This checklist outlines what total cost of ownership analysis actually involves, looks at its strengths and limitations, and suggests some situations where it is suitable and others where it is less so.
Originally developed by Gartner Research in 1987, total cost of ownership (TCO) analysis is a tool which aims to systematically calculate the overall costs involved in buying, running, and developing a system or asset over its full life cycle. Frequently employed as a decision support tool in information technology environments, TCO analysis is also widely used to help to assess the likely costs involved in acquiring, installing and operating, then finally developing a wide range of systems or assets, such as production machinery, vehicles, aircraft, or even scientific equipment.
Thorough TCO analysis can help businesses to gain a deeper understanding of the true life cycle costs involved in a potential decision. For example, it can help managers to avoid rushing into a deal that at first glance appears to represent good value on the basis of a low acquisition cost, when analysis of the operational and development costs could paint a very different picture. Detailed TCO studies can help to bring operating costs that are not obvious but nevertheless substantial to light ahead of a critical decision. TCO analysis can be especially valuable in IT-related decisions, when the cost of operating a computer system for several years is usually a large multiple of the initial purchase costs.
To perform TCO analysis, a matrix is usually employed, with one axis listing the full stages of the particular case subject’s life cycles. These should include (but not necessarily be limited to) the purchase/procurement phase, the operational/maintenance phase and the development/growth phase. The other axis is typically more complex, detailing all the categories of resources that are set to be required, even to a small degree, from the beginning to the end of the product’s useful life cycle. In typical applications such as IT systems, the resources axis could include basic costs related to hardware, software, internal staff expense, external consultancies, and facilities. For more advanced IT systems these broad categories could be expanded considerably. TCO analysis permits the projected costs for each stage in the life cycle to be broken down into individual years, thereby increasing the transparency of the cost patterns.
|Purchase||Operation||Development and growth|
In its basic form, TCO analysis forms a readily understandable decision-support tool.
TCO can grow with the complexity of the application, with scope to develop both the resources and life cycle matrices.
The analysis can help to shed light on costs that could otherwise be simply overlooked.
TCO focuses purely on costs, with no consideration given to benefits.
TCO’s analysis on costs risks emphasizing the benefits of the cheaper option rather than a potentially more advantageous but more expensive alternative.
Even the most thorough cost analysis process cannot guarantee to take account of every conceivable cost that could ever arise.
Identify and understand the full spectrum of your cost base before performing TCO analysis; remember
some costs may be far from obvious.
Consider how technological change could potentially shorten or extend the possible lifespan of the asset.
Use TCO as a means to study how standardized IT costs vary over time; this may help to decide when a product is nearing the end of its commercial life cycle.
Dos and Don’ts
Consult as many potential stakeholders as possible when constructing the TCO matrix—some specialists can help to expose otherwise-hidden cost.
Remember that TCO is most useful when comparing options that deliver similar perceived levels of benefit.
Use TCO in conjunction with other management aids, such as cost/benefit analysis.
Don’t include in the matrix costs that have no relevance to the option under consideration—adding in unnecessary costs only complicates the picture.
Don’t make the mistake of seeing any one single decision-support tool as providing the definitive answer.
Don’t ignore the initial costs associated with TCO analysis, even though TCO has proven its value over the long term in helping companies to choose options involving lower costs across the full life cycle.