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October 12, 2007

The True Value of a Hosted Server

Now that I've ranted on a few accounting shortfalls for the hosting industry I'm going to rant once more. I think that the way hosting companies must book the value of their assets per accounting rules shortchanges hosting companies. Some basic rules of finance clearly show the likelihood that significant value is missing on the financial statements.

Let's consider a mythical server that costs the company $10,000 to buy and the company depreciates it evenly over 3 years. After year one, the value on the financials is $6,667. After year two, its book value is $3,333 and finally $0 after three years. Suppose that the company deploys the server for five years. In reality, after three years, the server's true value is certainly above $0, and the hosting company is shortchanged by not being able to reflect this value on its financial statements. Multiply this effect by thousands of deployed servers and you can see that there is significant value in hosting companies that just isn't found on the financial statements.

So how should we reflect the value of a server? I would propose the use of a "capitalization rate" or "cap rate". This is a common method of appraising real estate and the formula is simple: take the projected net cash flow over the next 12 months and divide by the cap rate, and that's the value. So, what would happen if we applied this to a server?

Looking at our mythical $10,000 server above, for simplicity's sake, let's ignore any allocations of the switches, routers, generators, HVAC, etc., needed to operate it. Let's also assume it produces net cash flow of $100 per month and will do so for 60 months. Its 12 month projected net cash flow is $1,200. We would divide this by the cap rate to find its value.

Naturally, the next question is "what do we use for the cap rate?" For a given investment, the cap rate is the lowest return that an investor will accept for the given risk of that investment. In our server's case, the $10,000 investment produces a return of $1,200 per year. How much would an investor need to invest in lower risk alternatives to get the same return? For a risk-free investment of the same 5 year duration such as a 5 year Treasury Note at 4.25%, you would have to invest $28,235.29 to get $1,200 per year in return. If we use 4.25% as the cap rate in our scenario, the value of the server becomes $28,235.29. However, investors in hosting companies generally look for returns far above 4.25% and these returns are not without risk, so this is not the appropriate cap rate. For simplicity's sake, let's assume that the hosting company investor's minimum acceptable rate for the investment is 10%. In other words, if his investment in the hosting company was expected to return less than 10%, the investor has other lower risk options to invest and get a 10% return and he would not invest in the hosting company.

So if we use 10% for the cap rate in our mythical server scenario, the true value of the server is $12,000 ($1,200 / 10% = $12,000). As long as the 12 month projected net cash flow stays above $1,200 then that value holds constant. Check out the graph below to compare the value of this server from both the cap rate perspective and the accounting rules perspective over the five year life.

From month 36 to month 49, there’s a $12,000 difference in value between the two methods. If a hosting company has a thousand servers like this, that’s $12 million in value that isn’t reflected in the company’s financial statements. That’s huge.

-Gary

Categories: 
October 11, 2007

The Three P's are Changing

The three P's in the hosting world have always been Ping, Power and Pipe. Salespeople regurgitated them relentlessly and operations personnel just shortened them to the P's because we talked about them all the time. The three P's of hosting have changed in the recent years and those not aware of the changing landscape are doomed for failure. I propose a new three P standard (described below).

1) Power -- I list this one first because it is by far the most important. Power is the single greatest limiting factor to technology. If you don't understand the importance of power on future technology, you should exit the industry now. If you are not concerned with power, don't meter power and not fixated with power, you will be in serious trouble in the next 12 to 24 months. The entire industry has shifted to being "green" and large scale datacenter operators are so focused on power utilization, they are building and designing systems completely based on power usage and/or location. It's one of the most critical operating costs and must be understood to maximize long term success and profitability. Here at SoftLayer, we are obsessed with power utilization and efficiency and focus on mitigating power and heat (byproduct of power) to a bare minimum. We know the power usage of every server and network device located in the datacenter and track it real time. We are continuously seeking new low power technologies, engaged in industry consortiums looking for new alternatives, and actively planning our power needs through the end of 2010.

