Tidal Cloud Case Study

For the exclusive use of S. Venkateshaiah, 2024.
IES903
July 2022
Tidal Cloud: Cost Allocation in the Cloud

Robert Raney
It was July 2016, and an unusual tension replaced the typical chatter at the start of the regular
monthly meeting to review financial performance. Sara Sato, CEO of Tidal Cloud Inc. (hereafter
referred to as “Tidal”), was talking with Maria Singh, chief financial officer, while the chief
product officer, Nathan Landers, listened with a concerned expression. The decision to invest
heavily in cloud offerings had helped fuel several years of tremendous growth for Tidal, and the
potential of a lucrative exit event was on everyone’s mind. However, with the emergence of
AWS and other cloud competitors, it was becoming increasingly difficult to sustain the growth
of recent years and achieve the profitability metrics acquirers were looking for.
To make matters worse, AWS had just announced another price drop for its public cloud
offering. With no major differentiating characteristics between Tidal’s Public Cloud offering and
AWS’s, the Tidal team had seen no alternative but to match prior price reductions in an attempt
to maintain market share. However, looking at the company’s profits, and in particular the
profitability of the Public Cloud offering, the management team was struggling both to develop
an appropriate response to this most recent price drop and to update the strategic plan going
forward. Based on conversations with potential acquirers and local venture capital firms, the
company had set goals of demonstrating positive profit margins before sales general and
administrative expenses. Sara opened the discussion:
I am disappointed to see the results for our Public Cloud offering. Despite strong growth in
revenue, we continue to perform below our target profit margins. I just heard that AWS
dropped their prices again, which puts us in a challenging situation. If we match the 4% price
drop, I am not sure how we will ever meet our target profitability. But if we don’t match the
price drop, how do we compete with AWS for new customers, and how many of our existing
customers are we at risk of losing? Not that this is all bad news though. I just heard from sales
that there was no drop in demand following our 10% price increase last month for our Marea
Private Cloud offering. Maybe it’s time we shift our growth strategy more heavily towards
that product and away from Public Cloud?
This case was prepared by Professor Robert Raney. July 2022.

IESE cases are designed to promote class discussion rather than to illustrate effective or ineffective management of a given
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Last edited: 1/7/22
This document is authorized for use only by Sam Venkateshaiah in ACCY 503 Spring 2024 taught by Li Zhang, University of Illinois - Urbana-Champaign from Mar 2024 to Sep 2024.
C-806-E Tidal Cloud: Cost Allocation in the Cloud
History of the Company

