Total Cost of Ownership, or TCO, is a business term used to compare the upfront asset cost with its long-term value. The metric can help buyers, sellers, and businesses to determine how much it costs to purchase and operate an asset and, therefore, make more informed purchase decisions. Below, we are going to discuss how to determine and analyze TCO, as well as how to apply the metric in different situations.
Highlights/ Key Takeaways
- Companies and individuals can use the Total Cost of Ownership metric to determine the long-term value of a purchase.
- Total Cost of Ownership includes the initial purchase price of an item plus the amount you will have to spend over the lifetime of that item, - for example, on maintenance, repairs, and insurance.
- The TCO value can fluctuate over time. It can often be lowered by either reducing the upfront purchase price or finding ways to minimize ongoing expenses.
- Determining the TCO value can require significant research, depending on the asset in question. Industry benchmarks and consumer resources are great starting points to consider.
What Is Total Cost of Ownership?
Total Cost of Ownership is a business metric that describes how much an asset will cost over a specific period of time. It is equal to the purchase cost of an asset plus additional costs associated with its operation in the long term, until its ultimate disposal.
Evaluating Total Cost of Ownership is an excellent way of estimating the long-term value of a purchase to a company, taking into account all the costs and expenses that could be incurred during the product’s useful life.
“Total Cost of Ownership … is equal to the purchase cost of an asset plus additional costs associated with its operation in the long term, until its ultimate disposal.”
How to Calculate Total Cost of Ownership
To calculate the TCO value, you will need to determine or estimate the following components:
- The upfront purchase price of the asset.
- Expenses necessary to keep the asset operational, - like taxes, maintenance, repairs, and insurance.
- The asset’s operation life or how long you are planning to own or use the asset.
While the upfront purchase price of the asset is relatively straightforward to determine, you may need to conduct in-depth research to estimate the value of the ongoing operating costs. The research may take time, - luckily, industry benchmarks or dedicated consumer resources can provide lots of valuable information.
You may also not know for how long exactly you will keep a particular asset. You may keep the asset until it reaches its end-of-life, - or you may decide to sell it at some point in the future. Total Cost of Operation can be calculated for any period of time, but it is better to keep the asset’s operation life estimate realistic.
Total Cost of Ownership Formula
Once your estimation is ready, Total Cost of Ownership can be calculated as:
TCO = Purchase Price + Ongoing Expenses ( - Remaining Value)
Ongoing Expenses here represent the expected costs over a time period of your choice, - for example, five or ten years.
Sometimes, the remaining value of the asset is subtracted from the sum of the purchase price and ongoing expenses. In the Total Cost of Ownership formula, Remaining Value describes how much you can sell or salvage the asset for at the end of the time period of your choice.
Using the Total Cost of Ownership Metric
Conducting a TCO analysis can help your company make an informed decision before investing in a particular asset. Similarly, an individual may want to calculate the TCO value to compare his or her options before making a large purchase.
Total Cost of Ownership as an Industry Metric
Businesses often calculate Total Cost of Ownership to compare different capital project investment options or potential asset purchases. The calculation helps to determine how a particular purchase will impact business expenses in the long term, taking into consideration both direct and indirect costs associated with a specific solution.
As such, indirect costs can include the costs of installing a piece of equipment and training employees to use it, as well as setting up insurance or warranty for it. The long-term costs should also account for the maintenance and repairs of an asset, increased utility expenses associated with its use, and the purchase of necessary software updates over its lifetime.
Total Cost of Ownership Example
Company ABC is looking to purchase an industrial pump.
Pump A costs $10,000 upfront, with $5,000 in maintenance costs over 5 years. At the end of 5 years, the pump can be salvaged for $2,000.
The purchase price of Pump B is $20,000. While it costs more upfront, Pump B will cost only $2,000 to maintain over 5 years. It can also be resold for $10,000 at that time.
