Getting Started with a Total Cost of Ownership (TCO) Analysis
Weighing the cost of an investment against its ability to make or save money is one of the most common problems we face when making decisions about IT investments.
It’s generally pretty easy to calculate initial investments costs—such as the price of new hardware, software, and implementation services—once you settle on the details of the technology solution. The costs of supporting the existing assets is often limited to vendor support costs.
Despite these calculations, organizations often find—even with successful implementations—that their IT operations, support, and hardware/software maintenance costs continue to rise each year. The reason is that there are usually “hidden” costs not considered in the initial cost analysis.
Due to this pervasive issue, the concept of Total Cost of Ownership (TCO) has gained momentum over the years. Gartner developed the TCO concept in the late 1980s, but it’s really a common sense approach to evaluating any IT investment (or non-IT investment, for that matter). Simply put, TCO captures all of the lifecycle costs of an asset or project—through its acquisition, deployment, operation, support, and retirement.
Here are some tips for building a TCO analysis that will help you make better decisions about your IT investments:
1. Calculate all the direct costs associated with the asset or project.
To accurately quantify direct costs, you need an accurate inventory of your current assets, purchase records, facilities costs, and personnel cost information. It’s easiest to start with the hardware, software, and ongoing support contracts. Then consider the supplies and materials related to the operation of those assets, as well as operational costs such as internal labor, contract labor, power and cooling, data center floor space, network connectivity, telecommunications, and cloud services. Be sure to also include any administration costs such as training, hiring, and procurement.
2. Determine the indirect costs associated with the asset or project.
Reducing indirect costs is often the reason IT departments recommend new systems, so in your TCO analysis, make sure you include end user operations and support costs such as ongoing training, IT help desk, and informal self-help groups, for example. Don’t forget to include planned and unplanned downtime costs associated with the existing and proposed new system too.
3. Evaluate the profitability of the project.
To know if you’ll save money with the new asset or project, make a comparison between the costs of continuing with the existing system (business as usual) with the proposed replacement or upgrade. If the asset or project is part of a “green field” opportunity—a totally new line of business—you won’t have a business-as-usual measurement for comparison, but knowing the direct and indirect costs will still help you understand the true profitability of the project.
4. Include only incremental, controllable costs.
Only incremental, controllable costs should be included in a TCO analysis. Don’t include sunk costs—money that’s already been spent—because these costs, by definition, cannot be affected.
Ultimately, a good TCO analysis is a great tool for comparing the costs of investment options, and it can provide some eye opening results that lead to more well informed decisions. However, be aware that TCO analyses won’t capture the strategic business benefits of a proposed change. For this, you need to analyze the revenue generating potential and/or business cost reduction benefits of a proposed initiative. This requires a business case, which primarily identifies the broader business benefits of an IT investment and often includes a TCO analysis. I’ll be discussing business cases in future blog cases, so stay tuned.