Economics refer to feasibility of the product or service. In business, profitability occurs when revenue exceeds expenses. Using the total cost of a product to calculate expenses gives you a more accurate picture of profitability. The total cost of a product takes into account a wide range of expenses, including all fixed and variable costs associated with producing the product.
Cloud computing brings the benefit of unprecedented economies of scale to IT operations. Cloud technology allows large data centers to standardize and pool computing resources, resulting in highly efficient operations. At the same time, cloud automates and streamlines many maintenance tasks, offering exceptional agility to end-users.
Many of these benefits are amplified as the size of the cloud increases due to the presence of three sources of economies of scale. Supply-side economies of scale result from consolidation of overhead costs, purchasing power, and power efficiency, making large datacenters up to 50% more cost effective than smaller data centers. In addition to the cost of capacity, the overall cost of IT is also determined by the degree to which the capacity is efficiently utilized.
Currently, infrastructure is built to meet peak demand. Assessment of demand-side economies of scale shows that pooling computing improves the utilization of IT resources and reduces costs by another 50%. Finally, multi-tenancy, which refers to multiple customers sharing the same application, allows those customers to divide the costs of operating the application and can reduce costs by an additional 20%. The combined impact of these economies of scale can result in long-term savings of up to 80% when comparing large and small clouds.
While private clouds can achieve some degree of cost savings from the scale economies while addressing some concerns about cloud, analysis reveals there is a price premium associated with private clouds, as the benefits of scale do not apply equally to public clouds and private clouds. Through our analysis, we show that over time the cost of private clouds will increase to be 10x higher than public clouds, while barriers to public cloud adoption will be addressed to a greater degree. Managers must therefore weigh the implications of both choosing a private cloud for their own IT and of enacting regulation that might inhibit the use of public clouds.
Reasons customers save money with cloud:
- Cloud helps customers replace up-front capital expense with low variable cost.
- Massive economies of scale and efficiency improvements allow to continually lower prices.
- Multiple pricing models allow you to optimize costs for both variable and stable workloads.
- Cloud computing drives down IT labor costs both up-front and on an on-going basis.
- Cloud delivers a premium security spec at non-premium prices.
- Cloud allows customer workloads to be highly available for a fraction of the cost of self-hosting.
The basis for the economic advantage is the economy of scale available to cloud computing data centers. The three areas of scale advantage:
1. Supply-side savings: Cloud data centers have lower costs per server, based upon purchasing power.
2. Demand-side aggregation: By supporting a mix of tenants, cloud providers are able to achieve higher server utilization rates than is possible for single-tenant data centers (even those for large companies with different departments, business units, or subsidiaries sharing the data center).
3. Multi-tenancy efficiency: Hosting multiple tenants spreads administrative costs and reduces cost per data center user.