The Deutsche Börse Cloud Exchange

Author: Hartmut Jaeger, HDP Management Consulting GmbH
As of: July 2013

At the beginning of the year 2014, Deutsche Börse Cloud Exchange AG will launch the first neutral, secure and transparent trading site for the industry with outsourced storage and computing capacities, or "cloud computing" resources. The transformation of IT services into products that can be traded on exchanges through a neutral entity represents the beginning of a new era in sourcing. This will boost to the long-demanded standardization and automation in IT and will trigger numerous innovations on technical and operating levels.

The road to tradable IT services

The market for IT services is enjoying continuous steady growth rates, and the outsourcing of such services has become firmly established as a management tool worldwide across of industries all the way up to public administration^{1 2}. The structures in this market, however, are subject to significant changes. The classic outsourcing market has seen a reduction of revenues, in particular in the case of large contracts³, standing in contrast to the growth in the IT market itself. Undoubtedly an explanation for these differences includes the more selective award of contracts for services to external service providers, a trend recurring at certain intervals of time toward partial insourcing and smaller contract volumes with shorter terms. Thus the trend is toward the flexible purchase of specific services from various specialized providers (buzzword "multi-sourcing") in contrast to the award of the entire IT services portfolio to one provider.

With the emerging of a new form of IT service offerings by new providers who focus on very specific, standardized services, this trend is intensifying. Cloud computing focuses specifically on these standards and the product is purchased as defined by the provider – thus is not subject to a statement of work individually prepared by the user. The many cloud variants that are marketed today address, among other things, the additional legal, regulatory or security-related needs of the customers. The success of cloud computing, which is reflected in its exceptionally high growth rates, is a sign of the readiness of customers to sacrifice individuality in the preparation or acquisition of IT services in favor of flexibility and cost efficiency. But the acceptance of more standardized products is only one part of the changes that can be observed in the market for IT services. The other part is the matter of commitment to a provider. Last but not least there is a clear trend to challenge the customer supplier relationship more frequently and at shorter notice. The ability to make use of other offers in the market is closely associated with the ability to transfer existing services delivery to another provider. Much depends on the time and effort involved in the transition of services, which is particularly large if the old and the new services are not based on the same standards but are configured very individually.

The advantages of flexibility of cloud services therefore can be fully utilized only if the change from one cloud provider to another can be executed with similar flexibility. But this requires that cloud providers agree on standards and that the technical framework is created in order to implement expense transition with minimal effort and cost. The definition of interchangeable cloud products, however, must also be supported by customers through provisioning of appropriately standardized interfaces.

The Deutsche Börse Cloud Exchange has now created the framework for standardization and interchangeability for IT services. Standardization is created through its own, and therefore provider-independent, product standards (integrated in a neutral cloud architecture software); legal frameworks (through admission requirements); SLAs; and processing methods. Interchangeability along with clearing and settlement is implemented through Zimory software components which create the technical foundation for fulfilling a provider relationship.

Through these two elements – standardized, neutral product definitions and interchangeability using Zimory software – the requirements for utilizing the mechanisms of an exchange are met. Thus supply and demand for a well-defined product can be matched on a trading platform, and a provider relationship can be executed in the sense of an exchange transaction.

In the first approach, two infrastructure product groups are being planned, namely computing capacity and data storage. These products differ as a result of certain parameters such as contract term, volume and place of delivery. But the concept can fundamentally be expanded to all IT services which are adaptable and can be adequately standardized. Thus alongside the infrastructure products, we also view application development⁴ and certain business processes as candidates for a further development of this trading platform.

