Tuesday, March 8, 2011

The Amortization of Cloud Futures and Derivatives

Really interesting tweet from @jayfry3 earlier today. In it he noted a reference by @joeweinman that said Netflix treats reserved AWS instances as CapEx and depreciates it's cost over 3 yrs. This immediately got me thinking -- Wow, now that's an interesting concept.

Before I go any further I warn you I am not a tax expert, and if you are, please feel free to correct anything I say from this point forward. This is a random thought, more than a proof.

First of all, I don't think what they were referring to is actually depreciation since depreciation strictly refers to tangible assets. Instead I think what they're talking about is a very similar concept of amortization which is basically the same but for intangible assets.

A quick recap in tax law, according to Wikipedia "amortization refers to the cost recovery system for intangible property. Although the theory behind cost recovery deductions of amortization is to deduct from basis in a systematic manner over an asset's estimated useful economic life so as to reflect its consumption, expiration, obsolescence or other decline in value as a result of use or the passage of time, many times a perfect match of income and deductions does not occur for policy reasons."

With the launch of SpotCloud which essentially is a Spot Market for computing capacity, the concept of being able to reserve computing capacity in the form of a futures contract or derivative has been a popular topic of conversation during my various presentations and pitches lately. Previously I saw the opportunity for "cloud futures" from the point of view of the provider the capacity. Basically allowing the provider a greater level of insight into future capacity consumption, inventory and capacity planning. The missing part of the equation has been on the buy side, other then potentially locking in a future price, (as a hedge) the rationale for buying future computing capacity was fairly limited. With the introduction of amortization to the equation the concept dramatically shifts from not only a capacity planning exercise but also to a tax and accounting strategy for major buyers of computing capacity.

So much like traditional depreciation, amortizing future computing capacity bought as a "reservation" or derivative allows the compute asset to be deferred rather than treated as a current expense with the difference of the spot price of the compute asset as recorded on the Spot market at that the time of consumption defining a gain or loss. Taking this concept even further, if the 'depreciable' or amortized compute asset is not actually used, but instead re-sold on a computing Spot market such as SpotCloud, the business can again recognize a gain or loss based on net basis of the asset. (The net basis is cost less amortization) Yup, crazy, and it would seem -- totally do-able.

Are we on the verge of a cloud futures market? Maybe sooner than you think.

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