Total Cost of Ownership Explained
Business owners, both new and established, recognise the value technology provides. According to Gartner, spending on IT products and services increases 5 to 6% annually as Australian businesses adapt to an increasingly digital marketplace. Information technology drives innovation, enabling companies to be more productive, and communicate more efficiently, providing a competitive advantage that powers growth and success.
However, given there are always tight budgets when it comes to lofty goals, it can be a challenge to work out how to best spend money on technology to achieve the best return on investment. It can be a valuable exercise to look at the total ownership cost when it comes to making the decision to invest in technology.
What is the total cost of ownership?
The total cost of ownership (TCO) is the sum of all expenses associated with purchasing, deploying, using, and getting rid of a product or device. In a nutshell, it is the estimate of the real cost of a product or piece of equipment over the entire life cycle. TCO allows full visibility into all costs relating to a product or device, including maintenance and repair costs, to give insight into how much it will cost to own, operate, and maintain a product over its useful lifetime. This information allows businesses to make informed decisions about which assets are vital. A high TCO would flag potentially hidden expenses or maintenance issues with the asset under consideration for purchase.
TCO provides a better foundation for estimating the return on investment of investment than the purchase price alone. For example, the initial purchase price plus setup costs, operating costs, and routine maintenance are deducted from the equipment’s residual value at the end of its lifecycle.
What’s included in the total cost of ownership?
Many firms often miscalculate the hidden expenses of new technology solutions, which can negatively affect their performance. Unless you have the money to keep your equipment in excellent condition or the education to educate your employees on the new product or service, your ROI will not be as high as you anticipate when you initially purchase it.
The total cost of ownership of a piece of equipment is the sum of the initial capital expense (CAPEX), the operating expenses (OPEX), and the additional hidden costs and repairs that may be required over the life of the equipment.
- CAPEX is the initial capital investment required to purchase the asset. It can include the cost of purchasing the asset, installation, and any required maintenance agreements for the life of the equipment.
- OPEX is the ongoing expenses, such as electricity, fuel, maintenance and repair costs. Hidden costs and repairs include asset failure costs and any additional repairs required over the life of the equipment.
Many organisations look at the TCO over a five or so year period, but depending on the type of business you are in, a shorter time period can be more useful. Regardless of industry, TCO generally includes these elements:
- Planning and selection
- Requirements of IT infrastructure
- Subscription or licence costs
- Design, configuration, and implementation of applications, systems, etc
- Administration and maintenance
- Training, security, ongoing support, etc
Hidden costs and repairs are costs that are not accounted for in the initial cost of the equipment. They may not be obvious, but they can increase the overall cost of a piece of equipment significantly. Hidden costs and repairs can vary greatly depending on the asset, but in terms of technology, things to consider as potential hidden costs are:
- Shipping
- Training required so new systems, hardware, or software can be used
- Finance methods needed to purchase the asset, including interest and fees
- Repairs or upgrades that require specialist technicians or out of warranty repairs
- Downtime for systems or networks if required for repairs
- Intellectual property, financial data, risk management, etc
Why is Total Cost of Ownership important?
The total cost of ownership helps you understand what it will cost to own, operate, and maintain an asset over its useful life, therefore it helps businesses make better decisions about what purchases to make. With this information, an organisation can make informed purchasing decisions based on the TCO of an asset, taking into account not just the price at the time of purchase, but also the amount of money the asset will cost over the period in which it is used.
Capital acquisition costs are only one piece of the puzzle. Operating and maintenance costs are equally critical. A low purchase price could be an indication the vendor is trying to move the equipment quickly because it’s not meeting expectations. In some cases, a seemingly low CAPEX might indicate the company is willing to offer a low price, knowing the total cost of ownership is relatively high. TCO is a very important metric to understand when making an informed purchase decision, and also very important to track as an organisation to ensure you are getting the best value for your investment.
TCO and environmental sustainability
With the rate of businesses beginning to shift their focus to digital transformation with sustainability initiatives front of mind, TOC becomes a valuable part of the procurement process. TOC plays a large role in providing transparency, visibility and control over the procurement process to set these sustainability initiatives in motion.
Frequently, sustainability initiatives have greater upfront expenses, but long term benefits such as a reduction in carbon footprint or lower energy consumption. The technology needed to drive these energy efficient changes are likely to have a higher initial investment cost, but over time less maintenance and less energy means the overall TCO is worth the investment over the life cycle of IT sustainable projects.
The challenges with calculating TCO
Operating costs for any piece of IT equipment can be difficult to estimate; some factors are easily overlooked or incorrectly compared from one product to another, including depreciation and warranties. Support costs on one server may include the expense of spare parts, making support costs higher than on another server.
It’s crucial to remember that a cost of ownership analysis does not account for unpredictable rising costs over time–for example, if upgrade part costs jump substantially more than expected due to a distributor change.
Vendor relationships and availability of upgrades and services are also not included in TCO calculations. If a software company stops supporting a certain application after three years, no longer supplies parts after five years, or terminates a certain functionality, the corporation may be exposed to unexpected and substantial additional expenses, which may cause the TCO to far exceed its original estimate.
TCO and IT procurement for your business
Investing in technology is a big decision for most businesses. When looking at the total ownership cost of a piece of technology, it is important to consider the initial purchase price, but also the cost of maintenance and upgrade, the cost of downtime if the technology fails, the cost of lost productivity when employees are training on new technology, and the cost of hiring outside contractors if internal staff are not trained to use the technology. Talk to the IT procurement experts at Virtu who can assist you with choosing the right technology for your business, with the greatest return in investment.