TCO, the real cost of the things

My father used to say that everyone looks to see if they have the money to be able to buy a car, but few look to see if they have the money to be able to use it.

The acquisition of any asset is not a decision to be taken lightly, as it involves a series of costs that go beyond the initial purchase price, they are the costs that accompany it throughout its life. These costs are known as TCO (Total Cost of Ownership) and are essential to evaluate the profitability and return on investment in the acquired asset. In other words, TCO indicates not only the initial purchase price, but also all the costs associated with it for as long as it exists.

TCO is important to organizations because it helps make more informed and strategic decisions about the procurement investment. By considering TCO, the real value and return on investment (ROI) of a product or service can be assessed, not just its initial cost. TCO allows us to compare different options and choose the one that best suits each need and budget.

Focusing on technology, TCO allows estimating the full cost of acquiring and using a technology solution throughout its life cycle, including all direct and indirect costs associated with acquisition, implementation, use, operation, maintenance, support and disposal.

For example, if we are talking about software, the initial cost may vary depending on the functionality offered, customization, etc. This is usually reflected in the cost of the license. If we think about TCO, the cost then also includes the costs of installation, training, licensing, support, upgrades, compatibility, security, storage, integration, migration, disposal, etc.
If we were talking about a printer, we could say that it is not only the cost of buying the printer, but its total lifetime costs will include the costs of ink or toner cartridges, paper, electricity, maintenance, breakdowns, support, upgrade, security, space, depreciation, disposal, etc.

Depending on the context, TCO is composed by different items

TCO is based on the principle that the costs of ownership of any technology are much higher than the cost of acquisition, and that these costs can vary significantly depending on the type of technology, the company acquiring it and the context in which it is used.

Calculating TCO is a complex task that requires consideration of multiple factors, such as:

Acquisition cost: This is the purchase price of the technology, which may include the cost of licenses, hardware, software, installation, configuration, customization, etc.

Implementation cost: This is the cost of integrating the technology with existing systems, business processes and end users, which may include the cost of consulting, training, testing, data migration, etc.

Operational cost: This is the cost of using the technology effectively and efficiently, which may include the cost of power, connectivity, consumables, personnel, etc.

Maintenance cost: This is the cost of keeping the technology in optimal operating condition, which may include the cost of upgrades, technical support, repairs, security, backup, etc.

Disposal cost: This is the cost of removing the technology when it is no longer useful or cost-effective, which may include the cost of uninstallation, disposal, recycling, etc.

Financial cost: This is the cost derived from the financings that have been made to cover the above costs, including interest, devaluations, etc.

By adding all these costs together, we can have a clearer and more complete view of the real costs of the investment, allowing more informed and strategic decisions to be made and not only looking at the short term acquisition cost.

Why is TCO important?

We have already glimpsed its importance with some examples in previous paragraphs, but TCO is relevant in many situations.

For example, it allows us to compare different technology options on an economic level considering the long-term cost. This helps to choose the best option that offers the highest added value and the lowest total cost of ownership in the future. In addition, we can use it as a basis for negotiating with suppliers to obtain better conditions and prices.

With it we can also optimize resources and maximize the profitability of investments, since the TCO allows us to estimate the return on investment (ROI) of the technology, in other words, the relationship between the benefit obtained and the cost invested. TCO is key to detecting hidden costs and avoiding or at least mitigating them.

At the organizational level, TCO facilitates planning and budgetary control by having a clearer and more complete view of costs, which allows for the prevention and mitigation of financial and operational risks that may arise now and in the future.

How is TCO calculated?

There is no single formula for calculating TCO, as it depends on several factors, such as the type of product or service, industry, size of the organization, time of use, etc. However, some general steps can be followed to estimate TCO approximately:

Define the scope and objective of the calculation: It must be determined what type of technology is to be evaluated, what time period is to be considered, what costs are to be included and what benefits are expected to be obtained.

Identify direct and indirect costs: All costs associated with the acquisition, implementation, operation and maintenance of the technology should be identified; both direct costs (which can be easily measured and allocated) and indirect costs (which are more difficult to measure and allocate, but which also have an impact on the total cost of ownership).

Quantify the costs of each component: this involves assigning a monetary value to each element of the TCO, taking into account the initial cost and the recurring cost over the life cycle of the product or service. Historical data, budgets, invoices, quotations, etc. can be used.

Add up all costs to obtain the TCO: All direct and indirect costs must be added up to obtain the total cost of ownership of the technology.

Once we have calculated the TCO we can use it together with the ROI (in case we know or have an estimate of the benefits we will obtain by having that system) to compare options, that is, to compare the total cost of ownership with the return on investment. ROI can be calculated as the difference between the benefit obtained and the cost invested, divided by the cost invested and can be expressed as an absolute value or as a percentage. The objective is to choose the technology option that offers the lowest TCO and the highest ROI.

Something important when comparing TCO is that we must compare them under the same conditions, i.e., if we take 5 years as the time horizon for calculating the cost of a good, for the rest of the goods compared it must also be 5 years, if we take electricity into account, electricity must be taken into account in all of them, and so on.

With everything seen, we can say that the future costs of the company can be reduced by performing a previous analysis of the TCO, comparing and choosing the most appropriate options, negotiating the best conditions and prices with suppliers, implementing good practices of use, operation, maintenance, updating, support and disposal of products or services. And this is not a single action, but a cyclical process in which the TCO is monitored and evaluated periodically.