The Total Cost of Ownership in procurement can then be calculated as:
TCO of Pump A = $10,000 + $5,000 - $2,000 = $13,000
TCO of Pump B = $20,000 + $2,000 - $10,000 = $12,000
While Pump B costs twice as much as Pump A upfront, it costs less to maintain and can be resold for a much higher price than Pump B. The resulting Total Cost of Ownership of Pump B ends up being lower than the TCO value of Pump A by $1,000, meaning it would cost a little less in the long run.
Total Cost of Ownership as a Consumer Metric
Just like companies, consumers may use TCO analysis to compare different options before making a large purchase. For example, when looking for a car to buy, one must consider its monthly costs along with unexpected repair expenses in the long run, in addition to the upfront price tag.
Total Cost of Ownership Example
Suppose you are looking to buy a new car. To estimate Total Cost of Ownership of the car, you must consider the following expenses:
- Upfront purchase cost. This could be the total cost of the car. However, more often, the upfront cost would include just the downpayment - however much you choose to put down.
- Financing payments. In 2022, the average cost of monthly payments on a new car was $716. This number may differ depending on the car purchase price and the size of the down payment, as well as the loan term and interest rate.
- Gas. The gas expenses can vary by size and type of the vehicle, as well as the number of miles driven. For example, if you drive 15,000 miles per year, you can expect to spend around $2,700 in annual fuel costs.
- Maintenance and repairs. Common car maintenance costs include tire rotations and oil changes. You can expect to spend around $121 in monthly maintenance on a new car.
- Registration. In addition, an average car owner will need to pay around $675 for logistic expenses such as registration, licensing, and taxes.
- Insurance. You must purchase auto insurance coverage to drive the car legally. This will cost around $1,588 per year on average.
- Depreciation. Cars lose value over time, which will affect your Total Cost of Ownership. In a normal market, cars lose 15% to 20% over their first year, maintaining 15% value loss in the next four years.
While manually estimating the car Total Cost of Ownership may be tedious, consumers can use resources like Kelley Blue Book, FuelEconomy.gov, and others to calculate the TCO value. This value can then be used to compare the costs of owning different vehicles and make an informed purchase decision accordingly.
The Value of Knowing Total Cost of Ownership
Total Cost of Ownership alone is an important metric used to compare prices of large purchases. However, TCO is often used as a step to calculating another key metric: Return on Investment, or ROI. The ROI metric takes into account both costs of owning an asset and the benefits it delivers over time.
By calculating both TCO and ROI, you will be able to get a fuller picture of the value of buying a particular asset. For example, if an asset has a relatively high TCO but delivers exceptional returns, its ROI will be high, signaling that it might still be a worthwhile investment.
“By calculating both TCO and ROI, you will be able to get a fuller picture of the value of buying a particular asset.”
How to Reduce Total Cost of Ownership
Expenses tend to add up over time, - nevertheless, it is still possible to lower Total Cost of Ownership in the long run. Some options for reducing TCO include:
- Lower upfront costs. A lower upfront cost will automatically translate into a lower Total Cost of Ownership. Try negotiating for a better deal or shopping around to find the best deal for your buck.
- Streamline your supply chain. Buying equipment components from different suppliers can be costly and inefficient. Instead, choose one vendor that can provide a range of components for your piece of equipment or service it on a regular basis. You can also negotiate a discount if you are buying more from one vendor.
- Reduce repair costs. Costly repairs aren’t always avoidable, but you can minimize the risk by sticking to a regular maintenance schedule and using the asset with care. For example, if talking about a car, regular oil changes and tire rotations will keep the long-term repair costs low.
- Minimize ongoing costs. Regularly assess ongoing costs and look for ways to save more. Going back to the car example, you may want to take advantage of a gas rewards program to reduce ongoing gas expenses.
Calculated as the upfront purchase price plus ongoing costs, Total Cost of Ownership is a key metric for businesses and consumers alike. The TCO value can be difficult to estimate, but it serves as an important, albeit not the only, deciding factor for large purchases and investment decisions.