When we heard the terms CapEx and OpEx a few years ago – capital expenditure and operating expenditure, most of us used to dismiss them attributing merely the accounting value to them. Recently have people started perceiving the differences between CapEx and OpEx business models and in turn, the benefits they bring. In this article, I am going to discuss why business should consider to turn OpEx from CapEx.
In simple words, CapEx is buying an asset and OpEx is leasing or renting or leasing it. Be it a tangible asset like land, house, infrastructure or intangible asset like a software or a patent. In other words, to turn OpEx from CapEx is outsourcing something rather than buying or doing it yourself.
There have been various views on whether CapEx is better or OpEx for a company. A wise man once said, “If it appreciates, buy it; if it depreciates, lease it!”
A lot of us still favour CapEx, as since ancient times owning an asset has been considered aristocratic.
There is another view advocating CapEx, which looks at the payback period of the investment versus total value of lease payment over years in OpEx. However, these advocates fail to consider the further expenses in addition to initial CapEx. Timely maintenance, spending on supporting infra or people, replacement in case of failure or in case of technology obsolescence and most importantly, money, time and people locked around this investment.
A third view favouring CapEx is the benefits of booking large depreciation in a company’s taxation. This is a real benefit unlike the first two. However, it gets overpowered by benefits of OpEx model.
From the experience of numerous businesses (and also of individuals), there are multiple benefits of OpEx model.
Firstly, in an OpEx model, one doesn’t need to make the fat investment upfront and breaks it down over a number of small payments at regular intervals. This helps in multiple ways. Making a budget decision for small periodic payments becomes much easier than making a decision for a huge one time expense.
It also balances the cash flows of the company.
Renting a flat instead of buying one is a classic example of this.
Secondly, OpEx help one get their focus better directed to their core function. A couple of examples to site here.
For a bank, it doesn’t make sense to have their own software development team to build a productivity software. They would rather outsource it, and focus their efforts, money and time on banking.
For a hospital, the core function is medical care. So they would (or should) rather outsource the reception and housekeeping staff than hiring on their own payroll, so as to not divert their focus from medical care to trivial operational tasks.
Another classic example to which a lot of working people can relate is outsourcing household help. The OpEx model with household help frees up considerable amount of time and energy for people to invest in more important responsibilities.
Thirdly, and in my opinion most importantly, it help the business be more flexible and agile. Agility of business can be translated in easy words as ability of a business to supply the right amount – no more, no less – with frequently and radically changing demand. For internal operations, it means availability of resources for operations according to changing needs with minimal or no redundancy.
When one is investing in hiring people or buying infrastructure, they need to make arrangements for current requirements as well as predict future requirements, and fulfil it to the full scope.
In OpEx, a business can always rent as much capacity as necessary and doesn’t have to worry about investing in and maintaining redundancy.
Lastly, when you buy tech infrastructure, you are stuck with it till its lifetime. In today’s world, technology advances much more rapidly than the lifetime of a tech product. Once bought, one has only two options in case of new, more efficient or more effective technology is available – dispose of your old infrastructure as scrap and again invest in new infrastructure or keep using the old one and be sad about it!
On the other hand in OpEx model, one doesn’t need to worry about the technology obsolescence.
Of course, there are things one must take care of while moving from CapEx to OpEx. Right precaution must be taken in order to milk the benefits of this model. However, it is definitely a step forward towards being the ace of one’s core business rather than a jack of all trades needed to run the business.
A lot of experts have written about moving the IT and telecommunications infrastructure from CapEx to OpEx model in last decade, along with moving to SaaS models from investing in building your own softwares. A lot of writing is also available on how renting a house is a better option than buying one. The consumers are well aware of nitty-gritties of transactions in these markets.
In the next article, we will take a look at such precautions while dealing with mechanical, electrical infrastructure and capital equipment in OpEx model.