This is part2
https://dev.to/nawras_lateef/is-cloud-aws-computing-actually-cheap-part-2-5e8k
Total Cost of Ownership (TCO)
TCO is the purchase price of an asset plus the costs of operation. Assessing the TCO represents taking a bigger picture look at what the product is and what its value is over time.
TCO is a financial estimate that helps enterprise managers determine direct and indirect costs of a system. TCO goes beyond the initial purchase price or implementation cost to consider the full cost of an asset over its useful life.
The TCO is considered by companies and individuals when they are looking to buy assets and make investments in capital projects. For a business, the cost of purchase and the costs of operations and maintenance are often itemized separately on financial statements. The former is booked as a CapEx while the latter is part of OpEx. A comprehensive analysis of the cost of ownership is a common practice for businesses.
Companies use the TCO over the long term as a framework for analyzing business deals. Looking at the total cost of ownership is a way of taking a more holistic approach that assesses the purchase from a broad perspective. This analysis includes the initial purchase price as well as all direct and indirect expenses.
While the direct expenses can be easily reported, companies most often seek to analyze all potential indirect expenses that can be of significant influence in deciding whether to complete a purchase.
Used at the right time, TCO can help win more deals, and it can certainly be the clincher to a fast close. It also provides a robust response to objections about price.
TCO includes all the costs to run a system over its lifetime, and is the best metric to compare the costs of cloud computing and installed software. It not only incorporates the fees paid to vendors, but also equipment and staff costs.
After examining the total expenditures for both systems, the more cost-effective option is clear -- cloud computing offers a lower TCO than installed software. It requires less up-front investment and lower long-term operating costs.
The components of TCO depend on the item but should always include the initial purchase price as well as any costs associated with operating the item, ongoing maintenance, training needed, and how long the item is expected to last before replacement is needed.
Example of Total Cost of Ownership (TCO):
An example of a business investment that requires a thorough analysis of the total cost of ownership is an investment in a new computer system. The computer system has an initial purchase price.
Additional costs often include new software, installation, transition costs, employee training, security costs, disaster recovery planning, ongoing support, and future upgrades. Using these costs as a guide, the company compares the advantages and disadvantages of purchasing the computer system as well as its overall benefit to the company for the long term.
On a smaller scale, individuals also use the total cost of ownership when making purchasing decisions. While the total cost of ownership can be overlooked, its analysis is essential in preventing unnecessary future losses that can arise from focusing only on the immediate direct costs of a purchase.
TCO in IT:
Gartner defines total cost of ownership as a comprehensive assessment of information technology or other costs across enterprise boundaries over time.
The components of TCO may vary depending on your industry and business needs. Be sure to include the following components while analyzing the TCO for your next technology investment.
Acquisition Costs
These are the costs of the software or application, including software licenses or subscription fees. It also includes the costs of installation and employee training.
Operating Costs
These are recurring costs throughout the lifespan of the software. It includes setting up, maintenance as well as updates of the product, ongoing training with every software update, support services and security of your software.
Resource Costs
You will need knowledgeable personnel or professionals to run the software to gain optimum results. Hiring in-house technicians or third-party consultants to manage the software translates into additional costs.
Return on investment (ROI):
Return on investment (ROI) is a financial ratio used to calculate the benefit an investor will receive in relation to their investment cost. It is most commonly measured as net income divided by the original capital cost of the investment. The higher the ratio, the greater the benefit earned, this value describes anything from a financial return to increased efficiencies.
ROI is a common business term used to identify past and potential financial returns. Managers and executives look to the ROI of a project or endeavor because this measure indicates how successful a venture will be.
TCO and ROI, or return on investment, are frequently confused and misused, but they actually must be used together to properly evaluate customer relationship management projects. Don’t pay too much attention to costs and too little to benefits. Rather, forecast and compare costs over the life of a project. A proper TCO analysis often shows there is a large difference between the price of something and its long-term cost.
Essentially, any benefit could be part of the analysis, including intangible or soft-dollar benefits. In calculating CRM benefits, consider improvements in efficiency and effectiveness, as well as cost savings. If your project has them, predict improvements in intangibles, such as strengthening customer loyalty and increasing brand recognition.
Remember, however, to use both TCO and ROI to evaluate your project, and not to focus too much or too little on either the costs or benefits side.
ROI calculations can help you analyze your finances and make quality decisions about the future of your business.
There are several versions of the ROI formula. The two most commonly used are shown below:
ROI = Net Income / Cost of Investment
or
ROI = Investment Gain / Investment Base
Benefits of ROI:
Only smart businesses that spend wisely and monitor ROI closely survive in the long run.
If you aren’t seeing an optimal ROI on a certain endeavor, stop throwing money at it; you’re better off scrapping it. Continuing to spend on lost causes is a surefire way to run out of money and run your business into the ground.
Understanding your profits, and the impact of an investment on your business, is important and extremely helpful when making decisions for your company.
Here are two more benefits that calculating your return on
investment provides.
- Using an ROI allows business owners to track and analyze short- and long-term projects.
- ROI helps you evaluate your business’s financial performance.
Alternatives to the ROI Formula:
There are many alternatives to the very generic return on investment ratio.
The most detailed measure of return is known as the Internal Rate of Return (IRR). This is a measure of all the cash flow received over the life of an investment, expressed as an annual percentage (%) growth rate. This metric takes into account the timing of cash flows, which is a preferred measure of return in sophisticated industries like private equity and venture capital.
Other alternatives to ROI include Return on Equity (ROE) and Return on Assets (ROA). These two ratios don’t take into account the timing of cash flows and represent only an annual rate of return (as opposed to a lifetime rate of return like IRR). However, they are more specific than the generic return on investment since the denominator is more clearly specified. Equity and Assets have a specific meaning, while “investment” can mean different things.
Resources:
- https://www.investopedia.com/terms/t/totalcostofownership.asp
- https://www.suse.com/suse-defines/definition/total-cost-ownership-tco/
- https://www.techtarget.com/searchdatacenter/definition/TCO
- https://www.gartner.com/en/information-technology/glossary/total-cost-of-ownership-tco
- https://www.investopedia.com/terms/r/returnoninvestment.asp
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