Turning Capex to Opex: What Works, What Doesn't

I enjoy presiding over roundtable discussions. You get to pose questions to a relaxed group of high-level CFOs around a breakfast or lunch table, observe them in insightful interaction and even participate in peer-to-peer banter.

 
A recent roundtable organised by CFO Innovation with AT&T Asia Pacific Group, the regional arm of US telecom multinational AT&T Inc., is no exception. We invited 14 finance executives to talk about turning capital expenditures (capex) into operating expenses (opex) as part of cost management.
 
The free-for-all conversation yielded interesting insights about cloud computing services, outsourcing and other cost management issues that CFOs in Asia face today.
 
The consensus was that turning capital expenses into operating expenses should be part of the CFO’s cost management arsenal. “There are various benefits,” said Chia Chey Hui, who is Country CFO for Singapore and Area CFO for ASEAN & Pacific at Philips Electronics. Among them: standardising processes, having the flexibility to make changes to projects, gaining IT flexibility, and optimising use of office space.
  
Capex Vs. Opex
Internally, said New York-based Eric Weinbrom, Vice President for Finance at AT&T, “we ask ourselves: Do I want to build this myself [capex] or can I use my partners’ facilities to do things [opex]? It’s a function of looking at where the core competencies are in our business versus the things that we can outsource to someone else.”
 
“Like any other company, we spend a lot of time making capital decisions,” added another roundtable participant. “If you step back and ask: How can you spend US$19 billion and not have enough? The answer is: It’s easy.”
 
It was clear that the others at the table shared their mind-set – up to a point. “Opex can be more expensive than capex,” said Sirish Kumar, Finance Controller, Asia Pacific, at Motorola Electronics (he is now Senior Business Finance Controller at Nokia Siemens Network).
 
The company will need to pay operating expenses year after year, whereas capex payments end after a pre-determined period. It’s the corporate equivalent of buying versus leasing a car. Also, if opex increases, current liabilities may also rise and require financing through short-term loans, which are more expensive than the long-term borrowing that typically funds capex.
 
There are also the issues of security and competitiveness. “If you are giving your database to someone else to administer, I’m not sure whether you can sleep well at night,” said a participant. Spending on servers and other infrastructure to keep this business process in-house might be the better strategy.
 
The takeaway: Every company must weigh the benefits of capex versus opex in the context of its own unique circumstances, state of its balance sheet, financial condition and other issues.  
 
Pulling the Plug
However, for some at the roundtable, the gains from turning capex into opex outweighed the negatives, at least for their own organisations.
 
“The hardest thing with projects [that require capex] is when to stop them,” a participant observed. “Some things just aren’t going to work and there comes a time when you just have to stop them. But when people have put money into the project, they don’t want to stop.”
 

It is easier to pull the plug if the company had not spent so much on servers and other infrastructure by opting for a cloud computing solution, for example.  

 
Rakesh Dhamija, Senior Vice President and Chief Financial Officer – Asia Pacific at wealth management and banking company Northern Trust, recounted his experience in another company. “We were investing in data centres in anticipation of getting a lot more business,” he recalls. “But after we had bought, server prices fell dramatically.” The company not only lost out on the cheaper prices; the anticipated business also did not materialise, leaving it with excess server capacity.
 
In hindsight, Dhamija felt that it would have been the better option to rent the servers of another organisation, at least in the beginning. That company would have had the necessary scale, “and that scale is so significant that they could have gotten a price that’s 30% to 40% better than we did.”
 
And when the anticipated business did not materialise, it would have been easier for Dhamija’s former employer to make the decision to pull the plug because it would not have spent so much on the project and would not need to worry about what to do with the idled equipment and other infrastructure.
 
Cloud Computing
These days, Dhamija’s previous company can also tap providers of cloud computing services. But here, too, according to the roundtable participants, there are constraints that should be kept in mind.
 
Graham Ford, General Manager, Finance Services Operations at Fuji Xerox, said that his company has embarked on a “study approach” to the cloud, starting with travel expenses management. “Just to try, just to experience,” he explained. So far the experience “has been fine.”
 
“For us it was a conscious decision to [use a cloud solution for] some things that are not so sensitive and which requires specialist expertise that we don’t have,” he added. “There are other processes we can put on the cloud, but we’ll take it step by step. But definitely we’re not going to put our GL [general ledger] out there.”
 
There were quite a number of processes that some roundtable participants indicated they would not put on the cloud or outsource to third parties. “If you are giving your database to someone else, I’m not sure whether you can sleep well at night,” said one of them. “When you outsource CRM, you’re giving your entire business away. Security of the data, management of the data, is a key risk.”
 
One simple test, said another participant, is to ask yourself what the process is meant to do.
 
“Things that are required to keep the lights on could be turned into opex, but things that drive the strategy and value of the business, you have to think twice. Is it a key driver of organic growth? Does it add value to the service you provide your customers?
 
Said this participant: “Generally my preference would be to keep these things [the strategy value drivers] in-house, but to see if some elements can be outsourced. Not the entire basket.”
 
