Total Cost Of Ownership

Total Cost Of Ownership

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Total Costs of Ownership: a case study


The purpose of this research paper is to provide a description of the phenomenon Total Cost of Ownership. This is done on the basis of a case study which is about supply manager Joe Smith who has to buy 1000 computers for his organization. Organizations tend to scrap on the purchase price of a product; where it is much more effectively and efficient to bargain on the other Costs of Ownership. Although in business life people tend to think that buying is always more expensive than leasing, the opposite is true. Leasing 1000 computers over a life span of 3 years is more profitable than buying them.

Total Cost of Ownership a case study

Introduction to the phenomenon
It was the year 1987 when the Gartner Group popularized the form of full cost accounting named Total Cost of Ownership (TCO)(author, Gartner Total Cost of Ownership). Originally TCO was mainly used in the IT business sector. This changed in the 1980’s when it became clear to many organizations that there is a distinct difference between purchase price and full costs of a products ownership. This brings us towards the main strength of conducting a TCO analysis, besides taking the purchase costs into account, which consist of the amount a money an organization pays for the required service, product or capital outlay. It also considers 1. Acquisition costs; these can consist of sourcing, administration, freight, and taxes. 2. Usage costs, which consists of the costs associated with converting the given product or service into a finished product. And finally 3. End of life cycle costs; the costs or profits incurred when disposing of a product. TCO can be seen as a form of full cost accounting; it systematically collects and presents all the data for each proposed alternative.
In the case of making a TCO model, also opportunity costs and present value are taken into account. Taking present value into account means; making a difference between future and past cash outlays. This way the time value of money can be considered when comparing the different alternatives. Opportunity costs finally can be described as:
“The value of the next best alternative foregone as the result of making a decision”(Brue, 2005)

Having explained the phenomenon TCO briefly, we can take a look at the case study presented to us.
The case study-Buying 1000 Personal Computers
“Supply manager Joe Smith was considering the purchase of 1,000 desktop Personal Computers (PC’s) for his organization.

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The life cycle was 3 years and the organization’s cost of capital was 12%. He calculated the TCO for one of the purchase options as follows:”
Table 1
[pic]
The questions raised by the case are the following:
“1. Determine the total cost of this contract over 3 years
“2. How would you approach this supplier about reducing the total cost of ownership for computers over the life of this contract?” (Author)

The Case study- The answers to the questions
The outcome of the 1 question can be found on in the appendix of this case study. For the second question there is not one set outcome, it is open for discussion.
In general one would argue that Joe Smith should start by negotiating about the purchase price. This is not strange, on first hand it seems to be a severe expense; namely $1.200.000. Merely the opposite is true, it only consists for about 12 %( 1,2mln dollars) of the TCO for the 1000 Personal Computers (PC’s). And do you want to negotiate about this 12%? No because the margin retailers earn on PC’s is very small, so reducing the purchase price with a considerable amount can be described as a mission impossible. An organization would probably not want to bargain about the retail price, but instead about the other costs of ownership. The diagram below explains this.
Diagram 1- Total Cost
[pic]
(unknown)
The results the diagram show use are unsettling, it shows that the purchase price of a product, service or capital acquirement is only a small portion of the total costs paid for a product over its life span. This shows us that when an organization wants to reduce the total costs of a purchase, the organization can better do this by negotiating about the acquisition, usage and end of life cycle costs.

Saving costs- The real costs saving possibilities
No we know where the costs can be saved, we will start with the last category; the end of life cycle costs. Receiving 36 dollars for a pc that cost you $1.200 three years ago may sound as a little amount of money for such an expensive product. And it is indeed a small amount of money, but considering that the $36.000 dollars is only about 0.4 percent of the TCO. It seems all the more irrelevant to do negotiate about the end of life cycle costs, also taken into account the lack of good alternatives for the disposement of the PC’s.
Now we have talked about the parts of TCO where you should not try to evaporate on, the fun stuff starts. As can be seen in the calculations in the appendix, the cost elements that require the biggest cash outlay are the equipment and network support cash outlays. Taking into account the high costs of the equipment support, one can assume that full equipment support is meant(author, Cardiff). This means that over the 3 year life cycle of the computers the supplier guarantees that will run any required software (Cardiff University). Know how do I save money on these huge cash outlays? (Respectively about 36 and 30, 6% of the total cost outlay). The key to saving money on these cash outlays is good negotiations. Negotiations in the sense that you maximize you’re buying power and decrease your TCO considerably. As an organization you should put on paper what you need and what you expect from the deal. And then you can go in the negotiations and discuss the conditions, the life span, level of support needed etc.
Some other suggestions for cost savings on TCO are the following:
Other measures to save costs are the following:
Acquistion costs:
← Buy a volume software license
← Buy pre-installed software

