Armanino Blog

Software Acquisition: Rent or Buy?

November 01, 2011

Admit it - you've always wanted a red sports car. When you travel out of town for business, you rent one. Hey, a person needs to get around...

The dynamics of renting versus buying a car are clear. If you rent, you pay per use, and you have your pick from any model on the lot. The rental agency deals with financing (and depreciating) the car and handles the maintenance, repair and servicing hassles.

If you were to buy the same red roadster, all these problems would be yours.

Until recently, if you wanted powerful financial software, you were in the position of the rental agency. That is, you would pay the upfront license fees and the annual maintenance fee, often 18% or more, and install the software on premises. You'd bear all the costs and the risks of ownership. If you wanted to customize the software - well, that's your business engine, but don't expect to re-use the same custom parts when you upgrade.

Recently it became possible to change positions in the market. You be the renter and the software vendor is the rental agency - responsible for making the solution work and accountable to you if it doesn't. Unlike traditional on-premises software, which is upgraded once every 18-24 months, cloud software vendors modify the online software on a monthly basis, continually introducing innovations that give you a more powerful vehicle with wish-list features. (Try that on the car in your driveway!)

Best of all, the vendor integrates the upgrades into the base version of the software so it is available online immediately. You can still customize - but you are configuring pre-integrated features (or even pre-integrated third-party software) rather than building or buying and bolting on parts.

You're not just a car lover, you're an accountant and business executive. You recognize that the rental car is a fixed asset from the agency perspective and a service from the customer perspective. If your company were making the rent vs. buy decision for a company car, you would be comparing the advantages and disadvantages to your business of making a capital expenditure vs. an operating expense. The same reasoning applies to software acquisition.

A small company which has to guard its cash flow may prefer to avoid the up-front capital cost and use the service, accounting for it as an operating expense. In any size of company, a departmental budget might not cover the capital expenditure but may cover the operating expense. This would mean gaining the use of  more powerful business software than it could otherwise afford.

Treating software acquisition as OpEx also confers income tax advantages to any company.  However, the company may prefer to account for the purchase as CapEx, despite the larger up-front cost. As Diffen states, "If a public company wants to boost its earnings and book value, it may opt to make a capital expense and only deduct a small portion of it as an expense. This will result in a higher value of assets on its balance sheet as well as a higher net income that it can report to investors." In this case, the smaller operating expense is the amount that can be depreciated. However, the (potentially larger) costs of supporting the software remain an operating expense.

Clearly this discussion would soon take us beyond a simple apples-to-apples comparison of the cost of licensing on-premises software vs. subscribing to a cloud application provided as Software as a Service (SaaS). It would take us into a discussion of Total Cost of Ownership (TCO) - a subject for future posts.

If you are ready to take a deep dive into into this subject right now, I recommend that you read Geva Perry's post, "Accounting for Clouds: Stop Saying CapEx Vs. OpEx," and the comments of his readers.  Perry, an MBA-credentialed software executive and consultant, surveys cloud computing from top to bottom - from Infrastructure as a Service to Platform as a Service to Software as a Service - so he has a particularly holistic view of the big picture and all its moving parts.

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