Tidal was founded in 2005 from the University of Washington dorm room of college student Sara
Sato. Sato had sensed an opportunity to turn her fascination with server infrastructure into a
managed hosting company, providing customized infrastructure solutions. Tidal was launched
with money raised from friends and family and bootstrapped its way through slow but steady
growth during its initial years. The company differentiated itself in the crowded managed hosting
space by providing greater customization, more fully rounded solutions, and a high level of support
and monitoring. A savvy entrepreneur, Sara closely monitored industry developments and made
sure Tidal was well positioned to capitalize on the huge upsurge in demand for cloud- based
hosting services in 2007. By 2012, the company had 60 employees and over 600 customers.
Recognizing the need to accelerate its growth to remain competitive in an increasingly crowded
space, Tidal finally accepted outside funding in 2012 with a $10 million A round led by a local
Seattle venture capital firm. By 2016, Tidal was one of the companies to watch in Seattle’s booming
tech scene. Not surprisingly, the company was considering raising another round of funding to fuel
additional growth, and investors were urging them to pursue various exit opportunities. In June
2016, the company generated close to $1 million in revenue, with a slightly positive operating
profit before sales general and administrative expenses (see Exhibit 1 for details).
The Products
The company offered three products: Managed Hosting, Public Cloud, and Marea Private Cloud
(see Exhibit 2 for product profitability). These products provided varying levels of infrastructure,
software, service, and management support, as outlined in Exhibit 4.
Managed Hosting customers leased hardware (servers primarily) from Tidal and paid the company
to handle the administration, management, and support of the infrastructure and operating
system. The customer retained the responsibility for building (or purchasing) and deploying the
applications run on the system. Customers were also responsible for managing the collection and
analysis of data generated by its applications. The server hardware was dedicated to the
customers, giving them exclusive access and greater control over performance, software, and
security. Managed Hosting was the first product offered by Tidal and still contributed a significant
amount to the company’s revenue (20%). However, resiliency was a concern with this product.
For example, if one of a client’s servers went down or needed to be replaced, they could
experience an extended period of unavailability and, in extreme cases, even a permanent loss of
data. Further, increasing or reducing capacity (adding or removing servers) was a time-intensive
task that required significant support from the Tidal Cloud Technical Operations and Customer
Support teams. With the emergence of cloud-based services that addressed these inefficiencies,
and with increased competition in traditional managed hosting from large players such as
Rackspace, GoDaddy, and SoftLayer, no one at Tidal had any illusion that Managed Hosting would
drive significant growth for the company in the future. Tidal couldn’t compete with the larger
competitors’ prices in the managed hosting space, and it was difficult to provide a differentiated
product. Still, the Tidal pricing was fair, and switching costs were significant enough that most
existing Managed Hosting customers were not expected to leave in the near future. As the chief
product officer was fond of saying to his team, “As long as we don’t break things, our customers
shouldn’t have an incentive to go somewhere else to fix it … so don’t break anything!”
2 IESE Business School-University of Navarra
Tidal Cloud: Cost Allocation in the Cloud C-806-E
Public Cloud customers leased virtual servers run on server hardware that was managed and
maintained by Tidal. Multiple virtual servers could run using one piece of hardware, allowing
Tidal (and other cloud providers) to more efficiently leverage the underlying server hardware.
This also made virtual servers more portable and scalable in the event of changes in capacity
requirements or problems with underlying hardware. Virtual servers could be easily switched to
new hardware or even run across multiple pieces of hardware to expand capacity. Tidal engineers
onboarded customers and set up the virtual servers, but the day-to-day management of the
operating system, applications, and data for the cloud was the responsibility of the customer.
Tidal managed the underlying hardware that supported the virtual servers leased by customers
and handled the data storage functionality and the virtualization.1 Similar to Managed Hosting,
Tidal Cloud provided 24/7 technical support to the customers’ IT professionals. However, not
managing the operating system resulted in a significantly lower burden on the Tidal Cloud
Technical Operations and Customer Support teams for Public Cloud customers.
Marea Cloud was a managed private cloud offering run on dedicated hardware. This product
combined some of the best qualities of the Managed Hosting and Public Cloud offerings and also
included expanded services. Marea Cloud operated on hardware dedicated to each customer,
providing exclusive access to the performance capabilities of the hardware and addressing data
sovereignty issues that could be a concern with Public Cloud. This made it an attractive
offering for applications in healthcare and government, and for business-sensitive workloads.
Marea Cloud also provided a more complete suite of support services, including application
development and management, data collection and analytics, metering, billing, and customer
relationship management capabilities. By offering these services via a virtual environment in the
cloud, Marea Cloud delivered improved scalability, portability, and availability for customers as
compared to traditional Managed Hosting. This allowed customers to focus more on running
their business and less on the details and potential constraints of the underlying server
infrastructure enabling that business. Marea Cloud was a unique offering that the company’s
development team was constantly working to improve and differentiate from the more basic
public cloud and managed hosting offerings saturating the market. Launching new customers
required a significant amount of deployment work, but the ongoing technical and customer
support required after launch was generally significantly lower than for Managed Hosting as a
result of the improved scalability and portability.
Back to the Meeting