2) Packets -- Five years ago, the internet backbones were full of big fat packets that were easily passed by backbone and edge routers without issue. In the recent years, small packet technologies have greatly reduced the size of the average packet transversing the internet. For those of n00bs out there, smaller packets reduce the overall throughput of the routers processing the packets. The smaller the packets, the greater the reduction in horsepower of those routers. The fast rise in gaming, VOIP and other small packet intense applications has cut the average packet size in half in the last two years and I would expect that to occur again the next two years. Packet size can take the aggregate throughput of a router from several hundred gigs at large packet sizes to potentially single digits of gigabit throughput due to the processing required. Here at SoftLayer, we have installed and upgraded to the fastest routing technologies by Cisco to ensure the greatest network performance, but there are many legacy carrier, broadband, and enterprise routers out there that have limited capacity due to changing packet size. Hosting providers that were built on eBay surplus network equipment from the late 90's will soon begin to implode.

3) IP's (IP Addresses) -- Ok…not really a "P" but I take a little creative leeway here. IPv4 addresses are disappearing faster than norm's plate at the Hungry Heifer. ARIN has publically announced the need to shift to IPv6 and numerous articles have outlined the D-Day for IPv4 space. Most experts agree, its coming fast and that it will occur sometime in 2010 at the current pace (that's about two years for those counting). IPv6 brings enough IP space for an infinite number of users along with improved security features and several other operational efficiencies that will make it very popular. The problem lies between getting from IPv4 to IPv6. We are caught in this "chicken and egg" scenario where we can't leave one without the other being completely reliable. Although I think we will get to IPv6 without too much of a headache, I do think the IPv4 space will become extinct prior to a full scale transition and there will be a time where the cost of IPv4 IP's will skyrocket because of supply/demand. This should be at the top of your list as a hosting provider because additional IP space typically means new customer and/or expansion of existing customers. If you don't have a conservation plan for IPv4, migration plan for IPv6, and transition plan between the two – you may already be too late. Here at SoftLayer, we have been planning for over a year and 2008 will include a rollout of IPv6 to all those customers who seek to run dual stacks and will include incentives to customers who are able to shift to IPv6 completely.

The Three P's will likely change again in a few years as the industry continues to evolve and we find a way to solve the current challenges facing the industry. For now, focus and plan on these three and you should have a long successful existence.

-@lavosby

October 4, 2007

Office Politics

Back in Computer Science 101 I was promoted to Assistant for the Networking Staff at Kemp High School, in the tiny town where I grew up. The networking staff consisted of exactly two people: a brilliant Pascal programmer with a penchant for networks and a veteran of the mainframe days, who would happily lean back and tell old war stories about 130 column chain printers and tape drives.

One thing I noticed upon entering their office was the strong smell of coffee in the air. Indeed, they had a large pot of coffee on perpetual brew. And these two techies would drink it down as if it were water from the river of life.

Fast forward 5 years. I'm now one of those techies, but I never got quite a taste for coffee. My coworkers, however, live off the stuff. That's when disaster struck.

Now, if you've not been in an office environment for a while, or you haven't worked in IT, the enormity of this disaster might be lost on you.

The office supply company has stopped producing SoftLayer's preferred blend!

Shockwaves rolled through the company, as the news was blasted from email to email. A democratic process was set up to choose a new blend from those that are left.

Votes have been cast left and right. Active campaigns for specific coffee blends can be heard in the aisles of the company. Some are moved to poetry on one blend or another. One vote for a specific blend reads like this:

How does this affect me?
Will this make me a better person? These and other such questions must be asked when sampling a new coffee.As the day goes by a fall back onto a sure thing is essential. Sipping this flavour of coffee is not unlike slipping into a pair of your most favourite and comfortable slippers after a long day af the office. It does indeed lift the spirit.

Dare I say that Kenya AA gives us another reason to love life and love living it. The spirit soars until it becomes unbeatable. We cannot combat this or even hope to understand this cosmic handshake. This coffee is a reflection on a productive lifestyle.

It has a hallowed place in our break room. It also smells better than the other coffees.
- Klaude

It looks like the leadup to the 2007 SoftLayer Office Coffee Blend Election will be quite the hot topic for weeks to come.

A consensus is starting to build, and soon these harsh days will be behind us, and work will proceed as usual.

