What is Total Cost of Ownership? Description
The Total Cost of Ownership (TCO) method is a technique which can be used
to make sure that all associated costs over a given time period are considered
when you are acquiring an asset. Some examples of assets are: a building,
software or a truck. TCO can be described as all costs of owning and operating
an asset over time. TCO does not only reflect the costs of purchase. It also
includes all other aspects in the further use and maintenance of the asset.
Origin of Total Cost of Ownership. History
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. Formula
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. Applications
Any purchase of a significant asset, that needs a comprehensive analysis
of long-term effects and hidden costs.
Strengths of Total Cost of Ownership. Benefits
- 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. Disadvantages
- 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.
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Total cost of ownership as a tool for inter-firm cost management
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Compare with Total Cost of Ownership:
Cost-Benefit Analysis
| Activity Based Costing |
Net Present Value |
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Free Cash Flow |
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