Saturday, August 07, 2010

Comparing and Selecting Solutions Using TCO Analysis

"TCO is defined as the total cost of procuring, using, managing and disposing of an asset over its useful life.” – Bill Kirwin - the Father of TCO, Gartner

Total Cost of Ownership (TCO) refers to a useful accounting system to tally all of the costs associated with a given asset over its entire useful life. Costs are tallied for planning, acquisition, setup & installation, manage & support, evolution and retirement.

For buyers, TCO helps to make better decisions going beyond the original purchase costs, to include total lifecycle costs such as service contracts, management and support, power and cooling, facilities space costs, evolution, and retirement costs. For sellers, TCO provides an account of all costs for various solutions, helping vendors compare and contrast their solutions with others, proving which solutions are not only less expensive up-front, but less expensive in total cost over time.

TCO was born in the late 1980s by Bill Kirwin of Gartner, used to initially compare the costs of mainframe / minicomputers with PCs and networks. In these studies of early IT investments, the purchase price of the hardware and software was found to be only 15% of the total cost of owning the asset. Management, direct support and hidden user support accounted for 85% of the total cost over the useful life of the asset. At the time, a PC that cost $2,000 to $3,000 might actually cost the organization over $8,000 per year or more to keep in service.



1994 comparison of TCO for PCs showing the top level “chart of account” line items

TCO is most useful when comparing different solution options, to determine which provides the lowest cost of ownership.

To do this, TCO first creates/uses an accounting system to tally all costs for the solutions being compared, when done correctly assuring that no costs are overlooked. The accounting system is called the “Chart of Accounts”.

Second, for all the solutions being compared, the costs are tallied for each cost category. Placing these costs in the chart of accounts and comparing them head to head illustrates where some solutions are more expensive than others. Totaling the costs for each solution and comparing the totals indicates the lowest total cost solution.

When comparing solutions, TCO only shows a portion of the decision making criteria. TCO is focused on costs, but places little on comparing the different business value of the asset. For example, to lower the TCO of productivity tools for users, desktop computers could be replaced with pen and pad, which has a TCO of $1.50, compared to an estimated $3,000 per year for the typical Windows computer system. As Lenny Liebmann of ComputerWorld indicates, “Lower TCO doesn't mean higher ROI: This is a classic error. The assumption is that if you whittle down the cost of a resource, it will provide a higher return on investment. Not! If I buy a cheap used car and lose my job because I can't get to work reliably, did I really save money? Sure, IT must control costs, but not through some arbitrary goal that isn't linked to real business drivers.”

Rightly so, by focusing on costs alone, the dramatic benefit differences of and between proposed solutions could be overlooked. It is therefore important to compare not just the TCO of different solutions, but the ROI differences as well (where ROI takes into account total cost of ownership versus benefits for each proposed solution).

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