However, there are some (and I am in this camp), who see this as a bigger issue. Yes, we have successfully saved the day by switching blends of coffee. And like some hard changes, it looks like this change might be for the better. But as everyone knows in IT, the cycle of obsolescence is a fact of life. Some fear that this is just the start of a long, trying cycle of acceptance and rejection; there's a low level tension that the choice being made right now must be made right, lest the coffee industry decide that our newly selected blend should also fade away into the night. Is there no solution? No solid ground? Some demand that we get approval of a blend from a standards body, such as the IEEE, to make sure that various vendor's competing blends are compatible with our tastes. Is this the solution to our problems?

This has caused me to worry about the future of IT. Will technology be dictated by the whims of the coffee industry?

Here are the originals. [1, and 2 (ghost writer?)]

-Zoey

Categories: 
September 28, 2007

Big Tex

If I could be anyone in the world, I would want to be Big Tex. I can't think of anything that says – larger than life – than Big Tex. For those n00bs out there, Big Tex is that iconic Texan that welcomes one and all to the State Fair of Texas every year. His two-story boots, size BIG denim jeans and 100-XL Dickies shirt are far from the norm. As Big Tex stands tall above the crowds at the state fair - he is often used for navigation, bellows out words of wisdom, poses for millions of pictures and captures the attention of everyone young and old. His size, stature, and presence lets everyone know – this isn't your typical cowboy.

It's the "different" part that I like about Big Tex. When we started SoftLayer, I challenged my team to think differently. I wanted to do something that had never been done before. What's the point in being like everyone else? I want SoftLayer to be the Big Tex of hosting. Something so different, so unique, so functional – it will be used by one and all. The challenge lies with creating something that is unlike its predecessors - improving upon the status quo and being innovative enough to spring forward into the future.

To be truly different - one has to rely upon experience, knowledge, education, intestinal fortitude and take a calculated risk. Can you imagine the person who recommended building a 52 foot tall cowboy in 1951 to attract visitors to a relatively small state fair? In contrast, can you imagine visiting the Texas State Fair and not seeing Big Tex? The greatest companies in the world all have one thing in common – they dared to be different. They invested in the uncommon, unknown, and non-existent in an attempt to become the next household name. While Softlayer is still young and far from "Forest Gump" status – we are anything but average. This isn't your typical hosting company.

-@lavosby

September 27, 2007

Who Counts Your Beans?

Just like any company, the search for ways to increase revenues and lower costs to make more money never ends. In the increasingly competitive hosting environment, raising prices is rarely an option but finding ways to cut costs while making the experience better for the customer can and must be done on an ongoing basis.

We have achieved some success to date with the provisioning of nearly 10,000 servers; however, the end game is far greater as the ultimate goal is to become a multi-national corporation serving markets all around the world. In the hosting space, you don't really have a choice, you either innovate and get bigger or you get out. The complexities are just too great to have the luxury of maintaining the status quo. The technology landscape is littered with companies that started reading their own press clippings and got fat, dumb and lazy. And keep in mind that copying your competitors only delays the inevitable; the "me-too" companies eventually go away. In the technology world, you must innovate and push the envelope to survive.

While we are constantly looking for new and better ways to serve the customer, a great deal of time is spent improving internal reporting systems. I work with a management team that understands the importance of budgeting and tracking various financial and operational metrics. To that end, we have made a substantial commitment in systems and people to gather data to help make the best decisions for us and most importantly, for our customers.

I would love to reveal all the data we have at our fingertips but for competitive reasons, I don't want to give away too much but let me leave you with this tidbit: I wonder how many of our competitors' CEOs can, from his/her desktop, drill down to any one of 10,000 servers in multiple data centers and know exactly how profitable each individual server is with the click of a mouse.

The best companies in the world are all supported by world-class accounting and finance departments providing pertinent financial and operational data to all its stakeholders. The right information gives you a tremendous advantage over your competition.

Find someone good to count and analyze your beans. Wal-Mart did and turned the world of retail on its head. With a little luck, we might be able to do the same to hosting.

-Mike

September 26, 2007

I Hear Voices...

