Total Cost of Ownership: Is TCO Just Smoke and Mirrors?

TCO often shows ownership costs exceed price

Captain’s Log, Entry 7650.1Thanks to all the public discussion on total cost ownership TCO,  most business people now understand this: There can be a large difference between the price of something and what it costs to own. Nevertheless, when presented with TCO analysis results, many are still skeptical. They ask: Is TCO analysis for real?

At the same time, conflicting marketing claims and other forms of TCO misuse no doubt account for the TCO metric’s poor reputation.As a result, many senior decision makers do not fully trust TCO figures. Most agree with the total ownership cost concept as legitimate. However, they also know that analysts can manipulate TCO results. In fact, most know that TCO results depend on so many factors that it means little to speak of “the TCO” for any asset.John Dobbs of Novell said it best:

“The only valid TCO data are your own data.”

Define TCO For Your Own Environment

Total cost ownership cost analysis (TCO) attempts to cover all the costs of ownership across a long ownership life

Total cost of ownership analysis tries to find all important costs due to owning certain assets.

Total Cost of Ownership shows there can be a large difference between the purchase price and cost to own. TCO analysis uncovers obvious and hidden ownership costsParticipants in our business case seminars tell us that when they support a funding request with TCO analysis, it is wise to find out first just how their own leaders define total ownership cost. And, they had better be ready to back up cost claims with credible proof.

But how, exactly, can they do that? What makes a TCO result trustworthy in the eyes of senior leaders? In a nutshell, begin by remembering that your own TCO lifetime costs will depend primarily on:

  • Firstly, how you structure the cost model at the heart of the analysis.
  • And, secondly, how you use the asset.

Credibility for your results, in turn, depends on your ability to communicate the following:

  • The reasons for cost model design choices.
  • Major assumptions about asset usage and your reasoning for them.

(For in-depth coverage of these points, and for a complete introduction to total cost of ownership analysis, see the online Business Encyclopedia for Total Cost of Ownership.)

Use Your Own Total Ownership Cost Model

The TCO concept is necessary because so-called hidden costs go with owning certain assets. Hidden costs are those that are easy to overlook or omit from purchase discussions. Nevertheless, hidden costs can be large and real, especially across a long ownership life.

Using a good cost model is key to delivering credible TCO estimates. Firstly, the model helps the analyst identify all relevant costs. Secondly, when the analysis is complete, the same model shows senior leaders that all relevant costs are in the analysis.

Example TCO Cost Model

This table, for instance is a cost model for an IT system purchase. Cost items in each matrix cell are together because they have common cost drivers. Rows refer to major resource categories, and columns refer to IT system lifecycle stages.

Acquisition CostsOperating CostsChange Costs
SWObvious costsObvious costsHidden costs
HWObvious costsObvious costsHidden costs
PersonnelHidden costsHidden costsHidden costs
NW & CommHidden costsHidden costsHidden costs
FacilitiesHidden costsHidden costsHidden costs

Each white cell includes a list of cost items that are more or less obvious. For example:

  • An item in the SW/ Acquisition Costs cell might be: “40 single user licenses for design system SW.”
  • The cell HW/ Operating Costs cell might include: “Monthly HW service costs.”

Each gray cell has a list of cost items that are more or less “hidden.” Such items, that is, must go with owning, but they are easy to overlook in planning. For example:

  • An item the Personnel/Change cell might be: User training.
  • The cell Facilities / Acquisition might include: Reconfigure office space.

A first rule for good TCO analysis is to be sure your model includes all cost categories, obvious and hidden, for your setting. And, when comparing TCOs for purchase options, be sure to use exactly the same TCO model for all.

Different TCO’s From Different Analysts?

In brief, TCO results depend entirely on the cost model for the analysis. And, when TCO results from two analysts differ, there are two possible reasons why they differ:

  • Firstly, the two analysts used different cost models.
  • Secondly, the analysts made different asset usage assumptions.

Total Cost of Ownership: Where To Go From Here? Further TCO Resources

The article Total Cost of Ownership presents calculated TCO analysis results. For new and veteran case builders alike, see the popular article Business Case Analysis.

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Author: Marty Schmidt

Marty Schmidt is Founder and President of Solution Matrix Limited, a Boston-based firm specializing in Business Case Analysis. Dr. Schmidt leads the firm's Management Consulting, Publishing, and Professional Training activities. He holds the M.B.A degree from Babson College and a Ph.D. from Purdue University.