How to Think About CapEx vs. OpEx in SaaS Procurement

Finance teams categorize business expenses to track costs more efficiently, analyze their organizations' financial health, and optimize balance sheets and taxes. Capital expenditures (CapEx) and operational expenditures (OpEx) are two of the main categories used. The former covers items that improve the value of the company in the long term, like new machinery or owned software licenses, while the latter represents recurring expenses that support day-to-day operations, like insurance and payroll. 

IT spending has changed dramatically since the advent of the SaaS model. Once, significant CapEx was required to build out hardware and infrastructure. Now companies have shifted more towards cloud-based SaaS tools, which are typically classified as OpEx instead of CapEx.

In this blog, we’ll discuss some of the implications of this change for finance and procurement teams and provide guidance on negotiating better contract terms to reduce OpEx on SaaS spending: 

• CapEx vs. OpEx: A high-level overview.
• The shift from CapEx to OpEx in the SaaS model.
• Negotiation strategies for optimizing OpEx in SaaS contracts.
• Can SaaS spend be treated as a capital expense? 
• Future trends and considerations.
• CapEx vs. OpEx FAQs. 

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CapEx vs. OpEx: A high-level overview

CapEx and OpEx vary based on how the expense impacts a business and in what timeframe it is used or expected to be used. While the procurement process for capital expenditures and operational expenditures is similar, they are treated very differently in a business's accounting function. OpEx can be deducted from taxes in full the year they are incurred, while CapEx must be deducted over the expected useful life of the expense.

CapEx explained

Capital expenditures are long-term investments in assets that will benefit a company for more than one year. These expenses are used to acquire, upgrade, or maintain assets such as property, buildings, technology, or equipment. Expenses are capitalized, meaning they are recorded as an asset on the balance sheet and then depreciated or amortized over the asset's useful life. This spreads the cost over several years. 

CapEx requires a large up-front investment, which may require you to predict your organization’s needs for several years to come — putting you at risk of over- or under-purchasing. With IT spending, this can be tough because it requires an organization to estimate scale over time or plan for evolving technological needs and hardware that could become outdated just a few months or years after it is purchased. 

CapEx purchases cause organizations to lose some flexibility to adopt new or better solutions over time. But on the plus side, CapEx provides a level of autonomy. Purchasing something outright gives an organization complete control over how to use the asset, or modify it as needs change. 

When an expense should be classified as Capex

• It provides a long-term benefit to the business.
• It leads to the creation of a new asset or significantly enhances the value/life of an existing asset.
• The expense requires several layers of management approval.

CapEx examples

• Property, machinery, equipment.
• On-premise software licenses. 
• Servers and network equipment.
• Upgrades or overhauls of IT infrastructure.
• Patents or licenses.

OpEx explained

Operating expenditures are short-term expenses required for the day-to-day functioning of the business. These include costs like salaries, rent, utilities, and raw materials, which are consumed within the year. These expenses are fully deducted in the same financial year in which they are incurred. They appear on the income statement and directly reduce the company's profits for that period.

The up-front investment for purchases categorized as OpEx is smaller, and they are typically pay-as-you-go. This leaves organizations with the flexibility to scale up or down based on usage or needs, enabling them to keep more cash on hand. OpEx related to SaaS tools provides a layer of flexibility and reduced risk. If you’re not satisfied with a vendor or solution, you can make a change without being locked into a certain structure. OpEx purchases also typically lead to reduced maintenance costs and shorter timelines to deploy a new product because of the on-demand service. 

When an expense should be classified as OpEx

• The expense is necessary for day-to-day operations and doesn’t necessarily provide long-term benefits beyond the current fiscal year.
• The expense is required for normal operations of the business and doesn’t result in significant improvement of an existing asset.
• There are typically fewer barriers to approving the expense each month or quarter, as it is already accounted for in the organization's operating expense budget. 

OpEx examples

• Employee salaries.
• Utilities and office supplies.
• SaaS subscriptions.
• Cloud service usage.
• Maintenance and support.

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The shift from CapEx to OpEx in the SaaS model

Traditional IT spending involved CapEx-heavy investments in on-premise solutions, like servers and data center facilities. But with the rise of SaaS and cloud services, many IT investments like data storage and managed IT or security services shift to OpEx classification. This allows organizations to spread IT costs over time and brings many benefits, including:  

• Predictability: More predictability in an organization’s budget, with predictable monthly SaaS costs.
• Flexibility: Less need for upfront capital investment, which increases cash flow and brings more flexibility to the IT team’s budget.
• Fewer Ownership Responsibilities: Using SaaS and cloud services vs. investing in owned assets like servers and data centers shifts the onus for stability, service quality, data security, and compliance from the organization to the SaaS vendor.  

Negotiation strategies for optimizing OpEx in SaaS contracts

To reduce operating expenses, it’s essential to negotiate the most favorable terms within a SaaS contract. To do so, consider multiple providers and get a clear understanding of the total cost associated with each solution — including any implementation fees, data migration fees, or additional user fees. 

You should also negotiate contract terms that add value to your organization. This may include asking for discounts for early payments, removing auto-renewal clauses that could lock the organization into unwanted contracts in the future, or requesting service guarantees to minimize the risk of disruptions that could impact the business. Another option is to negotiate usage-based pricing, which will help organizations avoid overpaying for features or services it doesn’t need. 

The Vendr platform offers pricing benchmarks, service details, and other valuable information that comes from negotiating over 40,000 deals across 5,000 suppliers. 

Can SaaS spend be treated as a capital expense? 

Some very large companies that incur huge SaaS costs will capitalize those expenditures, though this is fairly uncommon and would only occur for very large SaaS contracts. Another situation in which this could occur is if a company’s SaaS spend goes directly towards building a product or service, which itself could be considered a capital asset. 

Future trends and considerations

More companies are shifting to a usage-based consumption model. This is especially common in cloud computing, telecommunications, and utilities, where you see pay-as-you-go, pay-per-transaction, or pay-per-gigabyte models. With usage-based consumption, SaaS OpEx costs can become less predictable and more variable month to month. This shift has pros and cons. While it can lead to more cash on hand for an organization — and eliminate risk with incorrectly estimating needs — it can also complicate an organization’s financial forecasting if usage shifts drastically from month to month. 

CapEx vs. OpEx FAQs 

How can you determine if a project should be considered a CapEx or OpEx?

To determine if a project should be considered CapEx or OpEx, consider how it will impact long-term asset creation or improvement and how long the benefits of the investment will last. If it will significantly extend the value or life of an existing asset and benefit the organization for more than one year, it should be considered a capital expenditure. If it is necessary to conduct daily operations, won’t enhance assets in the long term, and will be consumed within the year, it should be classified as an operating expenditure. 

Is SaaS spending CapEx or OpEx?

SaaS spending is generally considered OpEx because of the subscription-based model, short-term usage (month-to-month or annual contracts), and the fact that SaaS solutions are used for day-to-day operations like project management and communication/collaboration. Some examples of SaaS expenses categorized as OpEx include monthly fees for a system like Salesforce or annual subscriptions for tools like Slack. 

Is R&D CapEx or OpEx? 

Research and development (R&D) efforts can be categorized as either CapEx or OpEx, depending on the nature of the expense. Materials used in research or the costs of conducting experiments and tests to keep a product or service functioning properly are typically considered OpEx. Costs related to developing a new product, like developing a prototype or building a new lab or facility, on the other hand, may be categorized as CapEx.

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