The total cost of ownership, or TCO, of a given product is the sum total of all the costs associated with owning it. This includes not only the initial cost of the product, but also everything you’re going to spend on maintenance, upkeep, repairs, and other necessities.
Why is this metric so important to understand and how can you estimate it more reliably?
The Basics of Total Cost of Ownership (TCO)
If you want to figure out the true, long-term cost of owning a given asset, you’ll need to factor in all of the following, at minimum:
· Purchase price. The purchase price is the most obvious, and usually the biggest component of TCO. However, it’s only the beginning.
· Costs incurred. You’ll also need to factor in the costs incurred when purchasing this product. This includes things like transportation, packaging, customs, and payment terms.
· Cost of acquisition. Procurement costs enter the equation here.
· Cost of ownership. You’ll have to factor in things like stock management and depreciation cost as well, contributing to the overall cost of ownership.
· Maintenance and repairs. TCO also includes calculations for maintenance and repairs. Over the lifetime of this product, you’ll likely need to service it regularly, replace parts, and make repairs when necessary.
· Usage costs. Operations and services need to be factored into your equation as well.
· Quality issue costs. If your product dies prematurely, or if it fails to meet certain compliance standards, it can introduce even more costs to your business.
· Disposal costs. You should also factor in costs associated with disposal, such as reselling, recycling, or securely destroying.
You’ll also need to consider hidden variables and secondary costs that may not be on this list.
Factoring in all these variables, the apparent cost of a specific product can suddenly look much different. For example, let’s say you’re interested in buying an electrical transformer for your business. Higher-quality electrical transformers are typically associated with a higher sticker price than their lower-quality counterparts.
Calculating TCO More Reliably
You can estimate TCO more reliably with the following:
· Historical data. Your best tool for evaluating TCO is historical data. Have you bought this type of asset in the past? If so, what expenses and costs were associated with it?
· Detailed estimates. You can also get closer to an accurate TCO estimate by thoroughly detailing estimates in every category. For example, how much electricity is this device going to use? How often will it need to be repaired?
· Conservative planning. It’s almost impossible to calculate TCO for a given product with perfect accuracy. But with conservative planning, you can make much more dependable estimates. Essentially, this means factoring in the unknown.
Still, there’s no way to get a perfect estimate with perfect reliability.
How to Reduce TCO
If you reduce TCO, you can increase the profitability of your investments. Here’s how to do it:
· Invest in quality. Generally, it pays to invest in quality. Some products are going to be more expensive than others, but this is often justified by the use of higher quality materials or higher quality control standards. The sticker price for Product A might be higher than Product B, but its TCO might be much lower.
· Find reliable partners. Work with reliable vendors who stand by their products. Purchasing products from dependable manufacturers and attaining better warranties can dramatically reduce your TCOs.
· Cut waste when possible. Keep an eye out for waste in all areas of acquiring and maintaining these assets. Can you cut down on transportation costs by working with local partners? Can you reduce stock management costs by keeping a more appropriate inventory?
· Practice smart management. Better, more efficient management practices can cut down on costs in multiple areas simultaneously. For example, tighter inventory controls can save you both time and money. Practicing preventative maintenance reduces the possibilities of exorbitantly expensive repairs while improving reliability and consistency of performance.
· Assess ROI and replan. Every purchase you make for your business is going to be associated with a return on investment (ROI). If the ROI is positive, the investment makes sense. If the ROI is negative, something needs to change. The higher your ROI is, the better. If you find that the ROI of one of your assets is underperforming compared to your expectations, try to figure out why. And if some of your assets are greatly succeeding, can you draw lessons that you can then apply to other asset purchases in the future?
TCO isn’t always easy to calculate or estimate, but if you have a better understanding of this metric, you’ll be able to make better purchasing and investment decisions for your business.
The more experience you have in this area, the more accurate your calculations will become.