After a moment of silence while Maria (CFO) and Nathan (CPO) thought about Sara’s statement,
Nathan responded.
Nathan: I don’t understand our competitor’s reactions. They have to be receiving the
same pressures and feedback on target margins from investors that we are.
I know they have some scale advantages compared to us, but I really don’t see
how that can justify the entire gap between where the new pricing would put
our profit margins compared to the target margins investors are looking for.
1 “VirtualMachine” refers to the process of running a virtual instance of a computer system via software built on top of
the actual hardware through a process referred to as Virtualization. Virtualization most commonly refers to running
multiple Virtual Machines on a single piece of server hardware simultaneously. However, it can also refer to running a
single more powerful Virtual Machine on a combination of multiple servers.
IESE Business School-University of Navarra 3
Sara: Well it’s a bad strategy if they’re trying to push us out. So much capital has
flowed into this space in the last few years that we and most other competitors
have plenty of cash to keep the lights on. That type of strategy would just end
up making everyone worse off, including AWS. It’s hard to believe that’s what
they are doing.
I just can’t shake the feeling that we are missing something. Maybe we need
to think about this from a different angle. What if the problem isn’t with the
pricing being unsustainably low? Maria, can you please explain where the
profitability numbers in these reports (see Exhibit 1 and 2) come from again?
Maria: These numbers are produced by our accounting system but need some
interpretation. The sales just reflect the total fees we expect to collect for each
offering provided during the month. The costs are a bit more complicated.
Some of the costs can be traced directly to the product offerings and are easy
to calculate. For example, we know exactly which servers are being used to
provide Managed Hosting or Public Cloud, so it’s easy to track the leasing costs
for our server hardware to each of the product offerings. However, most of
the other expenses, such as the cost of our data centers and support staff, are
indirect costs that we allocate to each product offering.
Nathan: This conversation is going to give me nightmares tonight about my university
accounting classes. Those didn’t go well for me.
Maria: Stop joking around. This is actually really important for you to understand.
Otherwise, these results become just a piece of paper with some numbers that
you don’t know how to use effectively.
Sara: Keep going Maria. What do you mean by allocate? How do we do that?
Maria: The idea is that you take all the costs you can’t trace directly to one of the
products and then use some metrics you can observe to help divide those costs
across products. In our case, we use virtual servers, what we refer to as Virtual
Machines [hereafter referred to as “VMs”], to allocate those indirect costs. So,
for example, if Managed Hosting accounts for 20% of the VMs at the end of
the month, we allocate 20% of indirect costs to Managed Hosting.
Sara: Okay, that seems fairly straightforward.
Maria: Yes, our current system is actually very simple and was last revised when we
first added cloud offerings in 2007. At that time, we had to update our thinking
for the new concept of a VM. The only tricky part is measuring VMs for
Managed Hosting, given that VM is more of a cloud concept. But Nathan’s
team already does that measurement for operations purposes and has a good
methodology based on processing and storage uses across the different Tidal
products. So far, this system has met the requirements for our tax and financial
reporting obligations without any problems.
Nathan: I vote we skip this whole allocation exercise entirely! Why bother going
through all this work when in the end it’s just an estimate anyways?
Maria: Well, there are some alternative ways of presenting performance we could
consider instead of the full-cost system we use now. For example, we could use
a variable cost system and just report the contribution margin by products based
on sales less all variable costs. However, I worry that if we don’t explicitly think
about profitability from a full-cost perspective, we risk losing track of expenses
and not having as good an understanding of our performance. Also, just because
product profitability from a full-cost perspective is an estimate doesn’t mean it
isn’t useful. We just need to make sure we’re calculating a reasonable estimate!
Nathan: Okay, fair point, and I could definitely see the sales team “selling” us right out
of business if all we provided them was variable cost information. But I am still
not convinced. I see how the system you described makes sense for the data
center costs, but I don’t see how the number of VMs has much to do with
explaining the use of some of these other—what did you call them—indirect
expenses? My team spends a ton of time and money making sure our
customers are well supported and that we can quickly resolve any technical
issues they encounter. But ask anyone and they will say that the average
Managed Hosting or Marea Cloud customer requires a lot more time than the
average Public Cloud customer. It’s nonsensical to use the number of VMs to
divide Support and Technical Operations costs. We might need to revisit how
we are calculating profitability.
Maria: I couldn’t agree more, Nathan. Do you remember last month at the company
offsite when we were discussing cross-department collaboration opportunities?
I pitched launching a review of our accounting practices and asked if I could pull
some of your team members into a project to explore improvements. You
immediately shot down my idea because you thought it would just be an
expensive distraction and make it harder to compare future performance to
performance under the old system. You said accounting was just a back office
function and we should be prioritizing other projects.
Nathan: Yes, I do remember that. I think I owe you an apology. I guess I didn’t understand
how important this was. How can we develop an effective strategic plan if we
don’t have a good sense of the current performance of our different product
lines? However, my concerns about adding costs and reducing comparability
with past information are real issues that we need to keep in mind.
Sara: Well, our current accounting system has gotten us this far without problems.
But we have grown a tremendous amount and added a lot of complexity to our
business. Maybe it’s time to rethink some reporting processes. To Nathan’s
earlier point, I would like to see this product profitability analysis redone with
the Technical Operations, Customer Support, and Development expenses
allocated based on something other than VMs. We track help tickets in our
CRM system, right? How about we use the number of help tickets by product
offering instead of VMs? Might as well throw Marketing in with that same
group of expenses as well. We could continue allocating Data Center, Service
Costs, and Credit Card expenses using VMs. That would provide an interesting
alternative view of product profitability that I want us to analyze. Maria, can
we see the results we get using this alternative method?
Maria: Of course, I will run the numbers that way. But I have another idea we should
also consider. You all know my husband is an accounting professor. The other
night at dinner we were talking about a concept he teaches to his MBA
students that I think is relevant to our situation. It’s called activity-based
costing or ABC. It may sound new, but it’s a method that has been used for
decades now. Rather than focus on expense categories from the financials and
how to allocate those, ABC recommends taking a step back and identifying the
core activities that create expenses in the first place. Once we allocate costs to
those activities, we can then think about how the different product offerings
use each activity differently and develop an allocation methodology that way.
Nathan: That sounds intuitive. I could work with Maria to put some structure to that.
Sara: Excellent. It sounds like we are in agreement then. Let’s re-calculate what
profitability looks like using both of those alternative methods for dealing with
indirect costs. Then, let’s meet again to discuss which cost allocation method
makes the most sense and what our strategy should be going forward.
Additional Information
Nathan and Maria gathered the Operations and the Marketing team managers together and
walked down to Pike Place Market to grab a coffee and discuss Maria’s ABC idea. The group was
able to determine the following.
 There were six core activities for Tidal: (1) Provide Computing Resources; (2) Process
Payments; (3) Onboard New Customers; (4) Support Existing Customers; (5) Build &
Improve Products; (6) Advertise & Promote.
 The indirect costs for Tidal could be allocated to the activities, as shown in Exhibit 5:
 Several income statement line items related 100% to just one activity.
 Technical Operations team spent approximately 35% of their time assisting with
onboarding, 45% supporting existing customers, and 20% working with the development
group discussing new products and potential improvements to existing products.
 Customer Support team spent approximately 20% of their time helping out with
onboarding-related issues and the remaining 80% supporting existing customers.
 Development expenses primarily related to building and improving the products (80%)
but also to onboarding customers (10%) and supporting existing customers (10%).
 The Key Performance Indicator (hereafter referred to as “KPI”) report (see Exhibit 6) that
the company already produced on a monthly basis contained a lot of observable
information that described how each product offering used the different core activities of
the firm. This information could be used to allocate the activity cost pools across each
product, specifically, the use of
 computing resources could be explained by the number of VMs that existed at
month end;
 payment processing could be explained by the $Sales for the month;
 onboarding resources could be explained by the hours spent onboarding new VMs
during the month;
 support for existing customers could be explained by the number of help tickets
addressed during the month;
 development and improvement resources could be explained by the number of
commits submitted by the development team during the month.
 Marketing activities could be explained by the targeted ratio of spending across the
three product lines developed in the annual budget of 10% for Managed Hosting, 65% for
Public Cloud, and 25% for Marea Cloud. Per the marketing manager, the actual spending
closely matched the targeted percentages.
Exhibit 1
Operating Profit for the Month Ended June 30, 2016
Sales $950,000
Equipment Leasing (237,500)

