Total Cost of Ownership

The 3 Elements of Total Cost of Ownership (TCO)

What is the Impact of TCO on Your Business

TCO is a technique used by businesses to measure the cost of their assets, including the expenses for their operation in addition to the price paid for their acquisition.

It is important to note that while TCO may sound like an accounting term, it is used neither in the recording or reporting of transactions. Instead, its purpose is for the evaluation of potential purchases (often referred to as “projects”) by the decision makers.

Total Cost is Not the Same as Price

All too frequently, business owners mistake total cost of ownership with price. However, TCO should be a method of drawing attention to the difference between price and what the project’s costs will be over the long term. Price is only a single part of the analysis performed for TCO calculations.

Once you understand the difference between price and cost of ownership, you will be able to utilize this important tool for important calculations regarding several kinds of purchase and investment decisions such as: buildings, IT infrastructure, manufacturing equipment, and vehicles.

By making a total cost of ownership analysis a part of your decision making process for purchases and acquisitions, you may be better prepared to have a more accurate view of the value of that decision. It can have an impact on everything from your capital acquisition prioritization, to vendor selection and even your budgeting process.

The 3 Primary Elements of Total Cost of Ownership

The three main elements of a calculation of TCO are:

·         Costs of Acquisitions – This part of the calculation has to do with the cost of property or equipment after discounts, commissions, closing fees, and purchasing incentives, but before taxes. Occasionally, this will involve the single acquisition of upgrades or peripheral products required for the installation or use of the purchase.

·         Costs of Operation – This factor includes the services and subscriptions that are required in order to be able to use the acquisitions that have been purchased. This may include direct operator labor, initial training, maintenance materials, equipment and services, and utility costs.

·         Cost of Personnel – This portion of ownership cost involves the overhead to cover personnel, which can include those involved in the operation of the acquisition, the support staff for the asset, facility housing personnel, and the administrative team. It may also include ongoing training personnel and labor for the maintenance and troubleshooting of the asset.

Contributions of Accounting to Total Cost of Ownership Calculations 

The actual cost won’t be accurate if it involves only the expenses, but must also include the incremental revenue flows or savings that are associated by owning and operating with this asset.

The TCO is mitigated by the “business status quo” versus the changes to the cash flow. That amount is calculated by use of Net Present Value calculations in order to analyze the value over the long term.

The Drawbacks of Using Total Cost of Ownership

There are a number of drawbacks with this process and its use for making decisions. While it can be a good guide, because of the following factors, it should not be the singular decision-making consideration. These factors are as follows:

·         TCO also doesn’t consider the option value within systems that are more flexible

·         It is very rare to be able to accurate perform a general comparison of two systems independent of circumstances

·         The quantity of difficult to forecast numbers makes data fundamentally unreliable

Due to these drawbacks, TCO analysis is intrinsically flawed. It does take some time, the compilation of many solid numbers, research, and a good understanding of the investment or acquisition as a whole in order to allow it to gauge the potential impact that it may have on the business.

That said, when used correctly and not exclusively, calculations using these methods can be highly beneficial as a part of a complete toolbox for decision making for a company of any size.