Understanding Enterprise Blockchain Cost Modeling Basics
Its all about the money. No matter what they tell you.
Blockchains and distributed ledgers are transforming the way entire industries work especially in the Fintech and logistics industries. With new deployment models being rolled out by cloud providers bring up the opportunities for companies to at least test out blockchain efficiently.
When it comes to blockchain it is important to understand that most of the cost savings that will be realized generally will be through implementing “business logic” into smart contracts. When this business logic is introduced companies can than look at other ways to reduce costs such as removing intermediaries and employees.
When implementing this logic, you’re essentially handing off your prior “intermediary” tasks to computer code (aka smart contracts or Chaincode) that will be triggered by events originating from perhaps different consortium members.
For example, in the Ethereum blockchain with the right use case it is similar to a cloud service where the responsibility of processing transactions is shared among distributed nodes. The one thing of course to point out that Ethereum is decentralized while cloud providers such as Google Cloud or AWS are centralized. Hyperledger or Corda you can run on premises or in the cloud as well. Each approach has substantially different costs.
However, organizations that require privacy, security and specific membership really can not take advantage of a shared
Return on Investment (ROI)
ROI analysis is typically used to compare investment scenarios. Typically, the customer is analyzing these scenarios and one of the scenarios would of course make better financial sense.
Let’s take two high level scenarios.
For example, if an enterprise customer is determining whether or not to refresh a SAN storage array for three, five years and seven years an ROI analysis would be requested to help determine which option is better from a “financial perspective”. Costs for this hardware is fixed (hardware, software, support, power, etc.)
On the other hand, if an enterprise customer is determining whether to implement a Hyperledger Fabric blockchain for three, five years and seven years an ROI analysis would be requested to help determine which option is better from a “financial perspective” as well.
However, the main difference here from an exercise standpoint is that the “hardware” has fixed costs generally easy to determine and a blockchain has both fixed costs and some not so fixed costs that can be “undetermined costs such as “development costs”.
The figure below shows some core common reasons to perform a ROI.
Figure 1 Return on Investment
When evaluating a blockchain opportunity generally you would want to start establishing what ROI formula to utilize. Essentially, the most direct approach to an ROI number or basic formula for ROI is
ROI = Net Profit / Total Investment * 100
Essentially, Net Profit is the “Return” and the “Total Investment” is allocation of costs which that are incurred from hardware, software, cloud services, blockchain consulting and development.
- The basic ROI calculation is also known as for some old folks like me Rate of Profit (ROP) or Rate of Return (ROR)
- The return should be considered income gained or lost on an investment, profit or loss, gain or loss, net income or loss for an IT project.
- The cost of investment is also known as investment or capital, in IT we use CAPEX and OPEX funding generally.
The figure below highlights some costs and provides some ROI formulas as well.
Figure 2 Return on Investment (ROI) Costs and Formulas
Tangible and Intangible Benefits
When calculating ROI, I generally like to process this in a chart or spreadsheet some potential benefits to highlight to visually present the customer. These benefits generally fall into two categories:
Tangible or Intangible
- Tangible benefits are generally benefiting that can be seen, measured easily or documented easily. These are known as well as “hard “ or “validated” benefits. An example would be to replace a legacy email system with a cloud service. Its clear that the legacy systems have been decommissioned and costs recovered.
- Intangible benefits are generally benefiting that cannot been seen, measured easily or documented easily. These are known as well as “soft” or “transparent” benefits.
An example of an intangible benefit would be replacing a call center system and experiencing higher customer satisfaction and potential in increased brand awareness.
Total Cost of Ownership (TCO)
Total Cost of Ownership (TCO) is widely used to estimate costs for a blockchain application. TCO is essentially gathering up all the costs whether direct or indirect to estimate a project.
The figure 3 highlights the high level cost tiers to consider when your estimating a blockchain application deployment.
Figure 3 Total Cost of Ownership (TCO)
Some more specific blockchain costs will revolve around implementation usually considered “startup cost” would be training for personnel, infrastructure hardware and software, licensing and consulting services.
Operational costs are incurred after startup and the application is in production. For example, management and monitoring services, bandwidth costs and transaction fees.
Retirement costs are incurred to “turn off” a service, which is essentially decommissioning the application. This could mean archiving data for compliance purposes, removing and disposing of server racks or tax consequences incurred.
Figure 4 covers common TCO costs and enterprise would incur deploying and application service in their data center.
Figure 4 TCO Costs
ROI VS TCO?
The major differences the two financial analysis models are the following.
- ROI model is a cash flow model and not just a costing model. Does the solution actually bring in a return? Or does it just save money?
- Costs need to be quantified as well as qualifying your savings by the investment in the blockchain.
- TCO is only total cost of acquiring and operating an asset over a period.
Next article up — Cost efficiencies in blockchain are routinely valid discussions when considering blockchains for your enterprise or discussing with your customer base.
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