total-cost-of-ownership

What is the total cost of ownership (TCO)?

The total cost of ownership (TCO) estimates the total cost associated with purchasing and operating an asset. TCO is a more comprehensive way to understand the real cost of ownership. Thus, how much it really costs in the long-term to own something, with all its related direct and indirect purchase costs.

Understanding the total cost of ownership

The total cost of ownership places a single value on the life-cycle of a capital purchase.

This value is derived from every aspect of owning an asset, including costs relating to acquisitions, operations, training, documentation, and so forth. The calculation considers the direct and indirect (hidden) costs of purchase.

TCO is an important consideration in any scenario necessitating a large capital purchase. A business wishing to overhaul its IT system needs to consider the cost of new software, installation, security, downtime, and employee training. The purchase of a new business vehicle needs to consider the ongoing cost of fuel, maintenance, insurance, and depreciation.

Ultimately, TCO is used in business to gauge the viability of capital investment over time. It is often incorporated into a cost-benefit analysis.

Calculating the total cost of ownership

The particular parameters of a TCO calculation will vary from industry to industry. Nevertheless, a standardized calculation allows decision-makers to compare the viability of otherwise unrelated assets.

Incurred costs are usually calculated from eight key areas:

  1. Purchase price – how much did the investment cost to acquire before taxes?
  2. Associated costs – such as customs, duties, packaging, transport, or other payment terms.
  3. Acquisition cost – or the cost of actions undertaken by the purchasing department. For example, acquiring new software may incur licensing, installation, or subscription fees.
  4. Cost of ownership – including stock management and depreciation.
  5. Maintenance costs – such as cleaning, training, inspecting, reporting, troubleshooting, or servicing.
  6. Usage costs – otherwise known as operating costs, these usually relate to employee wages or other overheads such as rent, electricity, and water.
  7. Non-quality costs – what are the costs associated with meeting deadlines or initiating a non-compliance process?
  8. Disposal cost – or costs associated with the asset once it reaches the end of its usable life. This includes disposal, resale, or recycling cost.

Important TCO considerations

Determining the total cost of ownership is a nuanced process. Here are some important considerations for all businesses regardless of industry:

  • Spend some time considering the hidden costs of an asset purchase. The better a business becomes at identifying hidden costs, the more accurately it will be able to calculate TCO.
  • The method of financing used to fund the purchase will have an impact on TCO. Decision-makers must liaise with finance and accounting to understand how factors such as deductions, expenses, and depreciation impact the final calculation.
  • Total cost of ownership is fluid. For example, the costs associated with maintaining a piece of equipment increase over time as the equipment ages. Inflation also increases the cost of long-term maintenance.
  • Do not forget labor costs, which may decrease or increase as the result of new investment.

Key takeaways:

  • The total cost of ownership is the purchase price of an asset plus the costs of operation.
  • Depending on the industry, the total cost of ownership can be calculated by considering costs grouped into eight categories: purchase price, associated costs, acquisition cost, cost of ownership, maintenance costs, usage costs, non-quality costs, and disposal cost.
  • When calculating the total cost of ownership, decision-makers must identify hidden costs. They must also understand that the TOC of an asset fluctuates because of age, financing method, inflation, and labor demand.

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which reached over a million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get The FourWeekMBA Flagship Book "100+ Business Models"