This article is the first in a series of three regarding total cost of ownership (TCO) and return on investment (ROI). This discussion is an overview of TCO. In later discussions, we will look at its applicability within an SAP environment.
Introduction
The year 1990 was just around the corner and Gartner Group was about to celebrate its 10th anniversary. Mini-computers were on the way out and paying attention to ROI was the purchasing mantra.
Three-tiered systems were now in vogue and becoming mainstream within corporate America. To meet the challenge of how to compare and manage IT costs, Gartner devised TCO as an efficient means of evaluating costs associated with IT expenditures. Since that time, TCO has been applied alongside ROI ~ sometimes with competing goals.
In this article, we will look at what elements make up the concept of TCO. In later articles, we will look at ROI -- and in the third article of the series, we examine how they relate to SAP today.
Knowledge learned in this article can be put to use when:
Executives require an understanding of TCO
Users require an understanding of the various methods used in establishing TCO
TCO and ROI – What's the Basic Difference?
The quickest answer is: you must manage your TCO to achieve ROI.
When Gartner devised the concept of TCO, they aimed its initial use toward the purchase of PC installations – which in the late 1980's were steadily becoming the de-facto corporate standard. Because the three-tier concept was taking hold (database, application and presentation layers) – something we take for granted today – IT purchasing needed to know how to evaluate the associated costs. The three-tier concept involved purchases outside the norm; PCs were moving away from terminals (the prior standard) and databases which were co-located with the application (a two-tier system – a lá mainframes and mini-computers). Purchasing IT and associated software applications for three disparate levels of technology and tracking investment costs and returns on those investments was a daunting task back then. That's when the concept of Total Cost of Ownership was devised – it was based upon what was seen occurring within IT organizations.
What TCO brought to light was this: there are multiple (and sometimes ongoing) investment points which require tracking – and therefore management – in every IT initiative. But how does this differ from ROI?
To begin, ROI ( Return on Investment ) is generally approached from less a pure financial angle ~ ROI is typically computed from a business case perspective (often before an initiative is even undertaken).
With this in mind, ROI business cases define the various business benefits and costs. These measurements are employed to justify capital expenditures – along with on-going project resource commitments (time people and money).
Now, let's look closer at TCO. In later articles, we'll look at ROI and how it intersects with TCO.
How is TCO Measured?
A classic definition of TCO is: “TCO is a method for identifying all of the costs associated with a System over the life cycle of that System. Costs include evaluation, acquisition, implementation, maintenance, operation/usage and management of the system.”
These investment points (or costs) have historically fallen into two major categories (which are largely interchangeable):
Disaster Recovery (includes DRP and memorialization methodologies)
Periodic Upgrades/Releases (Hot Packs, Service Packs, etc.)
Integration Consulting Services
Hardware/Software Installation & Setup
Hardware/Software Maintenance
Data Cleansing/Conversion/Migration (includes ETL)
Environmental/Facilities
Travel/Seminars/Conferences
Other Miscellaneous Expenses
Important Note: To compute TCO, it is important to distinguish between one-time costs (such as paid-evaluations, acquisitions and implementations) and ongoing costs; such as those listed above.
Once identified and tracked, the direct and indirect costs are registered and calculated on a per annum schedule. The resulting number equates to the realized TCO.
One important consideration to remember: TCO does not include the following valuations organizations must take into consideration:
Value of benefits derived - the added value that a technology delivers to business processes or operations
Efficiency or productivity enhancements - the ability to produce more units of work (UoW) in a given time period
System performance improvements - faster response times and other key measurements of performance
The listed valuations are somewhat nebulous and consist of ongoing costs – costs frequently not taken into consideration during the nascent stages of most projects.
How Do You Use These Measurements?
After compiling the various data types, a baseline for continued measurement is established. From this point forward, metrics are established for continued TCO use. Organizations realizing the initial TCO measurements are just that – the first measurement – will be better able to keep TCO in check (using the ongoing metrics to adjust spending and reduce costs where possible).
Conclusion
Using TCO wisely will mitigate tendencies to rush projects from planning into production. Applying TCO methodologies equates to managing your IT landscape. Although some costs are shrinking (i.e., blade server hardware, hard drives, memory, etc.) other costs (direct and in-direct) must be carefully husband.
Written by Geoffry Houze, Data Management Group SAP Practice Manager
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