Running the fastest growing hosting company in the world takes its toll on me sometimes. Other entrepreneurs often ask me how I continually seem to be ahead of the game and I tell them "it's easy, I hear voices".

Before the staff carries me off to an insane asylum, let me explain a bit further. A very bright man once told me to shut up and listen to those around me. As I sat in his office trying to figure out how to schedule next semester’s classes – he showered me with a ton of invaluable knowledge that I was lucky enough to absorb along the way. His words resonate in my head to this day – "If you REALLY want to know what's wrong or right with your company – ask your employees and your customers!" I remember thinking at the time, uh yea – I paid for this? But as I progressed down the executive tracks – this notion seems to elude a lot of the top brass that I come across on a daily basis.

So just when and where do I hear these voices? Well, I hear voices at work sometimes (obviously) – but I am more likely to hear them at dinner, over drinks, chatting, texting, IMing, at a party or simply spending time with my cohorts. After spending years building relationships with both my team and my customers – I have found that nothing is harder to do and nothing provides more insight into how to improve the company and build for the future. I'm somewhat amazed at times what both sides will share with me (good, bad and ugly), but I have learned to "shut up and listen."

My advice to other business owners out there is to parlay on my secret. It won't happen overnight and it certainly takes a lot of time and effort on your part. My customer stable (Vik, Eric, Mark, Joe, Chris, Nick, Peter, Kevin, ….et al) has grown over the years and some I talk to almost on a daily basis. Without their input, SoftLayer would not be the company it is today. I am not saying everything they say or want is feasible (sorry guys), but for the most part their voices help shape the current and long-term vision of the company. If you manage a company and can't pick up the phone and call dozens of customers for real feedback, I would suggest that you are severely out of touch with your customer base.

Equally important is your own employees. Your people are your greatest assets -- they ARE the company. Throwing my two cents in here: hire bright motivated people, give them authority and responsibility, share your direction and vision, let them flourish and most important – "shut up and listen!!" My standing personal goal is to surround myself with brilliant people – it makes me look like a genius!!

-@lavosby

September 21, 2007

How do You Want to be Perceived in the Market?

When you look at the names below, what is your first reaction?

Barry Bonds
Bill Belichick
Shoeless Joe Jackson
Pete Rose
Tanya Harding
Ben Johnson
Rosie Ruiz

For most, the common thread is that each has been accused or admitted to cheating in their respective sport. Barry Bonds for using steroids (and don’t tell me he didn’t use them); Bill Belichick for filming the Jets defensive signals; Shoeless Joe and Pete Rose for gambling; Tanya Harding for trying to disable her competition; Ben Johnson for steroid used to sprint faster than any other human being and Rosie Ruiz for only running half a marathon. All of them will forever be associated with scandal first and their accomplishments second.

But sport is not the only place where cheating is running rampant. The financial markets have been and continue to be rocked by financial scandal. We all know about the high profile cases like Bernie Ebbers (Worldcom) and Andrew Fastow (Enron) but a recent university study has shown that from 1978 to 2006, there were 788 Security and Exchange (SEC) and Department of Justice (DOJ) enforcement actions for financial misrepresentation or as the layman would call it, "cooking the books". In those actions, there were 2,206 individuals identified as being culpable for some or part of the financial fraud. While all the sports figures above had their reputations tarnished, only some of them have suffered financial hardship and if I remember correctly, none served jail time for their initial actions. For financial misrepresentation, the penalties are far more severe. Over 93% were fired or left their jobs with another 31% barred from future employment as an officer of director of any publicly traded company. In addition, 617 of these individuals have been charged with criminal violations; 469 were found guilty and sentenced to an average of 4.3 years in jail and 3 years of probation. Needless to say, their financial position suffered as well. On average, these managers lost $15.3 million in stock value once the scandal was revealed and paid $5.7 million each in SEC fines.

Cheating never comes to good end. Most scandals generally start small, then greed sets in and the rest is history. Is cheating worth it? Even if you don't get caught, you will always be looking over your shoulder. And sometimes scandals can occur even with the best of intentions. Compared to other industries, hosting is still in its infancy and is just beginning to address the provisions of Sarbanes-Oxley. Who knows what kind of accounting and operational issues will come to the forefront as some of the leaders in the industry enter the public markets?

