What You Need to Know About TCO
Cost/Benefit Newsletter No. 95, 11 August 2006
- “Windows has a proven lower cost of ownership than UNIX…there is no reason to believe that Linux is significantly different than other versions of UNIX when it comes to TCO.”
~Microsoft - “The TCO of Linux is little more than half the TCO of UNIX.”
~Red Hat and IDC - “Linux has a lower TCO in some situations—a lot lower. Yet, in other scenarios, Microsoft is a more cost-effective option.
~Aberdeen Group
Everyone involved needs to understand why the TCO concept is legitimate and important, but also how it is misused and misunderstood. There is no sign the TCO debate will disappear from the scene any time soon. More important, TCO thinking is spreading far beyond the walls of the computer room.
The difference between price and cost
At our case building seminars, we receive TCO questions from participants who are either buying or selling machine tools, for instance. Machine tools, even more than IT systems, have a long life and high requirements for maintenance and labor. Over a long life, the difference between purchase price and the cost of machine tools can be massive, and the only way to understand clearly what future machine tool budgets are in for, is to build a good, long term TCO analysis.
The same is true for spending questions about vehicles, aircraft, laboratory equipment—even dentistry (I’ll explain in a moment). All have long lives and require lots of maintenance and labor. TCO questions arise legitimately when owners discover that the difference between price and cost is large and measurable.
Those who follow the TCO vendor wars, however, know by now that TCO results depend on so many factors that it means little to speak of “the” TCO for any product. TCO results can vary drastically, depending on the cost model for the analysis and the way you use the product. John Dobbs of Novell said it best: “The only valid TCO data are your own data.”
So, what do you do with vendor-produced TCO figures?
Use you own cost model
The importance of the TCO concept lies in the contrast between obvious costs and the so-called “hidden” costs of acquiring, operating, and maintaining something for its usable life. One key to an accurate and trustworthy TCO estimate is to use a good cost model, one that helps identify all the hidden costs that might otherwise be overlooked.
This figure, for instance is an IT system acquisition cost model that works well for many situations. Cells of the matrix identify cost items that are planned and managed together (have common cost drivers); rows represent major resource categories, and columns represent IT system lifecycle stages. (Read more on TCO cost models in the whitepaper “Business Case Essentials” and the Business Case Guide).
TCO models like this one date from the late 1980’s. At that time, Digital Equipment Corporation hired Index Group to find out how much cheaper it was to own and operate DECnet compared to IBM’s SNA networks. No surprise, with a cost model that includes labor costs and change costs (hidden costs!), the typical 5-year expenditure for SNA networks turned out to be two to three times the DECnet “comprehensive cost of ownership” (that’s what we called it in those days).
It wasn’t long before this news moved from the academic-like pages of Computer Economics into Digital’s advertising copy. The cost of ownership marketing wars were on. By 1990, Sun Microsystems had turned the tables against Digital by using the same approach. Later, in the mid 1990’s, Gartner Group and other analysts got on the bandwagon and re-christened the subject as “Total Cost of Ownership.” TCO—like ROI after it—has became a minor industry in its own right.
Can you trust vendor-produced TCO figures to predict costs in your environment?
One reason for different TCO results from different sources is that they all use different cost models. A first requirement for good TCO analysis is to be sure you include all the cost categories, obvious and hidden, that apply in your environment for the ways that you use the product. In other words, be sure the cost model at the heart of the TCO analysis is your model.
TCO alone does not address business objectives
Last month, my business partner got a lesson in TCO from unexpected source: his dentist.
The question was whether to choose amalgam and plastic fillings, or ceramic implants. The amalgams last 7 years, the plastic 12 years, but you can expect to take the ceramics to the grave (and he is quite young). The ceramics come with a much higher price and a longer and more laborious installation process but, the dentist argued, the less pricy fillings would have to be replaced 6 or 7 times in a lifetime. And, each replacement is more expensive then the last because each cycle takes away substance from the teeth and the drill has to go deeper.
In TCO terms, it’s a no-brainer. Take the ceramics with the lower TCO.
My business partner chose the ceramics—but not because of the lower TCO. His main objective is to keep his teeth intact, and he was thinking more in ROI terms. Good return on investment thinking uses TCO, but only to compare it to the value of meeting objectives.
When vendors approach with TCO figures in hand, it’s a good idea to remember that TCO analysis addresses one business objective and only one: cost savings. TCO leaves every other business objective and benefit out of the picture.
On a personal level, do you choose to wear only clothes you can find with the lowest TCO? Do you drive the car with the lowest TCO? Choose the pet for your child that comes with the lowest TCO? (In TCO terms, a goldfish wins over a dog or cat every time). Cost considerations may play a part in those decisions, but very likely other objectives are equally important or more important.
Similarly, in business, TCO without an ROI or other solid business case analysis is missing something important.
Take action by learning more in a business case seminar or read The Business Case Guide.
Marty Schmidt
11 August 2006
mschmidt@solutionmatrix.com
www.solutionmatrix.com
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