Data Center Facility Costs (218,500)
Service Costs (9,500)
Credit Card/Processing Fees (19,000)
Technical Operations (161,500)
Customer Support (104,500)
Development (95,000)
Marketing (85,500)
Operating Profit before SG&A $19,000
Sales, General, and Administrative Expenses (323,000)

Operating Profit $(304,000)
Source: Prepared by the author.
Exhibit 2
Product Profitability Analysis for Month Ended June 30, 2016
Managed Public Marea

Company Hosting Cloud Cloud
Sales $950,000 $191,900 $469,300 $288,800
Equipment Leasing (237,500) (47,500) (114,000) (76,000)

Allocated Indirect Costs (693,500) (138,700) (381,425) (173,375)
Operating Profit before SG&A $19,000 $5,700 $(26,125) $39,425
Profit Margin 2.0% 3.0% −5.6% 13.7%
Notes:
 Equipment leasing costs are directly traced to product lines.
 Indirect Costs include Data Center Facility Costs, Service Costs, Credit Card/Processing Fees, Technical Operations,
Customer Support, Development, and Marketing expenses. All indirect costs are allocated to product lines based on
the number of virtual machines for that product line at the end of the month.
Exhibit 3
Details of the Main Items in Tidal’s Income Statement
 Equipment Leasing includes leasing expenses for hardware (primarily servers).

 Data Center Facility Costs include cooling, electricity, rent, and salaries for data center
employees, and other expenses related to the data center facility where the servers are
located and operated.
 Service Costs includes expenses related to the routine service and maintenance of
hardware.
 Credit Card/Processing Fees are 2%-3% of Tidal’s sales receipts when customers pay with
a credit card. Fees are payable to the credit card company.
 Technical Operations includes primarily salaries for the team of engineers that handle
customer onboarding, help the customer support team with more technical support
issues, and contribute to building and improving products.
 Customer Support includes primarily salaries for the team of professionals that manages/
resolves customer support tickets. When necessary, they facilitate involvement of the
technical operations team.
 Development includes primarily salaries for the team of engineers focused on improving
and expanding product capabilities.
 Marketing includes advertising, trade show promotions, event expenses, and other marketing
expenses.
 Sales, General, and Administrative Expenses includes salaries for C-Suite, human resources,
sales, legal, and accounting professionals in addition to other expenses that include office
rent, insurance, office equipment, and other.
Exhibit 4
Differences in Services Across Products
Notes:
For Marea Cloud, the customer and Tidal share responsibilities for Applications and Data Management:
 Tidal is responsible for optimal performance of the applications with minimal outages and also for ensuring access to
the data contained in the applications or otherwise stored in the cloud. In addition, Tidal manages software that
supports data collection and analytics, metering, billing, and customer relationship management capabilities.
 The customer assumes responsibility for creating, updating, and deleting data or applications and is also responsible
for the configuration and robustness of the login credentials utilized for applications or to otherwise access the cloud.
Exhibit 5
Allocation of Indirect Costs to Company Activities
Provide Onboard Support Build &

