Total Cost of Ownership(TCO)

Developed by Gartner Research in 1987 in order to determine the cost of owning and deploying personal computers The Total Cost of Ownership analysis (TCO) is a business case designed especially to find the lifetime costs of acquiring, operating, and changing something. TCO analysis often shows there can be a large difference between the price of something and its long term cost.

TCO Pyramid
Purchase Cost + Joint Cost + In- House Costs = Total Cost of Ownership (TCO) Visible Costs
Purchase Price Transportation Warehousing Packaging Utilization Inventory R&D Capacity

Hidden Costs

Specification
Data Warehousing Field Failures Purchase Process Cost

Constituents of TCO
TCO has 3 main constituents:
1.

Acquisition costs

2.
3.

Ownership costs, and

Post-ownership costs

Acquisition Costs

Acquisition costs represent the initial cost associated with purchase of materials, products and services.

1. 2. 3. 4.

It includes the following costs broadly: Purchase price Planning costs Quality costs Taxes

Ownership Costs

Ownership costs are associated with the ongoing work or operations of a purchased product or service.

Quantitative aspects include energy usage, downtime, scheduled maintenance, repair and financing.

Qualitative aspects include ease of use, ambience, aesthetic, and ergonomic, etc.

Ownership costs broadly include the following costs: Downtime Costs Risk Costs Cycle time costs Conversion costs Non-Value-Added costs Supply Chain/Supply Network costs

1. 2. 3. 4. 5. 6.

Post-Ownership Costs

Post-Ownership costs have a significant long tem impact on the purchase made. It mainly includes: Warranty costs Product liability costs Customer dissatisfaction costs Salvage Value Environmental costs

1. 2. 3. 4. 5.

Total Cost Of Ownership Models

Net Present Value approach Dollar- based approach Value- based approach

Net Present Value approach

Analysis of holding period of the asset Calculated using the present value of the Initial expenditure Likely future revenue streams

Likely future expenditure streams

Formula-

Helps analyst in making sound

TCO = A + P.V. i=1(Ti+ Oi + Mi - Sn)

recommendation between alternatives

Dollar- based approach

Relies on gathering or allocating actual cost data for each of the relevant TCO elements

Similar to ABC- Analysis

Limited for TCOs for repetitive decisions

Value- based approach

Combines cost data with other performance data

Complex as qualitative data is transformed into

quantitative data Suppliers performance is scored within categories and

points allocated among categories reflecting the

buying organizations estimate of the cost of various performance discrepancies.

Requires a great deal of effort to develop proper

weightings and point allocations

Value- based TCO Illustration

Total cost of item per dollar purchased= [(100- score)/ 100]+1 Category Quality Delivery Technology Support Example: Delivery % of line items delivered on time (A) 100% 99% 95-98% 90-94% 85-89% 80-84% <80% Percentage of maximum points allotted (B) 100% of maximum 95% 85% 70% 45% 25% 0% Maximum Points 30 20 30 20 Score

(A X B)
20 19 17 14 9 5 0

Computing the Adjusted Cost

Example: Category Quality Delivery Technology Support Total Score Points awarded 25 19 30 18 92

Total Cost per item per dollar purchase = [(100-92)/100]+1 = $1.08 total cost factor Adjusted cost per unit = Price X Total cost factor= $10.00 unit X 1.08 = $10.80/unit TCO

TCO in different industries

The additional costs that must be added to the initial purchase price to calculate the total cost of ownership (TCO) vary by industry Information Technology industry- TCO is used heavily in the IT industry. When used in evaluating the purchase of a computer or system, usually includes purchase, repairs, maintenance, upgrades, service and support, networking, security, training, and software licensing. Automobile industry Some companies have a TCO calculator that adds depreciation, interest, taxes and fees, insurance premiums, fuel costs, maintenance, and repairs to the purchase price of a car or truck. Financial industry Many mutual funds and similar products charge quarterly management fees and/or have withdrawal charges. These indirect costs must be considered when calculating the true cost of these investments.

Benefits of TCO Analysis

It is sensible to consider all costs when an asset is acquired. TCO is a long-term measure, and reduces the total costs over time TCO can bring out so-called "hidden" costs of ownership. TCO can put the spotlight on potential cost problems before they become problems. It is necessary to well understand the costs over time to compare against the benefits over the same time-frame. It can vary substantially across solution vendor alternatives

Limitations of TCO Analysis

The effort that is needed to do a TCO analysis. Performing a TCO analysis has itself a cost. No general formula exists. TCO does not offer help for the valuation of intangible assets. Sometimes it can be difficult to determine whether, and to what extent, certain costs must be allocated to an asset. Because TCO is a long-term measure, it reduces costs over time. If you have to cut cost immediately, TCO is not very useful. Since TCO modeling tracks long-term, life-cycle costs, capturing the benefits of TCO analysis in a single years budget can be difficult. TCO modeling does not assess risk or how well a particular technology fits with an agencys or facilitys strategic goals or needs. TCO modeling does not necessarily track environmental or social costs and benefits.

Source Exploring the Supply Chain www.12manage.com www.techwise.com