Table of contents

1. What is Total Cost of Ownership (TCO)?
2. For how long have companies been analyzing the total cost of ownership?
3. What is considered by a total cost of ownership analysis?
4. What is the Total Cost of Ownership concept useful for?
5. How does a TCO analysis work?
6. Why is it necessary to calculate the TCO?
7. When do you need a TCO assessment?
8. How to calculate the total cost of ownership?
9. Adapting the TCO model to other requirements

The concept of total cost of ownership (TCO ) is based on a holistic view of the cost factors that products, goods or services generate over their entire life cycle. This includes not only the acquisition costs, but also all running direct and indirect costs.

Every product and every service has its price – but it is not just the purchase price that you pay when you buy it. In the period of use or operation, various other costs will normally also arise, for example for use, energy, maintenance, repairs, support or disposal. In order to be able to estimate which investment is the most economical before the purchase, all the costs triggered by it must be compiled and scrutinized. The term “total cost of ownership” (TCO) is used for this purpose.

Analyzing total cost of ownership has been common practice in business management for several decades. When the IT world took off in the 1980s, countless companies began to invest large sums into hardware and software solutions. However, no one could predict when these investments would pay off in monetary terms. In 1987, Microsoft boss Bill Gates was fed up with the excuses about unpredictable costs. He commissioned the management consultancy Gartner Inc. to create a concept that would break down all the costs associated with a product or service and thus provide a reliable basis for decision-making.

This concept should not only take into account the one-off investments – for example for the purchase of hardware, office inventory or data centers – but also all ongoing costs, such as maintenance contracts, electricity costs, license fees, etc. “Hidden” financial expenses, such as for operations or employee costs, should also be included in the calculation. The result of the Gartner company is the concept of Total Cost of Ownership (TCO). Its purpose is to create a high level of cost transparency with regard to an investment.

The investment evaluation using a TCO shows

• whether the TCO approach is relevant for a company or a product
• where high costs arise
• what causes them
• where there is potential for savings

This provides an excellent basis for decision-making and ensures cost-effective processes, as the costs that will arise are known in greater detail.

A TCO analysis is helpful in a number of ways when it comes to business management topics and tasks.

For service providers, the concept is a real advantage because it helps to reliably calculate service prices and models for operators.

The concept forms an important basis for investment decisions, as it examines all potential costs that a consumable or capital good might cause over its entire service life before procurement. In addition, the total cost of ownership can be used to analyze the profitability of a strategic project. For example, even before new regulatory guidelines are passed, it is possible to check what extra costs will be associated with the project and whether the business model will still be profitable.

Last but not least, the TCO analysis is an important tool for identifying cost drivers and potential savings and thus effectively reducing expenditure.

The TCO can be determined by collecting information as well as estimating and calculating the total costs. This can be time-consuming, but the analysis helps to avoid bad investments, identify hidden cost drivers and allow products or investments to be compared with each other. The TCO can help to identify high savings potential.

For a reliable analysis of the actual total costs, all activities and steps associated with the use of a product or service must be taken into account. These are, for example

• Delivery
• Installation
• Support
• Implementation
• Energy consumption
• Maintenance processes
• Repairs
• Return
• Disposal

In order to determine real data with regard to these factors, all information and facts about a product or service must be obtained. If the TCO analysis is to serve as a basis for decision-making, it is also recommended to compare different options with one another – in other words, to consider alternatives. Several questions should be considered for all available products, for example

• What will it be used for?
• How will it be used?
• How often will it be used?
• When will it be used?
• Could problems or complications arise under certain circumstances?
• What should happen to the product after its lifetime?

Once these questions have been answered, the TCO analysis of the respective products or services can be carried out.

In short, the TCO is a decision-making tool, for example when selecting products and alternatives. The reason for this is that it takes into account not only the purchase price, but all costs that occur during the service life. However, it should be noted that some factors remain uncertain and are difficult to add to the purchase price with sufficient precision.

In principle, TCO assessments can be used as a planning tool for all capital or consumer goods. The usefulness of the total cost of ownership analysis depends on various factors. On the one hand, this is the amount of the investment costs – on the other hand, the maturity of the project and the planned lifespan of the product must also be considered.