New price setting and pricing models determine sourcing

With the availability of the trading platform and the short time in which a transaction can be completed, prices for the products will also be set at a much higher frequency. Daily prices will be available for valuing a sourcing transaction, whether through the exchange or bilaterally on a more individualized basis. These prices can be further supplemented by indices pertaining to the products, and trends and volatilities can be deduced. Thus the formation of price models in sourcing contracts is changing in general. Even in contracts relating to a quite individual, classic sourcing transaction, the price model can take into account the developments on the exchange market. While classic price models are based on a snapshot at the time of the request for bids and contract negotiation, with corresponding clauses for price adjustments and quantity changes (ARC/RRC models for purchases above or below the agreed amounts), new price models can be based on the current value on the exchange market – this also includes the price adjustment for changed purchase quantities. It will undoubtedly be possible to configure the derivation of prices for offers not traded on the exchanges more simply than providers assume. With a growing number of IT services that are tradable over the cloud exchange and for which price formation takes place on a continuous basis, the price development of even complex and long-term sourcing contracts will be geared toward the price development of the cloud exchange.

Next to the fact how always updated prices are used in the market and in price models, the possibilities of fully scalable trading will influence pricing on the exchange. Full scalability means that even small providers can trade small quantities of a product. This opens up the opportunity also for customers who have capacities of their own to trade their excess capacity on the exchange, in a forward transaction for a precisely defined timeframe. Since these excess capacities bring mainly negligible costs on the part of the owner, they can be offered on the market at a very attractive price. We therefore assume that following an introductory period of trading primarily by large providers, there will be additional price pressure as a result of these additional market participants.

Altogether sharply falling prices are expected in the long run as a result of the introduction of the cloud exchange. On the provider side, the decline in prices will be partially offset by an increase in production, sales and marketing efficiency. In addition, providers can achieve higher levels of the cloud value-creation chain more easily as a result of the standardized market place offerings. The price drop will have to continue to be offset through economies of scale. This undoubtedly will be easier for larger providers.

The mechanics of the financial markets will influence the market for IT services through derivatives

Following the launch of the spot market in Q1 2014, a derivatives market is also planned for 2015. For customers as well as for providers, this will open up completely new possibilities for hedging the value of sourcing agreements. This offers the possibility in particular for providers to hedge against excessive price drops and thus to protect capital investments. The exploitation of excess capacities can also be more easily controlled with such derivatives.

With the development of indices or other instruments that do not reflect a single product but instead the IT market or IT market segments including derivatives on such instruments, speculation by market participants will also take place that will not necessitate the actual consumption of IT services. It must be assumed that as a result of this, the price drop will regulate itself over time.

Does the industry still need price benchmarking or rather a rating of the market participants?

In current sourcing contracts, there are usually benchmarking clauses included with the intention to compare contracted prices against service market prices from time to time. To accomplish such a benchmark, specialized companies are doing research in the market to identify the best service package for the requested service comparison. The major effort here is to transform the individual service package in such a way that it is comparable with a standardized service offered in the market.. For this purpose, the analysts usually use reference services that are derived from many analysis engagements. In addition, transactions suitable comparable with these performance packages, in terms of a series of parameters such as volume of the service units or the industry of the customer, will then have to be identified. With the availability of prices that are up to date on a daily basis for certain standardized reference products and the described market instruments of an exchange, an alternative to this process will arise. The exchange of course also bases it’s trading on standardized service definitions – but pricing reflects the entire market and thus all industries. While segmenting of pricing on the exchange into the individual industries would be theoretically possible, it does not necessarily make sense.

Even if classic benchmarking undoubtedly deals more specifically with the individually contracted service packages, the question must be asked whether the effort and expense entailed are justified. The exchange makes neutral pricing available based on a well-defined, transparent standard against an individually determined benchmark price – and does so at any time and at no cost. The product spectrum of the DBCE is naturally limited and cannot cover all individually negotiated service variants. But the information necessary for evaluating the prices can be derived from market developments.

The significance of benchmarks in sourcing therefore will decline significantly and in many sourcing contracts not traded on the market, benchmarking will be replaced through reference to exchange prices. In contrast, the significance of the qualitative aspect will increase for the tradable products. In particular it will be necessary to evaluate the quality of the providers in connection with the supply of the products. In order for this to be possible, parameters will have to be determined which can be measured, if possible automatically, during the delivery phase and from which a rating can then be derived for the provider. This corresponds conceptually to the rating of issuers in the bond markets and affects to the same degree the pricing of the products. The development of a rating of this type on the basis of continuously measurable sourcing performance requires an investment in research. The first initiatives in this regard have already begun⁵.