Usage costs:
← Environmentally conscious pc usage policies.
← Order a service contract for an additional fee in order to reduce equipment support costs.
← Internet/ computer usage policies and stricter control by management
.
Review and chosen course of action
A review of all the different available options on saving cost on TCO showed that there is considerable evidence that leasing a 1000 computers over a life span of 3 years is considerably less expensive than buying them (RFGonline). In the study is noted that there is a general myth on computer leasing, namely that it is always more expensive than buying. Therefore leasing may not be the option used most by different IT companies. From the study can be denoted that this is due to a to less innovating business approach of many companies. They tend to stick towards their old habits.
Other examples which show the feasibility of computer licensing are the following:
• Costs are more predictable
• Money is evenly spent over the 3 years
• More flexibility
• End of life cycle disposability options, including security disposability’s
• Off balance asset treatment.
Of course one may wonder whether leasing is more dangerous than buying. The proximities that your sensitive data will be “lost on the street” tend to be higher. But as can be seen in the listening above, there are several security disposability options, the one more rigorous than the other. Other negative sides related to leasing computers are

. Learning Experience from making the case
The first aspect of the phenomenon TCO that caught my attention was that the majority of the costs of a product are not the purchase costs, but all the other costs associated with a product. That these costs can be so exacerbating high, like almost 90% as shown in the case study. When I did some research about TCO, I came to the conclusion that I was not the only one. There are several companies out there who believe that the costs associated with making a TCO are too high and will not be earned back. Which seems strange to me, because a company will make its decisions not based on rational but on their business instincts. Of course I can understand that there are some negative aspects related to TCO, like no valuation of intangible assets, it takes the costs over the long term into account, it is hard to align TCO with a company’s strategic goals and it can be difficult to determine the exact costs of an asset (12 Manage the executive fast track). It is still hard to not see the benefits of a TCO model in my opinion. Also I improved my finance competencies, by understanding terms as FTE and PO.
Learning Experience from the presentation
By giving a presentation in a subject you are not yet familiar with, it is not unexpected that you make some mistakes. The same happened with our presentation, I and my colleague made some mistakes by both misinterpreting the given data in the case and by coming up with some naïve recommendations. Naïve in the sense that we focused too much on relative low expenses as the purchase price and salvage value of the computers. Although to some extent we tried to avoid bargaining on these expenses by choosing to lease the computers instead of buying them. It is definitely something that will help me both in my personal and professional environment. In my personal environment, by knowing that it can be very effective to negotiate about additional gadgets, warranty, support etc. when buying a high-end product. Even when buying for example an APPLE I phone, it can be very efficient to negotiate about additional gadgets, warranty and applications (Wired blog network). And in my professional knowing TCO can help me to negotiate more effective about sourcing, equipment support and network support.
Team Dynamics
Although our cooperation went well overall, I cannot under press the feeling that I have done the majority of the work. We met several times in the time period leading up to the presentation; although we were both present I did the majority of the work. It was I who did the calculations, came up with most of the possible courses of action to save costs, made the PowerPoint presentation and did a lot of work alone.
Works Cited List:12 Manage the executive fast track. (No year of publication known). Retrieved 02 20, 2009, from http://www.12manage.com/methods_tco.html
author, N. k. (n.d.). Cardiff. Retrieved 02 24, 2009, from http://www.cardiff.ac.uk/insrv/it/hardware/index.html
author, N. k. (n.d.). Gartner Total Cost of Ownership. Retrieved 02 24, 2009, from Gartner: http://amt.gartner.com/TCO/MoreAboutTCO.htm
Author, N. K. (n.d.). Webcat. Retrieved 02 20, 2009, from https://ncvista.blackboard.com/webct/urw/lc67299111011.tp0/cobaltMainFrame.dowebct
Brue, S. L. (2005). Microeconomics: Principles, Problems, and Policies. McGraw-Hill Professional. pp. 27. ISBN 0072875615. .
Cardiff University. (Date unknown). Retrieved 02 20, 2009, from http://www.cardiff.ac.uk/insrv/it/hardware/index.html
RFGonline. (2007, 5). Retrieved 02 20, 2009, from http://www.rfgonline.com/events/rfg_pctco_051007_0.pdf
unknown, A. (2009, 02 -). www.wcu.edu. Retrieved 02 18, 2009, from https://ncvista.blackboard.com: https://ncvista.blackboard.com/webct/urw/lc67299111011.tp0/cobaltMainFrame.dowebct
Wired blog network. (2007, 06 27). Retrieved 02 20, 2009, from http://blog.wired.com/gadgets/2007/06/iphone-total-co.html

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