Written by Bjarne Keytsman
The Total Cost of Ownership (TCO) refers to the lifetime cost of buying, owning & operating an asset. As such it goes beyond purchasing price and places a single value on the complete life cycle of a capital purchase.
From Napoleon to sustainability
TCO analysis isn’t a new concept, according to some experts it dates to the Napoleonic era. When army ordnance engineers would start to assess the efficiency of their cannons not only by the manufacturing price, but also service life, repairs-required, reloading times among other factors[1].
Further development of TCO analysis primarily happened during the final quarter of the 20th century, again in military circles. The US Department of Defense formalised a TCO approach[2] to assess the total costs associated with a defense program. At the same time, research company Gartner developed a TCO model to determine the cost of owning and deploying personal computers[3].
This marked the start of the adoption of TCO analysis within businesses, especially in the industrial sector to calculate manufacturing costs and afterwards their margins and sales price. But also, to calculate the cost of sustainability initiatives, as these often have a higher upfront cost while benefits can be reaped later.
Lately there has been more emphasis on the inclusion of sustainability metrics and go one step further towards lifecycle costing[4][5]. This way not only the financial impact would be measured but also to certain extent the social and environmental impact!
Common applications and benefits of using a TCO approach
TCO can be used in a wide range of industries: from oil, semi-conductor manufacturing and telecommunications to medical systems, automotive and aviation. Within these industries TCO gets employed for the following main reasons[6]:
· Supplier selection decisions
· Measure ongoing supplier performance
· Drive major process changes
Regarding sustainability, it can be used to identify and compare upfront costs with long term benefits, examples include insulation initiatives, investments in renewable energy or electrifying a vehicle fleet. These initiatives often require larger investments than non-sustainable alternatives, but these can be recuperated later as they could require less energy, less maintenance, or a more favourable regulatory landscape.
While the most common usage is for an internal assessment a TCO model can also be used in persuading potential customers. A high degree of transparency and honesty builds trust between a company and its customers[7]. This way a TCO model can be the key to both internal efficiency and business development.
We have already summed up some, but in total five key benefits can be observed:
· Performance management
· Decision making
· Communication
· Insight generation
· Continuous improvement support
How to perform a TCO analysis
The simplest form of a TCO analysis is adding the costs of purchase, ownership, and disposal, or in case of resale, remove the resale price. However, this can quickly become very complicated, or some costs might not even be there (e.g., when renting an asset). This requires a more diligent and iterative methodology, that can be used in a broader spectrum of applications.
We have identified six key steps in the creation of a TCO.
Once the TCO has been calculated, we can go one step further and allocate sustainability metrics (e.g., resource usage, carbon footprint) to the different cost categories that have been defined. This way decision making is not only guided by financial, but also by its sustainable impact. Next phase could be to use these insights to improve your business.
Want to discuss or know how TCO can be an added value to your company? Get in touch!
Want to know more about pricing, check out our dedicated pricing page!
[1] Thibault, G. E. (Ed.). (1984). The Art and Practice of Military Strategy. National Defense University. [2] Boudreau, M. W., & Naegle, B. R. (2005). Total ownership cost considerations in key performance parameters and beyond. Defense Acquisition Review Journal February-March, 108-121. [3] Moyle, K. (2008). Total cost of ownership and total value of ownership. In International handbook of information technology in primary and secondary education (pp. 615-631). Springer, Boston, MA. [4] UN Environment. ISO 20400 [5] Gundes, S. (2016). The use of life cycle techniques in the assessment of sustainability. Procedia-Social and Behavioral Sciences, 216, 916-922. [6] Ellram, L. M. (1995). Total cost of ownership: an analysis approach for purchasing. International Journal of Physical Distribution & Logistics Management. [7] Weinhouse, M. (2018). Why you should be radically transparent with your customers. Forbes.