Securing and insuring in multi-sourcing

Next to transparency in pricing, the availability and the interchangeability of IT services also offer advantages for the structuring of the sourcing portfolio. From a technical perspective, the offers on the cloud exchange are identical and can be used through uniform interfaces. Thus parallel operation using multi-sourcing with multiple providers is possible.

One of the technical problems associated with the implementation of the cloud exchange idea and with the creation of interchangeability in a multi-sourcing structure is the transmission and synchronization of content (data) between the service providers. The larger and more complex the data quantities are, the more critical the factor of time becomes. One approach to a solution of this problem could be multi-sourcing in which the transmission and synchronization costs are optimized for the services obtained through the cloud exchange. This will then lead to a portfolio strategy in which short-term and long-term contracts are spread over multiple providers. It is not primarily the question of whether one application can be transferred from one multi-sourcing entity to the other. It also needs to be examined whether an architecture can be established for splitting one application among two or more providers.

Using such concepts, data protection aspects, among other issues, can be addressed at the same time since personal data can be distributed in a way that covers these requirements.

Another aspect of the availability of standardized products in the cloud exchange is the predictability of the risk scenarios for the use of these offers. For example risks which result from the transfer of content by one provider to another provider in a defined window of time. As a result of the predictability of such risks, insurance products can then be developed for this purpose which will in turn make the offerings of the cloud exchange even more attractive.

New concepts for business continuity and disaster recovery

The ease of integration of products of the cloud exchange into one's own IT architecture in addition opens up new possibilities for implementing business continuity or disaster recovery (BC/DR) concepts. The provision of certain resources having specific interfaces and the synchronization of the content with the backup solution can thus be designed differently. BC/DR capacities can be obtained contractually at short notice over the cloud exchange or capacities can be operated in parallel in a multi-sourcing approach. Only the minimum required capacities for the synchronization of the content will be used, which will then in an emergency be expanded to the extent necessary for the period of time that must be bridged.

If the array of products that are tradable on the cloud exchange is also expanded by SaaS products, which would mean that it is possible to purchase standardized functionality of different providers, further possibilities for hedging operational risks would emerge.

Innovations through the cloud exchange

The cloud exchange will trigger an entire series of innovations through the implementation of standardization and interchangeability of tradable products. Starting with technical solutions for interchangeability which will optimize the transfer and synchronization of content (data) between product providers on the cloud exchange, further innovations will be necessary for the expansion of the product portfolio.

Technical solutions will have to be established in particular for issues that arise from a rapid, effective and inexpensive settlement. The costs for the transition to another provider must be added to the transaction costs and thus will become a critical factor for success for the cloud exchange. The secure, guaranteed transfer of large quantities of data or complex system structures represents another technical and organizational challenge. In addition to the settlement of a transaction through which the purchased resources are made available, the fulfillment of the SLAs and the total performance of the provider over the term of the contract will also have to be measured and communicated. New developments will arise in this regard as well, such as the aforementioned rating for providers in the cloud exchange.

The development of the sourcing market in the era of the cloud exchange

The realization of the cloud exchange as well as suitable supplemental approaches⁶ has the potential to change the sourcing market on a sustainable basis. It is being demonstrated that sourcing can be standardized and automated at a high level. The cloud exchange provides a reference model for a sourcing contract, for pricing and for statements of work. It will have to be possible to measure every expense which is invested for off-exchange sourcing using this reference model. This relates to all customers, providers and sourcing or legal consultations.

