TCO & Cloud Economics
5 exercises — master cloud economics vocabulary: total cost of ownership, CapEx vs OpEx, Reserved Instances / Savings Plans / Spot pricing, rightsizing, and presenting ROI and payback period to a CFO.
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Cloud economics quick reference
- TCO — total cost: hardware refresh + power/cooling + stranded capacity + staff + licensing. Average on-prem utilisation: 15-20%.
- CapEx — upfront hardware investment, depreciated over 5 years. Balance sheet asset.
- OpEx — recurring cloud bill, expensed each period. Flexible, but requires FinOps discipline.
- On-Demand — no commitment, highest per-hour rate. Use for variable/unpredictable workloads.
- Reserved Instances (1yr/3yr) — 40-72% discount for committed steady-state workloads.
- Savings Plans — flexible $/hr commitment; similar discount with instance-type flexibility.
- Spot / Preemptible — 50-90% discount for fault-tolerant batch/ML workloads. Can be interrupted.
- Rightsizing — match instance to actual demand; AWS Compute Optimizer / Azure Advisor.
- Payback period = migration cost ÷ annual net savings.
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A CFO asks: "Our on-premises data centre is fully depreciated. Running it costs us almost nothing. Why should we pay for cloud?"
How do you construct the full TCO comparison?
A fully-depreciated asset is a sunk cost. The relevant question is: what does it cost to keep running — and how does that compare to cloud?
Hidden on-premises costs (often excluded from naive comparisons):
PUE (Power Usage Effectiveness):
Ratio of total data centre power to IT equipment power. World-class hyperscaler PUE: 1.1-1.2. Typical enterprise DC: 1.6-2.0. All that overhead is pure cost with no compute value.
Stranded capacity example:
You provision 100 servers for peak load (Christmas, month-end). Average utilisation in the remaining 11 months: 18%. You are paying for 100% of those servers 100% of the time. Cloud scales to demand — you pay only for what's running.
Key vocabulary:
• TCO (Total Cost of Ownership) — all costs associated with owning and operating an asset over its useful life
• Sunk cost — a past cost that cannot be recovered; irrelevant to future decisions
• Stranded capacity — provisioned compute that is idle and paid for but delivering no business value
• PUE (Power Usage Effectiveness) — efficiency metric for data centre power overhead
Hidden on-premises costs (often excluded from naive comparisons):
| Cost category | Typical impact |
|---|---|
| Hardware refresh | Every 3-5 years; servers, storage, networking. Often ≥ initial cost. |
| Power & cooling | Typically 40-60% of hardware cost as annual overhead (PUE) |
| Physical security | Physical access controls, security staff, CCTV, cage rental |
| Stranded capacity | Avg on-prem utilisation: 15-20% of provisioned capacity |
| Operational staff | SysAdmins, storage admins, network engineers managing hardware |
| Licensing | VMware hypervisor, management tooling, OS licenses |
| DR / backup | Secondary site, tape infrastructure, backup software licensing |
PUE (Power Usage Effectiveness):
Ratio of total data centre power to IT equipment power. World-class hyperscaler PUE: 1.1-1.2. Typical enterprise DC: 1.6-2.0. All that overhead is pure cost with no compute value.
Stranded capacity example:
You provision 100 servers for peak load (Christmas, month-end). Average utilisation in the remaining 11 months: 18%. You are paying for 100% of those servers 100% of the time. Cloud scales to demand — you pay only for what's running.
Key vocabulary:
• TCO (Total Cost of Ownership) — all costs associated with owning and operating an asset over its useful life
• Sunk cost — a past cost that cannot be recovered; irrelevant to future decisions
• Stranded capacity — provisioned compute that is idle and paid for but delivering no business value
• PUE (Power Usage Effectiveness) — efficiency metric for data centre power overhead