TIPS & TRAPS:

Calculating Total Cost of Ownership

By Lowell Rapaport

Total cost of ownership has grown into one of the major buzzwords. In the face of commodity hardware pricing and stiff competition between high-end and low-end software, total cost of ownership has become a point of differentiation between products.

Marketing materials aside, it is important for CIOs to know what their total cost of ownership is, both to make intelligent decisions about new purchases and to know what their current expenses are so as to save money in the future.

1. Include all your expenses when calculating total cost of ownership. The expense left out most often from TCO calculations is paradoxically one of the most costly: labor. Typically TCO calculations include the cost of hardware and software, the cost of consumables and sometimes even the cost of electricity. Labor, including technical workers, is often on a different budget and therefore ignored. For example, a printer may use inexpensive consumables, but if toner and paper has to be replenished frequently, the savings is lost in maintenance time and the cost of placing orders for supplies.

2. Figure performance costs and meet your needs. That great deal on workstation hardware may look good on paper, but there’s no substitute for getting quality products. Aside from the obvious — cheap equipment will break down more often — slower computer equipment will slow down your whole enterprise. If you’re scanning large numbers of documents, slow scanning equipment and computers will keep expensive workers waiting.

3. Look at recurring costs — the smallest part of your total cost of ownership. Many CIOs have learned that hardware, even expensive hardware, is in fact the smallest part of their budget. Some estimate that software is far more expensive. While this is true, it’s also true that you frequently buy software just once. Software can often be used on several generations of hardware. Recurring costs, such as system administration and maintenance, can quickly exceed the purchase price of hardware and software.

   Incidentally, fixed costs should be amortized over the life of the product. If you buy software expecting it to be in use for five years, then amortize that cost. This makes it easier to compare the cost of products with different pricing models; especially as the software industry moves towards per-click charges and periodic licensing fees.

4. Figure the incremental cost of adding additional hardware and software. You can calculate this by dividing your IT budget by the total number of workstations and servers you have. Then you can know the cost of each additional workstation and server. Make sure to weigh the fixed and recurring costs. For example, a Unix server can be expensive to set up but will have very low recurring costs. A Windows workstation can be cheap to set up, but very expensive to maintain over time.

Incremental administrative costs are one of those hidden costs that are very rarely accounted for. Companies that are running smoothly with half a dozen servers and 50 workstations will think nothing of adding another three servers and 25 workstations. Those are fixed costs, right? Not when an overworked system administrator asks for an assistant. Fast-growing companies are often hit worst by these extra costs because they are overlooked. They are worsened by tight labor markets like we have today.

Next month we’ll explore how to reduce total cost of ownership.

Why do software developers release seemingly useless upgrades? Some companies regularly upgrade their products to maintain their revenue stream. Alternative pricing models are click fees and periodic licensing.

Many imaging users are already familiar with click fees. Software vendors charge a fee per thousand scans. In a similar vein, some document management system vendors license their software for a specific number of documents. As the customer’s needs grow, they can purchase licenses that will let them add more documents to their database.

Periodic licensing, also known as software leasing, lets you use software for a period of time. Afterwards, you can renew the license or cease using the software. The most radical example of this pricing model are application service providers (ASPs) who run software on their own computers and let users access them for a fee. ASPs provide everything to their clients — software, support, disaster recovery and guaranteed availability — at a lower cost than their clients could do themselves.

The advantages of these pricing models are that software vendors can concentrate on delivering bug-free applications, full tech support, and truly useful features. Periodic charges lower initial costs. The downside is that software costs can balloon after a few years.

Periodic software charges are on the rise. Some vendors can’t maintain the pace of development while remaining profitable, even with a successful product. We may have to accept periodic charges as the price of having the latest technology.