Flexible finance products can boost the take-up of private cloud, while data protection regulatory agreement changes can influence the market. Sotiris Kanaris investigates

Cloud computing has been without a shadow of a doubt one of the buzzwords of the decade. Businesses have been investing heavily in cloud technologies, with International Data Corporation predicting that half of all IT spending will be of this type by 2018 and 60-70% of all software, services and technology spending by 2020.

The private cloud, the type of cloud computing which involves a distinct cloud-based environment operated only by a specific customer, has been gaining popularity.

"I think the demand for private cloud is growing and the requirement for funding is going to grow as well," says Neil McLaren, financial services, treasury UK, Ireland and Nordics at Fujitsu.

EMEA vice-president at Dell Financial Services Cormac Costelloe explains that companies operating on outdated platforms realise they have a "real competitive disadvantage" to rivals that moved to more up-to-date platforms.

According to IBM, businesses that access cloud computing are able to transform their customer interactions and capture more business.

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"Cloud is powering business growth to enable new business strategies, speed the delivery of new products and services and access new services that improve business processes," writes IBM.

High cost

The private cloud’s high cost, which includes implementation costs like training and data migration, in combination with customers’ changing buying behaviour has increased demand for the consumption-based payment model over the ownership model.

"The old traditional model of companies buying their infrastructure and paying for it, maybe with some kind of finance lease over a period of time, is still there," says Costelloe. "However, we’re seeing more demand for finance products with a greater level of flexibility built into them and aligned to how the customer uses or consumes."

Stuart Hall, regional manager UK and Ireland at Cisco Capital, explains that the consumption-based and pay-as-you-use models not only help customers mitigate some of the potential financial and technical unknowns, but also help dramatically improve cash flows.
Managing director at Syscap Philip White says cloud financing can reduce the barriers to entry for SMEs for the acquisition of, or access to, some of the cloud products, where perhaps price is a limiting factor.

However he says that upfront costs pose a challenge not only to SMEs but also cloud finance providers.

"It is all very well selling the dream of ‘£20 per user, per month’, but in order to get the full benefit of these products there are often associated upfront costs," White says. If the finance provider sells the cloud at £10 per user, per month, but tells the customer it’s going to cost £15,000 to implement it, then the provider sells a ‘spend to save’ model which creates barriers to entry."

White says finance companies have an important part to play in SMEs accessing a private cloud, by funding the upfront services associated with cloud implementations and amortising that cost over a period equal to the licence or subscription term.

According to White, in the SME space there are end-users with wildly differing views and interpretations of what constitutes the cloud. He believes the inconsistencies give rise to confusion, where customers try to look at the return on investment model and where the tipping point is in that equation.

He says: "If you take software as a theme, research on cost of ownership shows that the tipping point in the equation is 4.5 years where subscription no longer necessarily becomes the most economical way of accessing products.

"This clearly varies depending on the utilisation of the business application. However, if you take a mid-market enterprise resource planning product as an example, the accumulative and inflated costs eventually become prohibitive as organisations end up paying much more over the lifetime of the solution.

"As a result many leading cloud-based independent software vendors see an increase in attrition rates after 12 months as their customers become aware of the ‘elephant in the room’," adds White.

Costelloe says upfront costs make the private cloud less viable for SMEs, as they don’t have the investment capability to build it.

Risk mitigation

White says cloud financiers have to undertake far greater due diligence around the seller than perhaps they would ordinarily do when engaging in ‘traditional’ end-user finance.

Finance companies contractually insulate themselves from performance risk, as they have no control over service provision.
"From a risk perspective, you need to ensure that in your contract you are very clear in terms of what you are doing,." says White.
"You are not providing the service and you need to ensure that all of the risks associated with that are very firmly with the software of the cloud provider."

Costelloe says that under any lease or loan contract, payment liabilities are there whether or not there are issues with performance.
However, he specifies that if there are issues with the service provided it’s likely to impact a customer’s payment performance.

Disruption rights

White says that disruption rights can be a way to tackle default on payments.

"If you are partnering a cloud provider you want to try and encompass some kind of disruption rights," explains White. "In the event of a non-payment you’ve got the threat of reducing access to the services that they are buying. Clearly that’s something you have to do in conjunction with the seller. It needs to be a robust and well-established software provider."

In addition, the fact that IT equipment is ‘mission critical’ for a business can act as a safeguard against such default.

"If you strip out the IT platform that the business operates on, you really don’t have a business anymore," says Costelloe. "The essential use nature of the asset provides you with a level of insulation that maybe you don’t get for non-technology assets."

Despite captive finance companies having an advantage over their own products, a number of bank-owned and independent finance companies are operating in the market.

