(Originally published in Small Business Computing, January 29, 2010)
Technology insiders tend to throw around technical terms and business jargon, assuming people outside the industry understand what it all means. By its nature, technology vocabulary is often confusing and complicated, and insiders often add to the confusion by over-complicating things. To help add a sense of clarity to the confusion, each month, Laurie McCabe, a partner at the SMB Group an dat Hurwitz & Associates, will pick a technology term, explain what it means in plain English, and then discuss why it may be important to you. This month, Laurie takes a look at IT Total Cost of Ownership (TCO).
What is Total Cost of Ownership?
In the IT world, total cost of ownership (TCO) is used to calculate the total cost of purchasing (or in the case of cloud computing, subscribing to) and operating a technology product or service over its useful life. TCO provides a construct to evaluate technology costs that may not be reflected or be apparent in the upfront pricing. For example, if you’re buying a new server, the server (including operating systems, database software and storage) usually accounts for roughly 15 to 25 percent of the overall, long-term costs to install, maintain, upgrade and support the server over time.
Why Should You Care?
Although many companies factor TCO into the purchasing equation, they often underestimate the hidden costs of a new technology solution, which can result in negative consequences. For example, if don’t have the resources you need to adequately maintain a solution, you may skip upgrades and patches required to keep the solution running securely and at peak performance. Or, if you misjudge the time and expense needed to train employees on a new product or service, they may never use it productively.
While TCO helps you to determine hidden costs of a new technology solution, return on investment (ROI) analysis helps to illuminate benefits that may not be readily apparent, such as improved employee productivity or increased customer satisfaction. ROI assessments can be more subjective in nature than TCO, because these indirect benefits are usually harder to measure than direct costs.
When two solutions provide roughly equivalent benefits over the solution lifecycle, but have different types of costs associated with acquisition, maintenance and operation, a TCO comparison gives you a framework to better evaluate competing solutions to a problem, and avoid getting stuck with hidden costs and unwanted surprises.
For instance, a cloud or software-as-a-service (SaaS) customer management solution may provide business benefits very similar to what an in-house customer management solution would provide. However, TCO over a given time period may vary greatly. That’s because the very different business and delivery models and the cost and pricing structures for cloud computing and on-premise solution significantly affect TCO.
For example, on-site solutions usually require significant upfront capital expenditures for hardware, software and application software, along with IT resources to install and configure these components. As a result, first-year costs for on-site solutions are often much higher than those associated with SaaS or cloud computing solutions, and total costs to maintain and manage on-site infrastructure and solutions continue to be a factor over time. On the flip side, TCO analysis may actually favor on-site solutions as the number of users rises and the total time period factored into the calculation increases.
What to Consider
Think about your business and how long you expect to be using a particular solution. In the case of a core business solution, such as accounting or financial, many companies look at a TCO a period of four or five years (generally thought of as the useful life of hardware and software without the need for major replacements).
In less core or strategic areas — which will vary from business to business — you may want to look at TCO over a shorter time period. Regardless, TCO calculations usually include several categories and components, such as:
• Planning and selection: How long will it take to evaluate the solution, the vendor and service level agreements (if applicable)? Consider whether you can try the product for free and/or if you need to invest money or resources to set up a test environment.
• IT infrastructure requirements: For on-site solutions, do you need to buy hardware and software upfront to run the solution? What associated expenses will you have for space, power and cooling? Consider if you will you need to add, shift or outsource IT personnel to manage and maintain the infrastructure, and how much this will cost. For a SaaS or cloud solution, do you need to upgrade or add networking capabilities or bandwidth?
• Application subscription or license costs: What is the per user charge for the license (on-site) solution, or the per user subscription fee (cloud or SaaS solution)? Are ongoing maintenance costs for patches, bug-fixes, upgrades, etc. included in this price or billed separately?
• Application design, configuration and implementation: What resources (internal and/or external) will it take to design and configure the solution so it fits your business needs? Factor in relevant data migration, integration and customization costs, and any system testing necessary.
• Administration and maintenance: For an on-site solution, what is required to transition daily system administration to your internal staff? How much time, resources and money will you need to invest to manage, upgrade, trouble-shoot, patch, etc. over the solution lifecycle?
• Training costs: What IT administrative training and/or end-user costs are involved to get everyone on board and productive in using the solution.
While TCO is very important for most companies, you should also consider other factors — including contract terms, service level agreements, data security requirements and customization and integration needs — just to name a few. Many companies under-invest when it comes to thoroughly evaluating IT solution requirements and options.
By doing a more careful assessment upfront — either with an internal team, or by hiring an independent consulting organization — you will save your company time, money and aggravation down the road.
Did this help you understand total cost of ownership more clearly? Let me know, and send me any additional questions you have on this topic. Also, please send your suggestions for other technology terms and areas that you’d like explained in upcoming columns.