Total Cost of Ownership

Total Cost of Ownership (TCO) is a financial estimate whose purpose is to help consumers and enterprise managers determine direct and indirect costs of a product or system. It is a management accounting concept that can be used in full cost accounting or even ecological economics where it includes social costs. For manufacturing, as TCO is typically compared with doing business overseas, it goes beyond the initial manufacturing cycle time and cost to make parts. TCO includes a variety of cost of doing business items, for example, ship and re-ship, and opportunity costs, while it also considers incentives developed for an alternative approach. Incentives and other variables include tax credits, common language, expedited delivery, and customer-oriented supplier visits.

Origin of Total Cost of Ownership

TCO was originally developed in the late 1980s by research company Gartner to determine the cost of owning and deploying personal computers. Their initial findings were that PCs cost an enterprise nearly $10,000 per year. At that time this caused an upheaval among financial managers and IT directors.

Calculation of Total Cost of Ownership

There is no broad accepted formula for TCO. The main thought behind is that you need to consider all relevant costs which are related to an asset. The following list contains typical cost elements of Total Cost of Ownership. Purchase price. Installation costs. Financing costs. Commissioning costs. Energy costs. Repair costs. Upgrade costs. Conversion costs. Training costs. Support costs. Service costs. Maintenance costs. Downtime costs. Safety costs. Productivity costs. Risk costs. Disposal costs. Which factors should you use? This depends upon the industry where the asset will be used and the characteristics of the asset. (Software, computers, buildings, automobiles, equipment, plants, etc).

Usage of Total Cost of Ownership Method

Any purchase of a significant asset, that needs a comprehensive analysis of long-term effects and hidden costs.

Strengths of Total Cost of Ownership

  • Obviously 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.

Limitations of Total Cost of Ownership

  • 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.
  • Generally, TCO does not assess the risks that are involved with a purchase of an asset.
  • TCO is not very helpful to align investments with strategic goals.
Business frameworks like Total Cost of Ownership are invaluable to evaluating and analyzing various business problems. You can download business frameworks developed by management consultants and other business professionals at Flevy here.

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Have you used Total Cost of Ownership in your work? Please share your experiences and insights in the comments section below.

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