TCO: Is It Relevant?

TCO is a cost trade-off and only one of a variety of factors that goes into any decision.

Total Cost of Ownership is often held up as the critical metric for IT performance, the usual argument is being what you want to provide a service at the lowest possible cost, both in terms of acquisition cost and ongoing "care and feeding." Perhaps this makes sense when applied to a commodity; however, overemphasizing TCO puts one into a commodity mindset in IT which spurns talk of misalignment with the business, outsourcing IT, etc. So, is TCO really relevant?

1. TCO is a Useful Metric

In a word, the answer is YES. TCO is indeed a useful metric but is only an indicator of initial capital costs and closely related recurring costs when utilized in most IT-based financial models.  Many components within IT are indeed commodities, but IT itself is a mature and complete business function that must be measured utilizing the same financial disciplines as all other business functions. TCO should be a reflection of the complete IT business function. 

• TCO without activity-based costing is useless. Treat IT just like a business: Strategic Plan for the future; Tactical execution in a cost-effective way without stifling innovation; and proper budgeting and governance including the use of TCO tools as describes for the commodity element of IT. As such, proper TCO measurement is dependent on knowing ALL of the associated costs of any asset or service. In IT, this includes servers, storage, networks, facilities, software licenses, personnel, real estate, etc. Each one of these elements carries its own costs, which in turn must be partially or fully allocated to the asset or service in question. In order for TCO to have real meaning, the costs must be related to accounting methodologies, financial policy, and asset utilization. 

• TCO is a component of a management framework that gets to ROI. TCO is a concept that cuts across typical budget lines. TCO is a combination of tech expenses, marketing expenses, operations expenses, etc. related to delivering a service or producing a product. Yes, TCO is often applied to tech expense today, but often because tech is a significant expense for a large percentage of companies. So, imagine you are running a multi-channel company. You have been asked to cut budgets by x%. Using TCO-related to tech, aligned with the business, provides a view into where tech dollars are being spent. So you, as the CIO or another tech leader of the company can go the business unit owners and say “X dollars of tech expense is used to support your business line, X for yours, and X for yours, etc.” Now, instead of a total tech expense discussion, the discussion shifts to what line of business provides the greatest return, which should be invested in for the future, etc. Alignment of tech expense or TCO by business process, channel, product, etc. provides a more accurate view of the value of tech. To simply try to push off TCO as an invaluable exercise and instead of attempting to fight tech expense. Understanding the expense side of ROI positions the management team to make better decisions not only related to tech, but to all expenses. 

2. Define Value First, Calculate Cost later

Producers do not define the value of the product or service. The “buyer” does. IT does not define the value of the services it offers, the “buyer” of the service defines that value. Where IT must “align with the business” is by clearly defining the features of the services it offers and the costs associated with the various features.

• Build Trust with “Buyers” of IT service: TCO, when done with granular cost pools that reflect the cost of assets and then roll up those costs into service features, is, perhaps, the most valuable tool for developing the kind of evidence that builds trust with the “buyer” of IT services. IT can prove that the combination of quality and price for any given service feature is comparable to the marketplace, or can buy those discrete services themselves for the company in its role as steward of IT and agent for the company. Once the “buyer” of the services can trust the “prices,” then the “buyers” can be given the “checkbook” and buy the services from IT, they wish on an annual basis. That’s true alignment. 

• Don't let TCO kill Innovation: TCO is important but not enough. TCO is a way of understanding your IT costs, but should not be an only critical measure. Cost-benefit Analysis of a solution is flawed if only economic costs and benefits are considered. Besides, the culture of only looking at it from the economic perspective kills innovation through self-censorship. IT should be measured in the way other business units are. You need some innovation to survive and build for the future. 

• TCO is a cost tradeoff and only one of a variety of factors that goes into any decision. Applied by itself, it overrides logic and potentially degrades overall corporate value. The quest may result in applying a metric that may not be the appropriate one for the decision at hand ... not all decisions within an organization are made for the same rationale. If you attempt to uniformly apply all corporate core decision values/principles to each decision, you create resolvable conflict. So it is a collective and prioritized set of factors that goes into a decision, and blindly applying anyone without a rational structure, is a path fraught with peril. Lowering TCO at the cost of losing core knowledge or the company's unique value, is a poor decision at best. 

• TCO is an implication of one principle; prudent financial management, a business voice. The corporate strategic planning will have identified relevant business initiatives and associated metrics (balanced scorecard or other). Financial is only one of the legs of "balanced" decision making. TCO is relevant but it all cases we should avoid both taking the output of TCO or any other metric as the set in stone. There are many qualitative factors to take into use. The principles - core decision values - used in each decision is different. However, these can be defined and allocated consistently, so that everyone makes decisions in accordance with these values. 

• TCO is important to measure but should be only one dimension of the overall decision in a technology purchase A solid risk-benefit analysis needs to be put together before any type of decision is made. Often times CFOs and CIOs are oriented on hard costs vs, soft costs on technology..... and soft dollar costs cannot be ignored to get a true TCO for any technology or service. TCO is just a due diligence thing we check along with many other factors, such as TCO, ROI, Macro and Macroeconomic indicators, etc. There does not exist one tool that can be used to dictate the direction of the organization, you must use an integrated approach. TCO, just like every other tool or model has its role but does not overly simplify the situation, a tool or model is not going capture all the quantitative and qualitative information required to make an informed decision, looking at the full lifecycle, and making sure all factors are included in any decision making regarding cost comparisons and IT management.

Thus, IT first needs a way to define the value to the organization, and to do that – it needs to properly understand all elements of value that are translated to the organization, and how all the pieces and parts of the organization are ultimately impacted, for good or bad, by each new initiative. Total impact and total value should be what need be defined, not just cost. Cost is a component of value – but ultimately what matters most to an organization is value. Therefore, shouldn't organizations be defining value and then measuring that?

Posted in: CIO Debate,IT Finance,IT Performance Management