Using Unit Economics to Manage Cloud Costs Anywhere on Your Cloud Journey

By Bill Buckley, SVP of Engineering, CloudZero

Today, cloud-driven businesses face a trio of deep-rooted problems, headlined by rising costs. The State Of Cloud Cost In 2024 report found that less than half of participating companies had "healthy" cloud costs.

Another impending challenge is the AI cost crisis. AI's cloud workloads require massive resources that can quickly consume an organization's cloud budget.

Third — but not least — is organizational misalignment. A company's disparate teams or departments often lack alignment regarding their goals, understanding, and management of cloud resources.

Cloud unit economics is a system of using objective measurements to ensure that your business maximizes profit when delivering and developing cloud-based software and services. This is especially helpful in highly dynamic environments where absolute cloud costs change quickly. Organizations need an approach that consistently tracks cloud spending, regardless of where they are on their cloud journey.

Cost Allocations vs. Unit Cost Metrics

Beyond the essential cloud cost management tools, you need to understand cost allocations and unit metrics. These are often confused, so let's examine what each means.

Let's start with cost allocations, separating absolute costs into custom business buckets. Examples:

Related:Cloud Computing in 2024: AI, Cost Optimization Shape the Landscape

Cost allocations organize your cloud costs by relevant business dimensions. Unit cost metrics, then, help you maximize cloud efficiency.

You can measure unit metrics in terms of any unit of consumption — GBs, API calls, fuel, etc. — but for our purposes, we will focus on cloud cost as our unit of consumption; hence, "unit cost metrics."

A unit cost metric focuses on the rate of change for cloud cost specifically, as opposed to infrastructure. For example, cloud spend divided by daily active users would yield the unit cost metric "cost per daily active user."

The pinnacle of sophistication for cloud unit economics is combining unit cost metrics and cost allocations. When you have both, you can segment unit cost metrics by business dimensions, showing you what specifically is driving unit cost metric trends.

Improving Gross Margins

If you want to increase your gross margins, you have two options. You can find ways to increase revenue — perhaps by raising prices or entering new markets — or lower your costs of goods sold (COGS).

Related:Cloud Cost Calculators: Benefits and Limitations

For most SaaS companies, COGS comprises two main cost categories: support (personnel) costs and cloud costs. You need to determine the percentage for each of these costs. If your cloud costs are, say, 75% and your support costs are 25%, you will want to focus on lowering your cloud costs.

Then, you need to look at the main categories of your cloud costs to find out which most affects your cost. Like in any cloud environment, not every COGS driver is equivalent. Various features contribute to it, and different features represent different cost levels. Some customers also affect COGS disproportionately.

When you understand how these factors contribute to your costs, you can begin an initiative to save on cloud expenses. Investigate as needed, then take the necessary actions to lower those costs. You can predict how much you'll need to spend on the cloud to hit your yearly and quarterly targets. Knowing your unit economics empowers you to calculate customer margins based on their cloud spending. Then, you can strategize properly.

The Holy Grail: Cloud Efficiency Rate

Cloud Efficiency Rate (CER) is a new metric designed to help SaaS companies and digital businesses evaluate their cloud efficiency. Why the need for this metric? While engineering teams drive the majority of cloud consumption, many engineering leaders tend to tune out during discussions about gross margin because it includes headcount expenses that often don't roll into the budget for those leaders. So, engineering leaders need help understanding the direct impact of their work.

Let's not forget that a significant portion of cloud spending doesn't roll into COGS. And let's be honest: In a world of multi-tenant SaaS, cloud-native and Kubernetes architectures, and free product trials, accurately allocating cloud spending to operating expenses versus COGS is complex.

CER gives you a clearer picture. It's like gross margin but leaves out those headcount and cost allocation complexities. Instead, it focuses on 100% of your cloud spend, giving you direct insight into how efficiently you're using your cloud resources in relation to your revenue.

Alleviating the Manual Approach

You'll need to gather the right tools, though. You could do all of this manually, but it would require an enormous amount of nontrivial work. A platform can make unit cost metric calculation and cost allocations simple. You only need to implement it to begin seeing unparalleled efficiency in a fraction of the time and for a fraction of the expense required for you to do it manually.

Once you've got unit metrics underway, the goal is to turn every engineer into a proactive cloud efficiency expert. This includes developing the correct reports for the right people, configuring automatic alerts, tracking efficiency wins, rewarding efficient engineering, etc.

Cloud Unit Economics for the Win

As cloud adoption and scale increase, so do their costs. It's always been a business tenet that you must know your costs to remain profitable, but this is usually challenging in the cloud. The goal for today's cloud businesses is to use unit economics in the cloud to better handle cloud costs, no matter where you are in the journey. Following the above best practices will help you calculate cloud unit economics for every stage of the journey: crawl, walk, run.

About the author:

Bill Buckley is a seasoned technology executive with a rich background in software engineering and product management. With a career spanning prominent companies such as EMC, Unidesk, Citrix, and now CloudZero, Bill brings a wealth of experience and expertise to his role as senior vice president of engineering.