Making an educated decision when acquiring software — Part II: Total Cost of Ownership5 min read
In Part I of this series, we discussed why you should adopt an acquisition model that re-uses what you already have, buys what you can't re-use, and builds what you can't buy.
We briefly discussed that one of the reasons why you shouldn't just buy something by just looking at the price tag because of the total cost of ownership (TCO), but we didn't go in details.
This article explains why you should consider TCO when looking at buying a new software.
What is TCO?
The term TCO was originally coined in the late 1980s by Gartner research to describe the cost of owning and deploying personal computers.
Their findings showed that each PC costs an enterprise nearly $10,000 per year.
Originally, it caused quite a stir in the technology community and among CFOs who scrutinized their methodology and -- eventually -- accepted it as a standard way to evaluate total costs.
Simply put, TCO consists of the costs, direct and indirect, incurred throughout the life-cycle of an asset, including acquisition, deployment, operation, support and retirement.
Some sources say that the amount on the price tag represents less than 10 percent of the total cost spent on IT assets over its lifetime.
In other words, the price tag of software is like the visible part of an iceberg, while the hidden costs are just like the submerged parts.
Like other tools, TCO does not solve all problems. For example, TCO does not assess risk or help align technology investments with your strategic goals. Nevertheless, TCO is an important tool for the analysis of IT costs and for the management of those costs in an IT organization.
When calculating your software's total cost of ownership, consider two areas:
- Obvious costs
- Hidden costs
Those are the costs that everyone who was involved in planning and vendor selection is familiar with, such as:
- Capital expenses: License fees and/or subscription fees. If buying an on-prem solution, you may also need to purchase new hardware.
- Operating expenses: Services, support & maintenance fees to keep the equipment running. Consider additional license costs each year (or the price increase at the end of each term is purchasing a subscription) and the number of years until a major upgrade.
These are the costs people usually forget about when planning to purchase new software.
The hidden costs are less obvious cost that are easy to overlook, but they can be very large.
Large enough to matter.
When calculating your TCO, consider the following "hidden" costs:
- Acquisition costs: the costs of identifying, selecting, ordering, receiving, inventorying, or paying for something. Will you have to go through an RFP process to purchase your software? Consider the cost of preparing the RFP.
- Installation costs: Year one install & setup costs.
- Upgrade, enhancement, or initial setup costs: Most software may require some initial set-up, even if you don’t intend to customize them or integrate with other systems.
- Reconfiguration costs
- Customization & Integration: Keep in mind that the more you customize your software, the more you will have to maintain and update when major upgrades occur.
- Data migration: When deploying a new system, it's often necessary to migrate your data from your existing system. The cost of this migration depends on the amount and format of the data. You may first need to convert the data to another format, consolidate it with other sources, or “scrub” it for duplicate, obsolete, or otherwise bad entries. When moving to the cloud, you also need to consider that some SaaS providers may charge egress costs which are often proportional to the amount of data transferred.
- Operating costs: for example, human (operator) labour.
- Change management costs: for example, costs of user orientation, user training, workflow/process change design and implementation. Training users is critical to get the most out of your new software. It may involve sending employees to training centers, bringing trainers on-site, participating in webinars, or creating custom courses and documentation. Keep in mind that you will also need to train new employees as they join your organization.
- Infrastructure support costs: for example, costs brought by the acquisition for heating/cooling, lighting, or IT support.
- Environmental impact costs: for example, costs of waste disposal/clean up, or pollution control, or the costs of environmental impact compliance reporting.
- Security costs:
- Physical security: If buying an on-prem solution, you may need to increase security measures in your building, including new locks, secure entry doors, closed-circuit television, and security guard services.
- Information security: for example, security software applications or systems, offsite data backup, disaster recovery services, etc.
- Financing costs: for example, loan interest and loan origination fees.
- Disposal / Decommission costs: Some jurisdictions may require you to pay disposal fees. You may also need to shred or demagnetize your electronic storage media.
this is not a comprehensive list by any means. It is just a list of costs I've tallied up over the years. You may have to consider other areas specific to your own situation.
How does the saying go? "Your mileage may vary".
When purchasing new software, you have to consider more than just the price tag.
Thankfully, more and more software companies (and research companies) have created online TCO calculators to help you identify those hidden costs.
I've found a couple so far:
Did I miss any obvious costs? Did you find any TCO calculators out there? Let me know in the comments.
Iceberg Image created by: Ralph A. Clevenger
Credit:© Ralph A. Clevenger/CORBIS
Copyright:© Corbis. All Rights Reserved