The Cloud and Equipment Lease Agreements

Cloud computing is having a revolutionary impact on the IT equipment market, with cloud providers offering not only software as a service (SaaS), but also platform (PaaS) and infrastructure (IaaS) cloud solutions.

The cloud providers frequently lease the infrastructure IT equipment, attracted by the scalability and cash management that leasing offers. But cloud providers need to understand that leasing servers, networking equipment, and software can produce the same material risks as any commercial equipment financing. Upfront costs, recurring fees, lease extensions, inflated buyout valuations, and the like can substantially add to the all-costs of leasing.

However, a look at how many cloud providers are operating shows a disregard for this risk, with the focus solely on fast growth of the top line. As long as budgets are being met, continued lease extensions and other inefficiencies are tolerated because leasing is seen as a convenient way to quickly respond to the changing technologies and rapidly increasing demand for cloud services.

The result of this lack of lease risk management is predictable—the lessees end up paying more for the equipment they use in their service provision than planned. In one unfortunate case, the cloud provider’s cost of equipment was 67% higher than the OEC!

Commercial equipment financing can work for cloud providers, but only if the urge to continue fast growth is paired with a careful, realistic assessment of lease risk and an emphasis on risk management.

Understanding Historical All-In Lease Costs

For a cloud provider to begin to control risks, the essential first step is to understand the cost of its previous commercial equipment financing. This can be a complex undertaking, involving an expert analysis of past lease agreements and various costs beyond the committed term rent.

The effort pays off, however, by enabling more-accurate lease vs. buy analysis based on a more accurate forecasting of future lease costs. And, vitally, by quantifying the costs of the contract terms that drive risk, it will help the lessee raise awareness of the importance of lease management throughout the organization.

Negotiating to Control Costs

Armed with the self-awareness that comes from a review of historical leasing costs, a cloud provider can negotiate from a much-stronger position. The evidence of historical all-in costs—which is typically considerably higher than the rental cost alone—can be used to drive down the lease rates and/or reduce risk in the terms.

The key is for cloud providers to understand the risks and their cost implications and bring this understanding to the table. Astute negotiation is the foundation of risk management in commercial equipment leasing.

Creating a Risk-Averse Culture

Ultimately, however, controlling lease costs involves more than negotiating a good lease agreement. For one thing, the master lease schedule will be trumped by individual lease schedules, so risk evaluation remains an ongoing process for all leases.

There’s also the challenge of establishing an enterprise-wide emphasis on lease management. Extending leases is simply the easiest and fastest solution for cloud providers in many cases—but key personnel need to be made aware that there’s a cost for this convenience, and that this cost has the attention of management. Lease extensions are essentially “kicking the can down the road,” and they should be discouraged without strong justification.

Lease extensions can often result from poorly negotiated contracts, but they also result from operational apathy. Cloud providers should work to ensure that this unconcern for the costs of lease extensions and other risks is replaced with a healthy zeal for minimizing all-in, long-term lease costs.