CapEx or OpEx: Software: Buy it or Rent it?

23.09.2022

Topic: Software Development and Implementation

The CapEx-to-OpEx shift is on everyone's lips in the IT world. In this article, we will discuss what exactly is involved, when it is advisable to make the switch and what advantages it offers.

CapEx and OpEx – the terms

CapEx stands for capital expenditure. It relates to expenditures made on longer-term fixed assets that are paid for on acquisition and which then depreciate over their useful lives. Typical examples are plant and office equipment, vehicle fleets, real estate and machinery. The use is designed to be retained over a period of years, and depreciation is thus spread over the useful life with an effect on net income. However, the full outflow of cash occurs at the time of purchase. This does not affect the income statement (P&L) because it is a conversion of assets: Current assets become fixed assets.

OpEx stands for operational expenditure. It refers to all costs incurred in maintaining the operations of a company. Typical examples are material costs for production, personnel costs, space costs and storage costs. In contrast to CapEx expenses, which are amortized over a longer period, OpEx expenses are allocated in full to the respective accounting period and are also cash-effective only in this period.

The difference between CapEx and OpEx can be boiled down to these questions:

• When is payment made, and what is the resulting effect on the company's liquidity? Once before or at the start of use, or continuously throughout operational use?
• Is there a charge to the P&L or is it an asset conversion?

Buy or rent: What offers which advantages?

When it comes to IT purchases and use, both forms – CapEx and OpEx – can be used. Hardware and software can be purchased as operating and business equipment: They are paid for in full at the time of purchase, used for several years, and depreciated over time, thus falling under CapEx. It is also possible to rent hardware and software (with a subscription model). In this case, the costs, i.e., cash outflow and earnings impact, are incurred continuously and concurrently and should be viewed as arising from the maintenance of operations.

The call option (CapEx) can make sense from a business perspective if a company has an above-average financial year. In this case, the high initial investment directly reduces the tax burden in the current year. In addition, in this case, more current assets are normally available, which would become fixed assets as a result of an acquisition.

The lease option (OpEx), on the other hand, is an option at any time, regardless of how the current fiscal year is going, for several reasons:

• Lease options are ideal for companies that want to secure their liquidity and avoid high one-time payments. This allows companies to take advantage of technologies they might not otherwise be able to afford or to use their liquidity in other areas. For small and medium-sized companies, this is definitely of relevance.
• With a subscription model, a company is positioned with greater flexibility. Of course, there are also minimum contract periods for rental models. However, these periods are usually shorter than the amortization periods for purchased hardware and software: Lease models often have a minimum term of 3 years, while the typical amortization period is 5 years. Thus, it is possible to scale up as well as down. This flexibility is particularly important for companies pursuing a growth strategy and also rely on M&A (Mergers & Acquisitions), for example.
• At the same time, the investment risk is lower with a rental model, likewise due to its higher level of flexibility. A psychological effect also plays a role here. Particularly in the case of innovative, as yet less widespread technologies, companies are more reluctant – and would prefer to rent a pig in a poke, so to speak, rather than to buy it.
• Subscription models also ensure predictability. The monthly, quarterly or annual costs are known in advance and it is clear what they are based on (e.g., the volume of transactions or documents).
• A subscription model also offers more security, in the sense that more of the risk is covered by the provider. Discrepancies must, of course, be remedied within the time periods set, even in the case of a purchase model. However, when it comes to (at times unplanned) follow-up costs for maintenance, upgrades, repairs, replacement in the event of a defect, etc., these are usually already included in a rental model, so you don't have to plan for any unexpected additional costs.

For these reasons, rental models are becoming increasingly popular in IT, whether for hardware or for software. A new trend is also emerging in software: Subscription was particularly familiar from SaaS and other cloud models, but now more and more software vendors are also offering rental models for on-premises installed software. This means that even companies that do not (yet) want to move to the cloud can benefit from the CapEx-to-OpEx shift.