This applies in particular to goods such as machinery, technical equipment or communication and information technologies. It is precisely in these areas that hidden costs lie dormant that affect the profitability of a purchase decision and therefore the success of an investment.

Calculating the TCO is often a little more complicated than it seems at first glance – especially when it comes to services. This is typically due to a lack of transparency, as financial management processes in companies are usually just as intransparent as the processes and structures of IT services. In order to implement a TCO effectively, employees must be trusted – they must be allowed to know what their workplace and associated services cost. Project staff should also be given insight into all relevant project figures.

The following example concerns the calculation of TCO for data centers, but can be applied to other areas in a similar way.

Step 1: Identify the sources of costs

As already mentioned, the cost items included in the TCO are divided into two areas:

• direct costs
• indirect costs

Direct costs are all operational costs that are associated with ongoing operations. In the example of the data center, these are primarily maintenance costs, licensing costs, electricity, bandwidth, etc. In addition, there are costs that arise at employee level – for example, the salary of the data center employees who are responsible for operating or maintaining the assets.

Indirect costs include aspects such as downtime, during which costs occur but no profit is made, along with training and further education costs.

Step 2: Define sources of information

In order to calculate the total cost of ownership, reliable information or raw data is required for both direct and indirect costs. This serves as the basis for the calculation. For a data center, for example, this could be data on the hardware and software used, licensing costs, ongoing contracts and the like.

This information must be read out in a clean, standardized and structured manner – and as automatically as possible in the interests of efficiency. It is therefore necessary to first identify which information is accessed and on the basis of which source. In the data center area, for example, the CMDB can be used to provide information about the existing hardware, while Zabbix/SCCM or other monitoring tools can deliver information about servers with different operating systems. Even the ticketing tool can be consulted to measure the time and effort required to complete tickets.

Step 3: Categorizing the data

Once the raw data has been extracted from reliable information sources, it must now be put into a structure that allows costs to be clearly assigned to specific assets.

1. Identify assets (e.g. Microsoft licenses, data centers, HP servers, etc.)
2. Identify contracts (e.g. EMC storage maintenance contract, Microsoft license contract, rental contract with data centers)
3. Define asset categories (e.g. servers, storage, services, etc.)
4. Link specific assets with corresponding contracts

Finally, there should be a structure that assigns all costs to specific assets, which in turn are grouped into asset categories.

Step 4: Break down total cost to a product or service

It is not always enough just to know how to calculate the TCO of a specific asset. For example, when considering the profitability of the business model, it is important to relate this TCO to the products and services offered: For example, if a software company programs software and makes it available on its own servers, it can be helpful to compare the costs of the product with the revenue it generates.

For this purpose, the product or service is used at the highest possible level. In this example, the software is provided on a server:

• The software is provided on a specific server, which in turn has certain attributes: For example, it consumes a certain amount of space in the data center, it consumes a specific amount of power, etc. Some of these attributes are linked to other cost items – for example, the server uses a specific operating system, which in turn causes license costs and runs on a storage medium that has its own costs.
• The software consumes internal bandwidth or external bandwidth during the delivery process. This bandwidth is then associated with specific costs.
• In the CMDB, the attributes of individual cost items and their connections to each other can be read out if necessary.

Depending on the business model and industry, the TCO model may have to meet different requirements depending on the purpose for which it is used. For example, a part of the company may want to set the total costs of its product in relation to profit. Or they might want to define what cost savings are possible if a certain part of the company is outsourced. A rigid model for calculating TCO would be a hindrance in such cases. However, there is a way in which the rigid system can be adapted to dynamic processes.

To do this, the data records collected are classified by asset, metric, measurement tool, virtual layer and keys:

• Assets: Individual assets (e.g. hp servers, emc disks) or entire asset categories (servers, storage systems) are summarized here
• Metric: This refers to a specific data point for the analyzed asset, for example the number of servers or the storage space for disks
• Measurement tool: This identifies which source of information was used to measure the data (see step 2)
• Virtual layer: The virtual layer represents the level on which you want to calculate your TCO. E.g. TCO of a specific product, business unit, or service. All cost are later assigned to the virtual layer
• Key: The key specifies the logic according to which assets are transferred to the virtual layer – e.g. “TB storage space per product”

As assets and contracts are already linked in the raw data, this inventory can be used to easily calculate the total cost of ownership (TCO) of any virtual layer.