The long-demanded industrialization of IT is receiving a new impulse through the standards we are setting and the placing of orders in the cloud is taking on its own dynamics. Market analysis is already showing that the cloud share of sourcing transactions is outgrowing the general sourcing market⁷. The process of admission of cloud products to the cloud exchange, which acts as a neutral, provider-independent entity, in itself offers a major opportunity for customers and providers to further expand the market for outsourced IT and business services. The cloud exchange can experience further support from the growing number of cloud brokers who align themselves directly with the Zimory Software and thus will be able to facilitate the switching process for customers and providers. The support of interchangeability, as in the case of telephone or electricity providers who take over the entire process for the customer, will become a competitive factor in the market driven by the cloud exchange.

In addition, new business fields will develop around cloud sourcing. Investors will use the market to fortify their portfolios with new investment instruments, and logistics or value transport companies could enter into the processes for fulfillment of transactions (in the sense of the physical transition of content/data).

In summary, the future in sourcing will thus be significantly influenced by the standardization and interchangeability created by the Deutsche Börse Cloud Exchange for cloud-based products. And this change will affect not only the products traded over this exchange, but rather the entire sourcing market including all sourcing contracts negotiated off-exchange and thus individually.

The instruments necessary for an extensive development of exchange-listed IT services have been in use and proven in the Deutsche Börse for other products, be it securities or commodities.

The use of derivatives, indices and other instruments of modern exchange trading will fundamentally change sourcing and will place it in an expanded business framework.

These changes will create positive momentum to the market and will trigger many important technological innovations.

About the Author

Hartmut Jaeger brings more than 30 years of international experience in consulting, operational IT management and global account management into his role at HDP Management Consulting. He provides expertise in global sourcing, service strategy and concepts, and his background includes contract negotiations, transparency assessments, service provider management and strategic leadership. He is working especially on all aspects of the relationship between clients and service providers, automation and standardization of the sourcing life cycle, as well as the development of tools for improved sourcing management.

Before taking responsibility for Strategic Sourcing Advisory at HDP, Hartmut Jaeger was Member of PA Management Group and Director at TPI (today ISG). He was in charge of Business and Product Development and a number of large European accounts. Prior to that he founded a consultant agency for IT services focused on Service Level Management and Service Contract Design, he worked at Sun Microsystems as a Global Corporate Account Manager for Deutsche Bank and at Electronic Data Systems (EDS), he served as a Business Relationship Manager of Financial Industries and built the financial industry practice. Most of his career, Hartmut Jaeger worked at Deutsche Bank as Vice President for Trading Room Operations and Investment Banking Research Operations being in charge of managing data canters, market data infrastructure and the complex trading room desk top environment.

He started his career at Interactive Data GmbH as a Consultant Manager and Managing Director, and at SESA Deutschland GmbH as a System Engineer. Hartmut Jaeger holds an engineering degree in mathematics and computer science from TH Darmstadt.
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About HDP Management Consulting

The HDP Management Consulting advises and supports companies that are looking to improve their competitiveness and performance in a sustainable and measurable way. As an innovative consultancy with a special focus on sourcing, we can count well-known and renowned large and mid-sized companies, primarily from the DAX-30 and MDAX, among our valued clients. With our combination of professional consulting experience and entrepreneurship, we have earned the confidence and trust of both businesses and investors.

We develop and implement the concepts and strategies which ensure that our clients can achieve their challenging and realistic goals. Great importance is attached to ensuring that our client services are understandable, transparent and measurable, leading to concrete results. Supporting research and setting directions in the sourcing market is a prerequisite for being accepted and valued as trusted advisor to our clients.
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¹ HfS Research Ltd. - Global IT Services Market Size and Forecast 2013
² pwc – IT Sourcing-Studie 2012
³ The Global ISG Outsourcing Index - Second Quarter and First Half 2013
⁴ A B2B market place for application development will be opened by the company pliXos (www.plixos.com) before this year is out. The further development of such a market place to an exchange market is the logical consequence.
⁵ The University of Bamberg in cooperation with pliXos started a research project on the topic of "Sourcing Performance Tracker".
⁶ E.g. B2B market place for SW development projects of pliXos GmbH
⁷ The Global ISG Outsourcing Index - Second Quarter and First Half 2013