TCO | Total Cost Of Ownership
Definition TCO – Total Cost of Ownership
Total Cost of Ownership (TCO) is an analysis metric that can be used to calculate the operating and acquisition costs of a product, asset or system. This holistic way of evaluating costs, especially in information technology, is very important for the business world because it is able to evaluate not only the cost of acquisition, but also and all aspects of long-term costs, i.e., usage, maintenance, or even energy costs of hardware, software and other devices or equipment. In addition, it takes into account indirect costs, such as labor or production downtime. Since the TCO analysis reveals all costs incurred over the entire life cycle of a product or service, it is a valuable aid when making investment decisions.
TCO models and cost categories
A TCO analysis is worthwhile in order to avoid bad investments and uncover hidden cost drivers. It also makes it easier to compare with possible alternatives and identify potential savings.
To perform TCO calculations, costs must be divided into three different categories: Procurement, Implementation and Support/Maintenance. They all pay into the total cost and can be broken down as shown in the diagram.
TCO – Total Cost Of Ownership – Overview
Direct and indirect costs for TCO calculation
In addition, a distinction can be made between direct and indirect costs. Direct costs have the ability to be quantified as their main feature, so this category includes the purchase of hardware/software (and their updates and licenses), support (training, travel, manuals, etc.), management (of networks and systems), development (of applications and content), and communications (infrastructure and fees). Indirect costs, which are more difficult to calculate, relate to operations or end users. The most important activities include occasional support and self-study or even repair work, which may involve work and production downtime.
Total cost of ownership: measuring the life cycle
The TCO calculation can be relatively time-consuming, as all information and facts have to be collected in order to estimate and calculate the total costs. Another factor is the life cycle of products or services, as they all have a certain useful life. Therefore, it is important to consider the following usage modalities:
Depreciation period: the number of years the asset or product will be depreciated (e.g. 5 years)
Economic lifetime: years in which the acquisition can bring the owner a financial return, which can be calculated from the costs necessary for maintenance and operation. If these costs exceed their return, this is already a sign that their economic life is over.
Factors for a meaningful TCO analysis
To achieve meaningful results, several factors must be considered:
- Clear statement of objectives: In order for the results to actually meet the pre-determined objectives, it is essential that the proposed targets for the TCO calculation are comprehensively identified.
- Definition of the relevant costs: for a satisfactory TCO calculation, it is important to understand what costs are associated with the purchase of a particular product or the introduction of a particular technology.
- Definition of the calculation period: Just as important as the above factors is the definition of the period to be evaluated for the TCO calculation.
Conclusion: The calculation of the total cost of ownership helps to make investment decisions
Total Cost of Ownership (TCO) is, in short, the overall consideration of all costs associated with the purchase and operation of a service or product. It aims to calculate the operating and acquisition costs of a product or tool and determine whether or not it is worth investing in. A TCO analysis can also reveal that it is not the product or service with the lowest acquisition costs that is the cheapest, but rather that a higher price in the acquisition offsets over the entire lifetime and the costs are lower overall.