Life Cycle Costing: Total Cost of Ownership
Total Cost of Ownership (TCO), an analysis that is meant to reveal various lifetime costs that are a result of the ownership of certain types of assets, is also referred to as life cycle cost analysis. Along with purchase costs, TCO also incorporates substantial costs for deploying, operating, upgrading, as well as maintaining the assets.
TCO Analysis—Areas of Application
In the case of certain acquisitions, TCO analysis discovers a big difference between the total lifecycle costs and purchase prices; this is especially true when the costs are viewed across long ownership periods. In the current scenario, Total Cost of Ownership (TCO) is being increasingly used for supporting acquisitions and planning decisions related to a wide spectrum of assets that bring with them significant operating/maintenance costs, across the asset’s ownership life.
In other words, TCO analysis takes center stage when a company’s management is confronted with acquisition decisions linked to computing systems, laboratory equipment, vehicles, buildings, factory machines, and medical equipment. It remains a central concern in the under mentioned situations:
Asset life cycle management.
Budgeting and planning.
Prioritizing of capital acquisition proposals.
Making lease versus buy decisions.
Vendor selection, and so forth.
Life-cycle cost analysis (LCCA) and TCO
Life-cycle cost analysis (LCCA) is typically a tool that determines the most cost-effective alternative from amongst various competing alternatives with respect to owning, operating, purchasing, maintaining and disposing of objects/ processes. Here, all costs are discounted and totaled to get a present day value referred to as net present value (NPV).
An integral part of Life-cycle cost analysis (LCCA), Total cost of ownership (TCO) is but a financial estimate that aids buyers/ owners determine the direct/ indirect costs of a system or product. A valuable management accounting concept, it is commonly used in context with full cost accounting and/ or ecological economics that include social costs.
As TCO is compared with conducting business overseas, in the case of manufacturing, it extends further than initial manufacturing cycle durations and costs to make parts. In fact, TCO encompasses several costs of doing business, for instance, opportunity costs as well as ship and re-ship costs. It also considers incentives like common language, tax credits, customer-oriented visits by suppliers, expedited delivery and other variables.
Use of Concept
TCO provides a cost-centric basis for the determination of the economic value of any investment. In case of financial benefit analysis, it considers the figures of internal rate of return, return on investment, economic value added, rapid economic justification, return on IT, and so forth.
Typically, TCO analysis takes into account operating costs and the total costs of acquisition. It is useful for gauging the viability of capital investments. Also used as an effective process/product comparison tool by enterprises, it makes it easy for financing agencies and credit markets to take strategic decisions. As TCO relates to an organization’s total costs of assets and/or allied systems, across all projects/processes, over time, it provides an accurate picture of its profitability metrics.
What does TCO tell Managers?
In general, TCO analysis brings out the "hidden" costs of asset ownership and includes all the costs related to system acquisition, along with the labor costs of those using/ supporting these systems. Instead of getting distracted by hardware/software costs, it includes "people" costs (expenditure related to how they are trained, employed, retained and managed) to determine the actual costs of ownership, thereby giving more accurate results. Additionally, TCO puts the spotlight on those cost problems that have the potential of becoming burdensome, and in good time.
But then, TCO analysis cannot be termed as a complete means of cost benefit analysis, and is blind to the business benefits resulting from projects, acquisitions, or initiatives like faster information access; increased sales revenues; or improved operational capability, competitiveness, and product quality. So, a simple naming of the cost of ownership of an asset/process fails to set the boundaries for accurate analysis—it becomes important to assess and communicate the costs that belong to TCO analysis.
If you are also looking at tried and tested ways of Life Cycle Costing, then you will not be disappointed by leveraging the many advantages of TOC—go for it.
Author : Uma Daga