Computing Process New Existing Improve Advertise
Resources Payments Customers Customers Product & Promote Total
Data Center Facility 218,500 - - - - - 218,500
Service Costs 9,500 - - - - - 9,500
Credit Card/Processing - 19,000 - - - - 19,000
Technical Operations - - 56,525 72,675 32,300 - 161,500
Customer Support - - 20,900 83,600 - - 104,500
Development - 9,500 9,500 76,000 - 95,000
Marketing - - - - - 85,500 85,500
Activity Pool Totals 228,000 19,000 86,925 165,775 108,300 85,500 693,500
Notes:
 Technical Operations is allocated 35% to Onboarding New Customers, 45% to Supporting Existing Customers, and 20% to Build & Improve Product.
 Customer Support is allocated 20% to Onboarding New Customers and 80% to Supporting Existing Customers.
 Development is allocated 10% to Onboarding New Customers, 10% to Supporting Existing Customers, and 80% to Build & Improve Product.
 All other income statement line items relate 100% to just one activity.
Exhibit 6
KPI Report for Month Ended June 30, 2016
Managed Public Marea
Company Hosting Cloud Cloud
Growth and Marketing
Sales $950,000 $191,900 $469,300 $288,800
Virtual Machines at month end (“VMs”) 36,000 7,200 19,800 9,000
New VM Growth % 2.0% 0.8% 2.2% 2.7%
Existing VMs Canceled % –1.0% –2.0% –1.0% 0.0%
Customer Acquisition Cost per VM $119 $285 $112 $89
Average Annualized Sales per VM $317 $320 $284 $385
Capacity and Performance

Compute Capacity per VM (hrs. per month) 544 432 504 720
Storage per VM (gb) 4.80 8.00 4.00 4.00
Capacity Utilization 75.5% 91.0% 79.0% 55.6%
System Availability 99.0% 99.0% 99.0% 99.0%
Onboarding and Support

#VMs Onboarded in month 720 60 420 240
Avg. Onboarding Time per VM (hours) 1.67 1.00 1.00 3.00
Help Desk Tickets in month 1,600 480 640 480
Avg. Ticket Resolution Time (hours) 0.50 0.50 0.50 0.50
Development
Number of code commits in month 2,000 100 800 1,100
Number of code reviews in month 390 10 160 220
Avg. Review Time (hrs.) 0.51 1.00 0.50 0.50
Notes:
 “Customer Acquisition Cost per VM” is calculated by taking the allocated monthly Marketing Expense for each product
and dividing by the number of VMs onboarded during the month. Marketing Expense is allocated to each product using
total virtual machines at month end, consistent with Tidal’s current allocation process.

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For the exclusive use of S. Venkateshaiah, 2024.

Tidal Cloud: Cost Allocation in the Cloud

This case was prepared by Professor Robert Raney. July 2022.

Last edited: 1/7/22

C-806-E Tidal Cloud: Cost Allocation in the Cloud

History of the Company

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Back to the Meeting

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C-806-E Tidal Cloud: Cost Allocation in the Cloud

Equipment Leasing (237,500)

Sales, General, and Administrative Expenses (323,000)

Source: Prepared by the author.

Managed Public Marea

Equipment Leasing (237,500) (47,500) (114,000) (76,000)

Source: Prepared by the author.

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Tidal Cloud: Cost Allocation in the Cloud C-806-E

 Equipment Leasing includes leasing expenses for hardware (primarily servers).

Source: Prepared by the author.

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C-806-E Tidal Cloud: Cost Allocation in the Cloud

Source: Prepared by the author.

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Provide Onboard Support Build &

Source: Prepared by the author.

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C-806-E Tidal Cloud: Cost Allocation in the Cloud

Capacity and Performance

Onboarding and Support

Source: Prepared by the author.

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