What is Total Cost of Ownership (TCO)?

Definition: The total cost of ownership is the sum of all costs involved in the purchase, operation and maintenance of a given asset during its lifetime. It is a financial analysis that shows all present and future costs of taking possession of the asset.

What Does Total Cost of Ownership Mean?

A Total Cost of Ownership (TCO) analysis shows a clear picture of what is the real cost of purchasing a given asset. It includes all costs involved in the purchase of the property but it also adds maintenance, upgrade and operational costs that occur during its lifetime. This tool is particularly useful to evaluate different options when a company wishes to make a certain investment. It helps the company to make an informed decision about whether to buy, lease or look for other options.

Present value is often included in these analyses, since some expenses are paid a few years after the purchase is made and the only way to compare between different options is to discount all future values to present time. TCOs are frequently employed before the purchase of computer systems. Given that there are some “hidden” costs that arise after a few years have passed or are not explicitly budgeted when the purchase is made, companies employ TCO analyses to understand what would be the actual cost of implementing one of these technologies.

Example

Company A is currently looking to invest in a Human Resources software that helps businesses to develop better relationships with its workers by using different tools to analyze their performance, habits and life style. The company that developed the software provided the budget and the operational details of the software to the Financial Manager and he needs to analyze everything to calculate the Total Cost of Ownership for the project. He identified that the cost of purchasing the software is $35,000 which includes installation and 24/7 technical support for five years. A license must be renewed each year and it cost $300 to do so.

Updates are free the first year, but after that the company has to pay $50 a month to get monthly updates on the software database and interface. Finally, training the employees involved cost $350 per employee, and the company has to train at least 5. The project was given a useful lifetime of 5 years. After performing the calculations, he figured that the TCO for the project would be $40,350.