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TOTAL COST OF OWNERSHIP

(TCO)
WHAT IS TCO
 All of the possible costs incurred in the life cycle of a
workstation, from acquisition to disposal

 A financial estimate to help consumers and enterprise


managers determine direct and indirect costs of a product
or system

 A business case designed especially to find the lifetime costs


of acquiring, operating, and changing something

 TCO analysis shows there can be a large difference between


the price of something and its long term cost
EVOLUTION OF TCO
 Emerged around late 18th century by French to establish
crucial elements such as investment capital and diminishing
returns

 Around 1920’s – Ancient Egyptians used this concept

 TCO analysis was popularised by Gartner Group around


1987

 Different methodologies and software tools have been


developed to analyze TCO since then
OBJECTIVE
 To support acquisition and planning decisions for a wide
range of assets that bring significant maintenance or
operating costs across a long usable life

 Is used when management is faced with acquisition


decisions about computing systems, vehicles, buildings,
laboratory equipment, medical equipment, factory
machines, and private aircraft etc

 Brings out the "hidden" or non-obvious ownership costs


that might be overlooked in making purchase decisions or
planning budgets
APPLICATION OF TCO
 Budgeting and planning
 Asset life cycle management
 Prioritizing capital acquisition proposals
 Vendor selection
 Lease vs. Buy decisions
 Areas like automobiles , IT , supply chain management, ERP

In each of these situations, the TCO analysis serves a different


purpose and each calls for its own TCO cost model.
TCO ANALYSIS PROCESS
 Step 1
 Begins with the design of a comprehensive cost model that
completely covers the subject of the case, and which
supports the purpose and needs of decision makers
 There should be no unpleasant cost "surprises" appearing
during implementation

 Step 2
 Add the names of resources to each cell
 Resource items that go together in a cell should be those
that are planned and managed together, and which may
have common cost drivers
TCO ANALYSIS PROCESS
Acquisition Operating Change
Costs Costs Costs
Software
Hardware
Personnel
NW &
Comm
Facilities
TCO ANALYSIS PROCESS
 Step 3
Other cells in the same model are similarly populated with
resources
 Step 4
 Different action scenarios were compared fairly
 The model should be designed so that one model covers all
relevant costs in all scenarios
 Some items may have 0 values in one scenario and non zero
values in others

 Step 5
 Estimate cost figures for each item, for each scenario under
consideration, for each year covered by the analysis
TCO ANALYSIS PROCESS
Cost estimates: $ in 1,000s
Proposed System Acquisition Scenario
Yr 1 Yr 2 Yr 3 Total
Server system purchase.... $454 $ 84 $ 70 $608
Business as Usual Scenario
Yr 1 Yr 2 Yr 3 Total
Server system purchase $154 $ 64 $ 64 $282
Incremental cash flow (Proposal less Business as Usual)
Yr 1 Yr 2 Yr 3 Total
Server system purchase $300 $ 20 $ 6 $326
TCO ANALYSIS PROCESS
Step 6
•The cash flow statements take their line items from the model and
retain some of the model's structure
•The cash flow statements have the parent cost model's vertical
axis categories, but in the horizontal dimension, the statements
present a time line covering the TCO analysis period
Step 7
Consideration of scenarios
Proposed System Acquisition
Business as Usual.
The Incremental Scenario - cost differences between
corresponding line items on scenarios (1) and (2).
TCO ANALYSIS PROCESS
$ in 1,000s Acqn C Opng Change Total %
osts Costs in costs of TCO

Software 444 121 220 785 5.5%


Hardware 874 222 122 1,218 8.5%
Personnel 188 5,699 3,925 9,812 68.8%
NW & Comm 255 1,082 892 2,229 15.6%

Facilities 60 46 106 212 1.5%


Total 1,821 7,170 5,264 14,256 —
% of TCO 12.8% 50.3% 36.9% — 100.0%

Proposed System Acquisition


TCO ANALYSIS PROCESS
$ in 1,000s Acqn Opng Change Total % of
Costs Costs in costs TCO

Software 274 82 138 494 2.9%


Hardware 539 97 71 707 4.1%
Personnel 55 8,873 5,952 14,879 86.2%
NW & Comm 146 543 459 1,149 6.7%
Facilities 0 15 15 29 0.2%
Total 1,104 9,610 6,634 17,258 —
% of TCO 5.9% 55.7% 38.4% — 100.00%

Business as Usual Scenario


TCO ANALYSIS PROCESS
 Step 8
 “Bottom lines" of the cash flow statements used to compare
scenarios by using standard financial metrics
 Step 9
 Incremental cash flow statement will show cost savings
 Further analysis extended with investment-oriented metrics
such as return on investment, internal rate of return, and
payback period
 Step 10
 To minimize cost for proposed system
INCREMENTAL CASH FLOW
$ in 1,000s Acquisition Operating Change
Costs Costs Costs
Software 170 38 83
Hardware 335 125 51
Personnel 133 -3174 -2027
NW & Comm 109 539 432
Facilities 60 31 91
CASE STUDY
Mainframe Server vs Open System Solution
• A large manufacturing company migrated its SAP application
suite from an IBM mainframe Server to a cluster of two HP
Integrated Servers running Microsoft Windows Server 2003
(Open System Solution)
• Total investment for the new configuration : $6,136,000
• Time : over 4years
• Costs : initial acquisition costs, annual support for new
equipment and software and one time migration labor
expenses
• During this same 4 year period, the company was able to
reduce operating expenses by $24,834,042
• Yielded an impressive 305% return on investment
CASE STUDY
Investment and savings summary
CASE STUDY
Annual Cost Comparison
 From TCO perspective,
the company was able to
reduce annualized
operating costs by 70.9%
 The Table shows the 4
year comparison of the
total costs for
maintaining the original
mainframe environment
v/s the acquisition,
migration and ongoing
operations costs for the
open systems alternative
CASE STUDY
Annual Cost Comparison

• In addition to annual operating costs, the Mainframe scenario


includes one time costs for the Mainframe hardware upgrade
as well as migration costs for upgrading the SAP application
version

• The Open Systems scenario includes all upfront costs for the
solution as well as on-going operating costs
CASE STUDY
4 year Annual total cost comparisons for the
Mainframe Systems environment
CASE STUDY
4 year Annual total cost comparison for the Mainframe
Systems environment
CASE STUDY
4 Year TCO Comparison
CASE STUDY
ROI Analysis

Total investment of $ 6,136,000 with the cumulative benefit of $18,698,042


yielded an impressive 305% ROI
CASE STUDY
Four Year Payback Analysis
DRAWBACKS
 TCO analysis is not a complete cost benefit analysis

 TCO pays no attention to many kinds of business benefits


that result from projects or initiatives

 When TCO is the primary focus in decision support, it is


assumed that such benefits are more or less the same for all
decision options, and that management choices differ only
in cost
SUMMARY
 TCO can bring out so-called "hidden" costs of ownership

 Every important cost item is included and that everything


irrelevant is excluded

 A uniquely powerful tool for analyzing life cycle costs

 TCO can put the spotlight on potential cost problems before


they become problems

 Creation of an Incremental Cash Flow Statement enables to


find Cost Savings and Avoided Costs
Thank you!