Total Cost of Ownership (TCO) is a valuable concept to understand and if used correctly, can be a valuable business tool. Here is an overview of what it is, its benefits, and its challenges.
What is Total Cost of Ownership?
Total Cost of Ownership (TCO) is a management accounting concept that can be used in full cost accounting or even ecological economics where it includes social costs. It is designed to help businesses calculate the total cost of a product or service.
TCO is often used to compare different products or services, or to make decisions about whether to make or buy as well as where to buy.
It can also be used to track the costs of owning an asset over time.
The TCO of a product or service includes (but is not limited to) the following costs:
- Direct costs: These are the costs that are directly associated with the purchase and use of the product or service. For example, the direct costs of a car would include the purchase price, insurance, fuel, road tax and servicing.
- Indirect costs: These are the costs that are not directly associated with the purchase and use of the product or service, but that still have an impact on the overall cost of ownership. For example, the indirect costs of a car might include the cost of parking, tolls, and depreciation.
- Opportunity costs: These are the costs of lost opportunities. For example, if you buy a car, it may cost more than taking the bus; the money you spend on keeping a car on the road may mean you can afford fewer holidays!
The TCO of a product or service can vary depending on a number of factors such as the specification of the product or service, sales profiles, delivery/lead times and locations, both suppliers and customers.
It is important to carefully consider all of the costs involved before making a decision about whether to make or buy.
What are the benefits of using TCO?
- It helps make better financial decisions.
- By understanding the total cost of ownership of a product or service, you can make more informed decisions about whether to make or buy and where to buy from.
- It helps identify hidden costs.
- TCO can help you identify costs that you may not have considered, such as indirect costs and opportunity costs. This can help you make more accurate financial projections.
- It can help profitability.
- By considering all the costs of a particular product or service a business can look to reduce these. For example, if a product is bought solely on unit price ignoring transportation, storage and holding costs, bluntly, the books will not balance and profitability will be reduced.
What are the challenges of using TCO?
- It can be difficult to calculate accurately.
- TCO requires an understanding of all direct and indirect costs involved. This can be time-consuming and complex, especially for complex products or services where supply chains cross the planet.
- The results can vary.
- The results of a TCO analysis can vary depending on any assumptions used. This is why it is important to carefully consider all of the factors involved before making a decision.
- It is not a guarantee of future performance.
- TCO is a snapshot of the costs involved at a particular point in time. The actual costs of ownership may vary over time, due to changes in the market, the usage patterns, or other factors.
Many assumptions cannot be quantified at present. Nevertheless, it is important to capture these. TCO should become part of ‘Business as Usual’ and therefore revisited on a regular basis.
Despite the challenges, TCO can be a valuable tool for businesses and individuals. By understanding the Total Cost of Ownership of a product or service, you can make more informed decisions about what to buy, from where and when.
When used correctly, TCO can show the true profitability of a product or service – You might be surprised!
About Andy Dobson
Andy is an engineer with 25+ years in Manufacturing running operations in the UK and abroad. He has spent 15+ years in Consulting; working with SMEs as well as multinational companies across Europe and beyond.
His hands-on experience ranges from direct Operational roles to Supply Chain and Supplier Development as well as start-up and scale-up including Pharmaceutical validation and many roles in process optimisation and crisis management.
If you would like to speak to Andy about TCO and how to implement it in your business, contact our team to book a call.
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