How to Calculate the TCO (Total Cost of Ownership) of Your Company

What is TCO?

TCO, or total cost of ownership, is an accounting tool used to measure the money spent purchasing any asset. The calculation of TCO is not just based on the acquisition price but also considers the cost to be born over the long term.

In essence, TCO measures everything from how much the asset costs, how much it costs to maintain it, and how much it costs to operate the asset.

Most businesses practice using TCO as a crucial metric for making decisions. Calculating TCO before an investment or purchase can help companies be more economical. This is especially important for small businesses as they need to make smart investments.

Initial high expenditure when acquiring an asset is not the biggest issue faced by businesses. Often, a particular asset's costs increase over the long term and, if not properly calculated beforehand, can lead to unplanned expenses.

When Should You Use TCO?

TCO is an important metric when a company acquires an asset or makes a large investment. Examples of when to use TCO are provided below:

• Purchasing new computers, servers, or other technology
• Renting or purchasing new office space
• Licensing a new software
• Purchasing a marketing tool

All assets with a long lifetime tend to generate extra costs over time. Software is a good example of this as it requires license renewals and needs a budget to train employees on how to use it.

Purchasing new office space brings maintenance costs of the infrastructure, other operational expenses, along with the cost of acquisition.

Calculating TCO makes it easier for businesses to estimate all future expenditures of an asset.

How to Calculate TCO

When calculating TCO, you must consider values that aren't obvious. Apart from the price of an asset, there are many factors to consider to calculate how much money must be spent.

There are two methods to calculate TCO. Determining which suits you depends on what you are trying to acquire and the situation. You can also add more values when calculating TCO when required.

The simpler calculation considers the following factors:

•  Initial cost (I): This is the cost of acquisition, the amount you have to pay to purchase the asset
• Maintenance cost (M): This is the cost that will be incurred to keep the asset operable
• emaining costs (R): This is the asset's price in the long term. This helps in making a calculation that includes the possible devaluation of the asset.

The calculation is:

(I + M) – R = TCO

The more complex calculation of TCO includes a few more factors to get a more accurate picture of long-term costs. The factors include:

• Initial Price (I)
• Cost of Operation (O)
• Cost of maintenance (M)
• Downtime cost (D)
• Cost of Production (P)
• Remaining value (R)

(I + O + M + D + P) – R = TCO

The two additional factors in this calculation include downtime, which is the expense born by the company when the asset is not in use, such as when it is undergoing repairs or maintenance, and production cost, which is the cost incurred while using the asset such as electricity expenses.

What Departments of an Organization Can Use TCO?

Various departments across an organization can use TCO before deciding to purchase. Below are a few examples:

Marketing

Marketing departments require automation, analytics, and other tools, which are the typical forms of expenses incurred by this department. Therefore, they need to consider the following factors before making purchasing decisions:

• Licensing costs
• Monthly fees
• Training costs
• The cost of new software if the existing one becomes obsolete

Accounting

The accounting department is proactive in purchasing decision-making, along with other departments.

They can analyze all additional costs that an asset purchase may bring, such as taxes. They consider both the present and future costs of the asset.

Management

Management makes purchasing decisions on equipment and infrastructure.

They are usually tasked with purchasing computers, office supplies, and other tools. They can play a part in purchasing office space.

Thus, TCO is a crucial tool for management before making any purchasing decision.

What are the Pros and Cons of TCO?

Apart from the benefits of using TCO, there are also a few challenges. Below are a few pros and cons of using TCO calculations:

Benefits

• Provides a comprehensive analysis of all potential costs of purchasing an asset over its lifetime.
• Provides a framework to calculate ROI
• Determines whether an asset is the best value for money when compared to alternatives
• Improves strategic cost management by reducing avoidable costs
• Improves decision-making and efficiency
• Allows the analysis of both a single unit of business and the big picture
• Challenges
• Operating cost is hard to determine over the long term
• Some costs can be almost impossible to predict
• It isn't easy to calculate all the benefits involved
• It is time-consuming to calculate
• It isn't easy to value intangibles
• Does not consider the risks associated with alternatives
• Limited practical applications

What to Consider When Calculating TCO?

Below are a few things you should consider when calculating TCO:

• Identify hidden costs: Related costs apart from the purchase price, including annual fees, management fees, insurance, training fee, etc.
• Labor costs:  If the asset you are purchasing leads to increased or decreased labor costs, it will affect the TCO. For example, a piece of equipment may seem expensive, but after calculating the cost of operation, you may discover that you need fewer employees to run it. Therefore, you would save money in the long run.
• Financing:  The TCO of an asset will be affected by how it is purchased. If the asset is purchased via financing, it will lead to a higher cost incurred when compared to paying by cash.
• The TCO can change: Most equipment will incur higher annual repair costs as they age, which should be factored in when calculating TCO.

Conclusion

Before making any significant purchase or investment, businesses must calculate TCO. This is especially true for businesses looking to make every penny count, such as startups. TCO allows firms to make an informed decision as it considers an asset's total cost and all future expenses.

Calculating TCO is quite difficult, though, as it is near impossible to predict every cost related to the asset that may come up. However, the benefit of having an estimate can help businesses manage expenses and expectations.