Around here we foster an environment of honesty and integrity. What are you doing in your company? How do you want your company to be perceived in the marketplace? Are you ready to face the public scrutiny of the SOX generation? Your customers and the markets are watching.

-Mike

September 18, 2007

Current Ratio Punishes Hosting

For the third (and final!) installment in this likely sleep-inducing trilogy of hosting and accounting blog posts, we'll cover Current Ratio and how it doesn't treat hosting companies fairly. Bear with me – this rant may run a bit longer than normal.

Current Ratio is easy to compute – simply go to the balance sheet and divide current assets by current liabilities and voila! You have the Current Ratio. OK, so what does it mean?

So why is this unfair to hosting companies? Well, where does most of the cash of a hosting company go? Into servers and networking gear! But guess what? These don't fall under current assets on the balance sheet and thus are excluded from the Current Ratio calculation. As a result, I'd wager that most if not all hosting companies have at some point been in the position of current liabilities being greater than current assets, where conventional wisdom says "the company may have problems meeting its short term obligations."

How does this hurt hosting companies? Suppose the company could use some short term financing for a network upgrade. If they go talk to a banker about this the banker might throw up his hands and say "I can't help you…you're in financial distress according to your Current Ratio."

I would argue with the banker that this is not necessarily so. Traditional GAAP places servers and networking gear in the bucket of long term assets along with things like buildings, bulldozers, cranes, heavy machinery, etc. For a hosting company, this placement just doesn't make sense.

Long-term assets, or capital assets, are things that typically can't be reconfigured, can't be easily converted into cash, and are used for a long period of time. A hosting company's, buildings, generators, HVAC gear, etc., is rightly classified in long term assets. But servers and networking gear are quite different in that they exhibit more traits of current assets than long term assets. Check out this definition. It would take far less than a year for a hosting company to convert its server fleet and networking gear into cash and these assets are the key source of funds for day-to-day operations.

A manufacturing company gets to count its inventory in current assets, whether it is raw materials, work in progress, or finished goods ready for sale. A hosting company uses its servers and networking gear in much the same way – it can reconfigure the processors and drives of servers, arrange the networking gear to offer new services, virtualize a server into several virtual machines or combine several servers into a grid. Then it can change things up next month if desired. This sounds more like current assets than a bulldozer. But according to GAAP and the 800 year old double-entry math system we must use today, servers get placed in the same bucket as bulldozers.

My question is, how do hosting companies as an industry get together and establish some specific accounting standards that will allow our financial statements to truly reflect our business? Simply moving servers and networking gear to current assets would more accurately reflect how we use them in our business.

Am I off base in asking this? Hardly. The real estate investment business has been doing this for years. Traditional GAAP simply made no sense to their business, and they developed accounting standards that fairly represent that business. See this and note this quote from the Real Estate Information Standards, which is published by the National Council of Real Estate Investment Fiduciaries and is widely accepted among the real estate investment management industry and the firms that audit that industry:

"The development of the Market Value Accounting and Reporting Standards resulted primarily from the realization that standardization of meaningful financial reporting was necessary in order to allow real estate to become more acceptable as an institutional investment asset class. Accounting standards promulgated by authoritative accounting bodies exist for various real estate entities, including public real estate investment trusts and other public and private real estate entities that utilize historical cost accounting [i.e. GAAP – my comment]. The reporting requirements and information expectations of the institutional real estate investment community required the development of a market value-based financial reporting model for which no accounting standards published by authoritative accounting bodies presently exist. Accordingly, the lack of adequate authoritative guidance applicable to market value accounting for institutional real estate investment vehicles necessitated the need for these standards to be published."

Translated out of accountant-speak, this simply says that GAAP didn't fit their business and they applied common sense to the situation. I suggest that this young business of web hosting also needs some industry specific accounting standards to fairly report information about the health of its companies to its investors, and that these standards do not presently exist. Finally, if you've made it all the way through to here, you may order a server with free double RAM up to 2 GB by using the promo code "toothpaste&OJ" anytime over the next week. [subject to approval by Lance of course]

-Gary

Categories: 
September 14, 2007

Blogging while Dryping

I get bored while driving to work so today I decided to Blog on the way to work. There are no corrections to what follows so easy on the spelling and grammar errors, you would make them too!

