 60%

  • Leasing can be an additional source of borrowing - 45%

  • Use of residual values can make leasing cheaper - 42%

    Main disadvantages of IT financing:

  • 35% of respondents cited poor value

  • 28% of respondents cited inflexibility

  • 22% of respondents cited complexity Source: Bloor Research

    Considering the finance options

    Is your organisation using or considering external financing for software:

  • 18% considering

  • 8% using

    Is your organisation using or considering external financing for services

  • 9% using

  • 9% considering.

    What might influence your chosen financing approach in the future?

  • New financing models -73%

  • IT as a business utility -68%

  • Accelerating deployment lifecycles -68%

  • Application rental from ASPs - 68%

  • E-commerce and e-business - 61%

  • multi-supplier solutions -56% Source: Bloor Research

    Origins of the financing trend

    As the commercial computer industry became established in the 1950s and 1960s, the cost of these mighty beasts was such that getting users to pay for them was a considerable challenge. As well as inventing the first generation of outsourcing - bureaux - which effectively shifted the capital cost burden of the horrendously expensive computers on to the bureau which then made money by running jobs for users (the ancestor of application service providers), the computer industry also invented IT leasing.

    Like the automobile industry, the computer industry resorted to lending its customers the money they needed to be able to afford their IT centres. Because it kept the capital cost of computers off the balance sheet, it was attractive to corporate accountants. All the leasing companies had to do was get their sums right when it came to pricing the lease and guesstimating the residual market value of the leftover computer at the end of the lease (unlike the car industry, there is no classic car market in old computers).

    Soon, every major computer manufacturer had a financing arm, either lending users the money to rent their computers or, effectively, buying them on hire purchase. Then pure finance houses joined the game, such as Kleinwort Benson and, more infamously, Atlantic Computers. Leasing became increasingly financially sophisticated, with concepts such as flexleases which sought to build in more protection for users against technical obsolescence, but often at the price of extending their lock-in to the leasing company itself.

    These days, leasing is lower profile but still a significant part of the IT industry, still seeking to square the perpetual dilemma of maximising return on corporate capital while minimising technology and contractual lock-in and still making an acceptable - but not outrageous - sustainable profit for the leasing companies.

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