Dell Financial Services’ Costelloe says being part of an overall technology business confers advantages compared to more traditional finance companies in relation to financing in the technology space.

Costelloe says that captive finance businesses may get insights on what is happening in the space that non-technology-owned finance companies wouldn’t have. He adds that a better understanding of the product evolution makes them more able to take residual positions.

"Traditionally, banks wouldn’t be keen on taking residual positions on technology equipment," says Costelloe. "As a captive finance business we’re probably in a position to be more aggressive about that, because we have a better understanding of what’s happening in terms of product evolution."

Costelloe says that the requirement from banks to carry greater amount of capital has shifted their attention away from financing technology.

"As banks need to put more capital in place, they have to make choices around where they are going to deploy capital, and for many banks, financing into the tech sector wouldn’t be considered core. We see cases where financial institutions like banks are pulling back from this space," Costelloe adds.

The capital challenge faced by banks has changed the vendor finance market, with some businesses linked with banks being "not as active", according to Costelloe.

He says that some non-bank aligned vendor finance businesses are coming back into the market, typically financed by private equity firms.

Despite Dell’s decision to move away from a vendor finance arrangement three years ago, to one where it has its own captive capability, Costelloe believes there is a role for vendor finance businesses in the market.

Fujitsu Financial Services’ McLaren believes there will be more vendor finance in the cloud financing space in the future, where deals will be created by the vendors and banks will remain involved.

"Payments will be agreed with the customers and then sold down into the banking market and these solutions will become more sophisticated in what they are actually offering," explains McLaren. "I think the banks will still perform an important role because essentially they will be using their balance sheet in order to fund quite a lot of these target business for all sorts of vendors and they will increasingly have to work with them,"

McLaren says that a challenge faced by the industry is for the customer to understand the economics for a vendor of providing the cloud platform and accept a certain level of committed payment. "This will enable vendors to continue investing in the solution," he says.

Unsafe harbour

In October 2015, following a two-year-old case taken to the European Court of Justice by Austrian privacy campaigner Max Schrems, the court ruled that ‘safe harbour’ – the European Commission’s transatlantic data protection agreement – was invalid.

Companies had relied on this agreement to transfer data legally across the Atlantic to the US since the year 2000. The ‘safe harbour’ was based on a promise from US companies to protect European citizens’ personal data.

Cisco Capital’s Hall says the decision taken by the EU to override the pact has been the most recent reminder of the impact that regulation can have on cloud service adoption.

Hall believes the invalidation of ‘safe harbour’ can increase demand for cloud deployment models. He says: "The net result in this case can be that of increased demand for cloud deployment models – such as on-premise private cloud – that allow organisations to better control placement of data and associated intellectual property without sacrificing the benefits that cloud can provide.

"In essence there will continue to be a number of data privacy, data sovereignty concerns that will most likely favour private cloud deployments, hosted or on-premises, with local data centre presence."

In February, the European Commission and the US agreed on a new framework for transatlantic data flows, the ‘EU-US Privacy Shield’.

Commenting on the failure of the EU and US to reach an agreement for ‘Safe Harbour 2.0’, Mark Thompson, privacy practice leader at KPMG, says: "Given the fundamental different cultural views on privacy between the EU to the US, it is not a surprise that there have been challenges getting to a "Safe Harbour 2.0" solution in the allotted time frames."

The new arrangement will provide stronger obligations on companies in the US to protect the personal data of Europeans and stronger monitoring and enforcement by the US Department of Commerce and Federal Trade Commission, including through increased cooperation with European Data Protection Authorities.

EU Commissioner of Justice, Consumers and Gender Equality Vera Jourová comments: "For the first time ever, the US has given the EU binding assurances that the access of public authorities for national security purposes will be subject to clear limitations, safeguards and oversight mechanisms. Also for the first time, EU citizens will benefit from redress mechanisms in this area."

Costelloe believes that if a new agreement which permits European data to be held in US-based data centres and vice versa was not reached it could have created serious challenges to cloud providers.

"I think if the transatlantic data flow haven’t been permissible there would have undoubtedly been some challenges in terms of certain cloud providers trying to deliver their services on a global level, or at least across the US and Europe,"says Costelloe. "I think there’s been a compromise agreed on that so I think it’s less of a challenge than perhaps people first thought it was going to be,"

On the other hand, ElasticHosts – a UK-based company with 10 data centres around the world – says that the new framework doesn’t end the uncertainty around data transfers.

The uncertainty created by the change in agreement could have an effect on European business’s choice of private cloud provider, which could also affect the finance market.

ElasticHosts advises European companies to store data within the region. "To completely negate any possible backlash, the best course of action for any involved company would be to work with European hosting providers to store data generated in the EU or set up data centres themselves in the region," the company writes.