However, when it comes to cloud computing, said another participant, there’s no way around the ultimate decision of taking a leap of faith. “At some point, you have to say, OK, I trust that someone else is going to take care of my data, even though at the end of the day, my customer is going to call me and not [the cloud computing provider] if there is a problem.”
 
Outsourcing Blues
The same dynamic is at work – and even more so – in third-party outsourcing, which is another way of turning capex into opex. Cloud computing typically involves infrastructure and software being ‘rented out’ to the client on a pay-as-you-use basis. In outsourcing, what the company’s own employees used to do are farmed out to the third-party outsourcing provider’s own people.
 
“I think outsourcing is the much better model,” one participant opined. “But the key is how you manage the whole thing. After the clock has started ticking, then the surprises come.”
 
His experience is instructive. The company hired a top-notch consultant to advise on which service provider to employ. “Then you go on to the actual outsourcing and you end up in a total mess,” this participant said. “You define the services required in one way, they define it in a different way.”
 
Another participant said that his company was in the early stages of the process of finalizing an outsourcing agreement as part of a major transformation of finance and IT.
 
“In the presentation, [the service provider] said 35% to 40% in savings is possible,” he recounted. “We wanted this to be written into the contract so that there was clear understanding on what was included in the scope [of the service] and what was not. The service providers were quite open to this and highlighted that it is a two-way process in order for both parties to benefit from the proposed relationship.”
 
While the contract has yet to be finalized, the discussions so far has been encouraging, including “future pricing strategies that are proposed to be shared amongst the two parties,” said this participant. “One of the key lessons learnt so far is about SLAs [service level agreements]. You need to have a clear understanding on the scope and honour your commitments agreed as part of the relationship for you to deliver the expected results.”
 
At Philips, said CFO Chia, “we tend to do shared services in-house first, and outsource after the processes are stabilized. We’ve done this with IT, we’ve done this with finance.”
 
She cautioned, however, against expecting too much cost savings from outsourcing. “Normally in this part of the world [Asia], companies might not see much cost benefit [from lower expenses] because labour cost is low here.” A company paying high Hong Kong wages may benefit from outsourcing to lower wage countries such as China, India, Malaysia or the Philippines. But a company in China outsourcing to India will not see much in terms of lower labour costs.
 
The real gains, said a participant, comes from having an expert take care of functions that are outside the company’s competence. “We have a hundred-plus ERP systems and 85 data centres,” he said. “Do you fix them yourself or do you let someone else fix them? In our case, we said, We’re not experts. We won’t get it right. Someone already has a process that’s working. By using them, we can focus on what we do best.”
 
Tele Conferencing
Another area where capex can be turned into opex is telepresence conferencing. “So far, it has been good for us,” said Jun Tu, CFO at Pepsico Foods (China) in Shanghai. “You can be in New York in the morning and Dubai in the evening – all without leaving the office. It’s almost real experience, face-to-face experience. It does fulfil its promises.”
 
Pepsico has built telepresence rooms in its offices around the world, including China. “Ours is capex,” Jun Tu explained. It is therefore important to maximize usage of the 24/7 facilities. “You have to make sure you’re using it all the time.” The downside is that people don’t think twice about arranging a meeting on weekends and after-office hours. “But the ROI is pretty good,” he said.
 
Companies have the option to make telepresence facilities, which can cost millions of dollars to build, an opex solution, rather than capex. For example, AT&T can provide an end-to-end solution including equipment, and then can charge the company a monthly fee. AT&T retains ownership of the telepresence equipment, which is sited in the client’s premises.
 
“Another option is for the client to buy its own equipment and we install and maintain it for them,” said Audrey Fung, CFO, AP Region, at AT&T Asia/Pacific Group. There are also AT&T telepresence rooms in business centres and hotels.
 
One participant said her company was looking at telepresence seriously. “I would like somebody to invest in these rooms without me having to pay for it,” she said. “But our offices are not in the major cities. If we are in a second-tier city in China, for example, our office will be in the outskirts. I’m not sure it is workable to have a telepresence room in remote areas.”
 
One Size Doesn’t Fit All
In this roundtable as in other CFO discussions I have moderated, a common thread keeps cropping up: One size does not fit all. What works for one company is not always effective or appropriate for another organisation.
 
There are many persuasive reasons for companies to explore turning capex into opex. The potential of reaping substantial savings is an obvious one, along with the flexibility to pull the plug if there is a danger that the expected returns on expensive projects would not materialise.
 
But what capex to turn into opex, if any at all, depends on your company’s financial condition, availability of outsourcing and cloud computing providers, your level of comfort regarding the transfer out of particular business processes and other factors.  
 
As experienced CFOs know, ‘best practice,’ the phrase often spouted by management consultants, enterprise software vendors, service providers and, yes, journalists, is really a guideline, not a prescription.
 
About the Author
Cesar Bacani is Editor-in-Chief of CFO Innovation
 

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