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Effective Savings Rate (ESR), a metric introduced by the FinOps Foundation, measures the efficiency of cost savings garnered from discounted cloud commitments like Reserved Instances (RIs), Savings Plans (SPs) and other forms of Committed Use Discounts (CUDs). This metric provides valuable insights into FinOps effectiveness.
This blog helps FinOps professionals understand the ESR metric, its underlying factors, and how to overcome its inherent limitations with smarter commitment management.
What is ESR?
ESR is expressed as a percentage, representing the gap between commitment cost and its on-demand alternative cost. As the latter corresponds with actual usage, it indicates not only commitment discount rates, but also the level of commitment utilization. Therefore, using ESR, companies can work towards ensuring they benefit from the maximum cost-saving potential of their cloud commitments.
How to calculate ESR
The ESR formula is based on two parameters used in the FinOps Foundation’s FOCUS™ specification. FOCUS normalizes cloud cost and usage data across all providers and practicing organizations. Flexera One Cloud Commitment Management supports both standard and extended ESR formulas, enabling customers to evaluate savings in the context of management costs and make informed decisions about portfolio strategy.
- Effective cost: The actual amount spent on commitments, including the proportional amortized cost of future ones.
- Contracted cost: The on-demand equivalent (ODE) of the discounted usage, after contracted discounts (EA, EDP).
ESR (%) = 1- (Effective Cost) / ODE)
Three things to know about ESR
ESR is a useful KPI to calculate the value of commitments. However, to make better use of it, there are some underlying aspects worth knowing:
#1: Consider the cost of managing your commitments
The FinOps Foundation defines ESR as the “ROI for cloud discount instruments.” This means that ESR can measure the cost-efficiency of your commitment management.
However, the “effective cost” in the above formula only represents the commitment cost charged by the cloud provider and does not include the supplemental costs of managing a commitment portfolio. Management costs might include man-hours spent by the FinOps analyst, DevOps engineer, or IT manager who manages the commitments, or third-party vendor fees.
Luckily, the FinOps Foundation offers another, less-known variation (see “option 2”) which brings commitment management costs into account:
ESR (%) = (savings – cost to achieve savings) / ODE
An interesting exercise would be calculating ESR for the same period with both formulas. The discrepancy is an estimate of your commitment management cost. Next, compare it with team reports on hours spent internally, or with third-party vendor billing.
Pro tip: “Option 2” of the ESR formula can help you compare commitment management alternatives more fairly. For in-house management, consider the engineering hours spent for the given period. For third-party management, consider the vendor fee. For example, Cloud Commitment Management calculates the fee as a percentage of commitment savings it generated.
Cloud Commitment Management further reduces commitment management costs through automation and white-glove analyst support, making the “Option 2” ESR formula especially relevant for comparing Flexera-managed portfolios to in-house or third-party alternatives.
#2: Beyond commitments
ESR focuses on commitment savings. In reality, FinOps practitioners use more savings mechanisms than just commitments. This is demonstrated by the scope of the FinOps Foundation’s definition of “rate optimization.” Besides commitments, it also includes:
- Using alternative cloud regions or availability zones (AZs)
- Supporting negotiated discounts that lower the contracted cost
- Leveraging spot instances, which offer up to 90% discounts compared to the on-demand equivalent—more than any existing commitment
A metric for calculating the overall effectiveness of rate optimization efforts should include these cost-saving instruments, too.
Cloud Commitment Management tracks ESR across commitments and spot instances, and supports over 60 services across AWS, Azure and GCP—more than any competitor. Cloud Commitment Management dashboard also offers a segmented ESR view: compute ESR, non-compute ESR and ESR from commitments and spot instances. This helps you understand how much your different rate optimization efforts are contributing to your overall savings.
#3: Consider the cost of lock-in
Increased savings—and a higher ESR—are often achieved through larger or longer commitments. However, commitments require financial lock in. Therefore, when presenting the ESR we recommend including the commitment expiration dates to showcase the actual ‘cost’ of achieving this ESR rate. Cloud Commitment Management helps mitigate commitment lock-in risk by building inherently flexible portfolios and adjusting near real-time based on usage trends and business changes, allowing customers to maintain high ESR without overcommitting.
Wrapping up: How to use ESR in your FinOps practice
ESR is helpful in evaluating the savings impact of cloud commitments. However, it doesn’t tell the whole story of cloud savings, or FinOps, which includes management costs, the full spectrum of rate optimization strategies, or commitment lock-in.
Therefore, to tap into its main insights, ESR must be used in context:
- To estimate your commitment management cost, consider the discrepancies between results given by the two ESR formulas.
- Remember that a low ESR may be the result of various considerations: oversized instances or committed usage capacity that result in waste; a lower-saving commitment type; high commitment management costs; or increased usage of spot instances, which reduces commitment coverage but is likely to yield higher savings.
- Alongside ESR, evaluate your level of commitment lock-in, to see if your current strategy fits your business needs, now and in one to three years’ time.
- If you aren’t doing so already, explore additional rate reduction instruments that are beyond the ESR’s scope, like spot instances or a wider geographic distribution of instances.
Cloud Commitment Management delivers superior ESR outcomes through automation, flexibility and expert management. Benchmarks show that Flexera-managed portfolios can achieve ESRs of 48%, compared to 39% for self-managed ones—translating to $480K in savings from a $1M commitment portfolio.
Learn more about Cloud Commitment Management, and register for our FinOps automation with Flexera One Cloud Commitment Management webinar to take your first steps toward FinOps automation!