So I drive about 1 hour to work everyday and I deciced on the way that the other kinman's acct blogs were too hard. Almost like homework and I decided it was time to blog while dryping. Dryping isd driving while typing. Its a very unsafe practice but I like living on the edge. I walk on banana peels too! Back to dryping, we all carry blackberries to make sure we can rapidly respond so that is what is making this possible. I have the 8700c with the full keyboard. There are 2 types of dryping single thumb and dual thumb. So far this has been all single thumb. Update I am 0sabout 1/3 of the way in. Single thumb is self explanatory one hand on the wheel and one on the phone. Dual thumb dryping is best in traffic or at red lights. Amazingly I get more people honking at me when dual thumbing at redlights. I. Must forget I am supposed to go on green. Unfortunatly my phone has no camera or I could be taking pictuires of the trip. Ok halfway and my thumb is tired. A big van behind me would like me to speed up. Btw this is a 41 mile trip so I have a tiny car that gets great mileage. So the van looks really big in the mirror. You' in the white van' if you read this, don't tailgate the echo! 20 minutes left and almost on the freeway for a little dryping while going 80. 80 is interesting because it makes your thumb feel as it should be dryping faster. So I came up with th word dryping a few years back; if I have since been copied I was first; and my goal was to hear them use the word on OC and I never did. Did you? I guess we will never know now. Now I have to think of what show it should appear on now. I would say "Lost" ut they only had one van and one satellite phone and I think they finally broke both. Maybe they can say it in high school musical 3. Ok 7 minutes to go I better wrap it up. If I sideswiped your mirror in the making of this blog my apologies but I do have insurance. Technology is cool. I have left all grammatical, punctuation and spelling errors intact for the full affect. Ok, oi know I can't do much better on a real keyboard with help from spellcheckers or dictionaries and thesauruses but it sounded good. Last exit. Tollbooth. Redlight. Dual thumbs enabled well that was short lived. Have a great day. And no dryping allowed. Professionals only. Key off

We like metrics, here are some stats from the trip above. The trip took 59 Minutes and is 41.8 miles. The blog is 452 words and 2300 characters including the spaces. That works out to 38.98 characters per minutes and 55 character per mile. Out of 452 words I see 12 misspelled or mistyped and 3 punctuation errors that weren’t intended. So I asked the other Kinman (Financial Wizard) what percentage was typed correctly and he gave me 96.68%. So now you know if a customer has an urgent need and I am mobile I can still take care of it at 38.98 characters per minute with almost a 97% accuracy while Dryping!!

-Skinman

Categories: 
September 13, 2007

Ultrasonic Wave Propagation Through Particulate Composites

That is a heck of a strange title for a hosting company blog post.

It was, however, a great title for a Master's thesis. Bear with me though and I'll put it together.

Once upon a time, I spent many a day (evening, night, whatever) in the basement of the Bright building at Texas A&M blasting ultrasonic waves at samples of composite materials and measuring the energy output on the other side. What we found was that if you hit the right frequency that made the little particles resonate, then a lot more energy was transmitted through the material1. But sending a lot of energy at the wrong frequency didn't do any good at all and most of the energy was absorbed. After a while, using the experimental data, we learned how to predict what frequencies transmitted the most energy.

Developing projects for a hosting company is pretty much the same. You can spend a lot of energy writing code and developing products, but if you don't produce something that resonates with the customer, no matter how much energy you put into it, you aren't going to get the results out of the other side. Having been in software development in the hosting industry for quite a while now, I have worked on projects that resonated with customers and a unfortunately on a few that didn't. The trick is to collect enough data before you start by using a mix of experience and customer interaction to predict what will resonate, and what won't.

See, I brought it all together and I get to tell myself that I still use my master's degree.

-@nday91

1I way oversimplfied this. My apologies to Dr. V. Kinra.

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