It is necessary to spend money to get new infrastructure items, products, or systems to optimize business results.
However, it is not always easy to perceive the actual amount of money needed for the acquisition. That’s why companies should be aware of the total cost of ownership (TCO).
Managers must analyze this metric before every new acquisition to make an accurate decision. Better detailing of costs helps you keep finances under control and have greater predictability about an asset’s life cycle.
Each company’s area must adopt this dynamic, ensuring that the investments are wise and generate a good long-term cost-benefit ratio.
In this article, we will discuss in detail the concept of TCO and how to use it. Below, you will find the following topics:
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What is Total Cost of Ownership?
The total cost of ownership (TCO) is a metric that measures the amount of money spent on acquiring any asset.
This calculation is based not only on the purchase price but also on the amount of money spent from a long-term perspective.
Therefore, we can understand that the TCO measures the cost of acquisition, maintenance, and operation of a given asset.
The total cost of ownership is a crucial metric for decision-making. Before making an investment or a purchase, calculating the TCO can bring better economic predictability.
Companies are concerned about the amounts spent on acquisitions because they need to make safe investments.
Indeed, high initial spendings are not always the most serious difficulty. A specific asset’s cost often tends to grow in the long term, and this situation can generate an unexpected expense.
If haven’t done so and want to start an LLC or any other type of company, you might want to include the costs of incorporation and other aspects into your TCO calculations as it is an investment into the future of your business.
When to Use TCO?
TCO is useful whenever a company aims to acquire an asset or make a large investment. The metric could be relevant in situations such as:
- Purchasing new computers and other tech devices.
- Renting a new office.
- Purchasing facilities for the company’s headquarters.
- Hiring a new management system.
- Purchasing a marketing tool.
Every asset that has an extended lifetime tends to generate additional costs.
Software, for example, needs a renewal of licenses and requires the company to have a budget for training so that employees know how to operate them.
New facilities for the company’s headquarters, in turn, generate infrastructure maintenance costs. They don’t embrace just the purchasing, but also operational expenses so that everything works fine.
By calculating the total cost of ownership, it’s easier to estimate all these additional expenditures generated over the long term. Thus, numbers are the basis of an investment choice.
How to Calculate the TCO?
The TCO calculation considers some implicit values. An asset has a price, but, besides this cost, many other factors will impact the amount of money spent.
You can make two calculations: a simple one and another more complex. The use of each one depends on the context and what you intend to acquire.
The simplest calculation considers three factors:
- initial cost (I)
- maintenance cost (M)
- remaining costs (R)
Thus, the calculation will be:
I + M – R = TCO
The initial cost is the label price, that is, how much you will pay for the asset.
The maintenance cost, in turn, involves the costs to ensure that the asset remains useful in the long term.
The remaining cost is the asset’s price in the long term, for example, in five years. This last factor helps us make a calculation focused on a possible devaluation.
The other calculation method embraces more factors when considering the asset’s total cost.
It is important to include more variables since, most of the time, many factors impact the acquisition cost if we consider a long-term perspective.
In this case, the factors are:
- initial cost (I)
- operation cost (O)
- maintenance cost (M)
- downtime cost (D)
- production cost (P)
- remaining value (R)
Thus, the calculation will be:
I + O + M + D + P – R = TCO
How Can Different Areas Use TCO?
Different departments within a company may use the TCO before making an acquisition decision. Let’s understand this better below!
Marketing
The marketing department has to spend its budget regularly. Acquiring automation, analysis, and collaborative management tools are the main types of expenses in this sector.
In these investments, it is essential to analyze factors that generate costs, such as:
- Licenses.
- The monthly cost of the plan.
- The costs of training employees to prepare them to operate the software.
- The acquisition of new software if the chosen one gets discontinued.
Accounting
Accounting is a department that needs to participate in the acquisition decision process, along with several other sectors.
This area can analyze additional fees, taxes, and other expenses that a purchase may generate, both at the time of the acquisition and in the future.
Management
Management is responsible for managing purchase orders for equipment and infrastructure-related goods.
This department usually purchases computers, office supplies, and tools in general. It can even participate in acquiring a new business office.
Management must always use TCO before making any purchase decision.
Challenges with Calculating TCO
Although there are many methods and helpful tools out there that make it easier to accurately calculate the total cost of ownership, it’s still not necessarily an exact science.
The challenges involved include the following.
Operating cost scope is hard to determine
This can especially be the case when acquiring assets like tech equipment.
Not only are there many hidden costs involved that are easily overlooked, but many companies fail to compare the correct products when assessing probable TCO.
Some costs are near impossible to predict
While some factors that affect the total cost of ownership are easy to anticipate because they’re so common, there will always be additional costs you can’t predict at all.
For example, unforeseen distributor charges could mean a specific replacement part you’ll need down the line suddenly skyrockets in price.
It’s difficult to calculate the benefits involved
When you only look at TCO when deciding whether to pull the trigger on a purchase, you’re simply not seeing the whole picture.
It’s much harder to put a price on the benefits of acquiring the asset in question, but they should be considered, too.
TCO Example
Want a closer look at how the total cost of ownership works within a business context?
Let’s use a hypothetical IT business as an example.
Let’s say this business is looking for a way to manage its databases more efficiently and is considering a server system upgrade as a means of doing this.
Naturally, the business’s purchase team will take a close look at all the available options on the market that could meet the company’s needs.
However, assessing the total cost of ownership will mean looking well beyond the initial price. For instance, one server option might have a great price tag but call for expensive upgrades within the next few years or require extensive additional training for in-house IT personnel.
Another option might represent more of an investment up-front but be more cost-effective and business budget-friendly to maintain over the long haul.
If it also requires little to no additional team training to get it up and running, then it’s likely the wiser purchase even though the initial price is higher.
What to Consider while Building a TCO calculator?
A company must have a tool to calculate the total cost of ownership.
It is necessary to consider some important standards while developing a calculator, which will ensure an accurate result.
Always consider that:
- The calculator should have as many factors as possible to allow the user to find the total cost.
- The calculator must consider the asset’s life cycle — the price it will have in a few years.
- When developing the calculator, you must consider your business’ market and its characteristics.
Wrap Up
The total cost of ownership is a metric that every company should use to ensure better asset and finance management.
Achieving an optimized cost-benefit ratio when investing is only possible if each cost involved in the acquisition and maintenance is known correctly.
You should find a developer or a tool to create a TCO calculator that considers your customer’s business’s essential factors. Therefore, get to know Ion, the perfect platform to help your company with that!
