How to Understand The Lack of TCO Estimation in Software Buyers

Executive Summary

  • The last thing most IT buyers want is an accurate TCO calculation.
  • This article explains why IT buyers prefer an underestimated TCO.

Introduction

TCO is barely performed in any shape or form in IT for either software selection or other IT decisions such as outsourcing, and when it is done, it is usually done poorly. However, I do not want to give the impression that this issue is specific to IT. Companies have major problems performing TCO, and these problems extend to all manner of areas. One is manufacturing outsourcing, where many outsourcing decisions were made by comparing part costs and not by performing a TCO analysis. Many companies compared the direct part cost between the US and China, found a lower cost of between twenty-five and forty percent, but did not consider other costs! Costs such as longer lead times, reduction in supply chain fl exibility, loss of control over the supply chain, bottlenecks, as well as many other costs needed to be evaluated before the outsourcing decision was made. The following graphic from Archstone Consulting shows all of the different cost categories that must be analyzed in manufacturing outsourcing.

Most companies that performed manufacturing outsourcing were not interested in getting to this level of detail. It was far easier to simply compare part costs and assume everything else would stay about the same. This is what passes for analysis at many companies. Based on a 2009 survey, Archstone Consulting estimated that sixty percent of manufacturers ignored twenty percent or more of the costs of offshoring.

Factors Left Out of TCO Analysis

Many factors are left out of the TCO analysis of manufacturing outsourcing, including the following.

“Currency Fluctuations: Last year’s invoice of $100,000 could be $140,000 today.

  • Lack of Managing an Offshore Contract: Underestimating the people, process, and technology required to manage an outsourcing contract. 
  • Design Changes: Language barriers make it diffi cult to get design changesunderstood and implemented.
  • Quality Problems: Substitution of lower grade or different materials than specified is a common problem.
  • Legal Liabilities: Offshore vendors refuse to participate in product warrantees or guarantees.
  • Travel Expenses: One or more visits to an offshore vendor can dissipate cost savings.
  • Cost of Transition: Overlooking the time and effort required to do things in a new way. It takes from three months to a year to complete the transition to an offshore vendor.
  • Poor Communication: Communication is extremely complex and burdensome.
  • Intellectual Property: Foreign companies, particularly Chinese, are notorious for infringing on IP rights without legal recourse for American companies.”
    — Michele Nash-Hoff

Considering the numerous accountants and fi nancial experts that work in so many companies, the rudimentary nature of how companies make cost decisions can be shocking.

“Accountants deal with hard costs such as material costs, material overhead costs, labor costs, labor overhead costs, quality costs, outside services, sales, general and accounting costs, profi ts, etc. What they don’t measure are the intangible costs associated with business such as the true costs of delay, defects, and deviations from standard or expected processes (the three D’s).” — Michele Nash-Hoff

Finding Help with TCO Calculation

Much of what I have described up to this point makes it diffi cult for companies to get assistance in developing accurate TCO calculations. Hypothetically, IT analyst firms should be good candidates for performing TCO analysis. Gartner, the largest IT analyst firm in the world, is actually credited with first introducing the concept of TCO to enterprise software. However, as has been discussed, most IT analyst firms have major conflicts of interest because they sell consulting services to vendors. They also take considerably more money from the large vendors in comparison to the smaller vendors—and not coincidentally larger vendors tend to charge more for their software, more for their consulting, and so on. The upshot is that the TCOs of large vendors will be higher. Since the vast majority of IT analyst firms take the most money from vendors with the highest TCOs, they have little incentive to provide detailed TCO analyses, as doing so would probably cause them to lose some of their software vendor consulting revenues. Also, different IT analyst firms have different interpretations of TCO. Gartner for instance tends to be “pro-TCO,” while Forrester tends to be “anti-TCO,” proposing that most companies cannot aspire to TCO successfully and that simpler approaches should be used. Forrester also points out that, according to their surveys, only about twenty-two percent of purchasing companies use any type of TCO in their decision-making.

Is TCO Even Possible?

Several entities disagree on whether or not a full TCO analysis should be a goal. In this section we will review the concerns leveled frequently at TCO. One of the entities—which could be labeled as anti-TCO and which is influential in the area of enterprise software decision-making—is Forrester, the IT analyst firm.

“To really implement TCO-based analysis it takes a comprehensive and continuously updated catalog of asset inventory, in-service dates, agreed upon operating cost rates for activities, and a scheme to divide shared costs among the constituent business processes that use them. For most firms, this is a pipe dream viewed either as a waste of resources in a futile quest for achievement or too intimidating to even begin. Forrester recommends a more expedient and realistic fi nancial approach that can be just as effective but much simpler to calculate—relative cost of operations (RCO). RCO can be a middle-ground solution, moving far beyond acquisition-cost-only analysis, while being more achievable than a full-blown TCO.” — Forrester

I agree with Forrester’s assertion that companies rarely use TCO, but I do not see why performing a complete TCO analysis is beyond most companies if they are properly advised. Because we take no money from vendors, we can legitimately say that our TCO analyses do not have a bias. One could always propose other non-financial biases—and these are possible and also come down to whether you consider exposure to a topic to be a bias or to be knowledge (babies after all are completely unbiased and open minded)—however, if one analyzes the major problem with respect to objectivity in analysis in not only the enterprise software arena, but also other areas such as fi nancial advisement—consistently the problem is financial bias.

This is true to such a degree that once financial bias is removed one has taken care of the vast majority of the problem. Forrester is not alone in their concerns regarding TCO. The white paper Rethinking TCO takes a similar view of TCO as Forrester. Rethinking TCO points out some of the limitations of performing a meaningful TCO analysis when they state:

“The large amount of variability in product complexity and comprehensiveness from one enterprise vendor is an important limitation on the potential for using TCO in multi-vendor analysis.”

Explicit and Implicit TCO

However, this type of calculation will be performed either implicitly or explicitly (with an actual TCO); therefore, it is diffi cult to see how the approach of not performing the analysis is better than performing a TCO, especially considering what is at stake. In fact, merely performing the analysis—imperfect as it may be—puts a company in a more analytical frame of mind during their selection process.

Rethinking TCO also made the following argument against TCO.

“…different companies within the same industry may have signifi cantly different business processes expressed in the same software product, or may have extensively customized a standard software package in order to gain some degree of competitive advantage. Indeed, this variability in use often represents a key strategic value for the enterprise software package: by using a standard software product in a nonstandard or customized fashion, many customers hope to gain competitive advantage over other companies in their industries that may be using the same or similar software.”

That is all true. However, this is where the implementation experience of individuals performing the TCO comes into play. If they are suffi ciently experienced, they can increase or decrease the cost of a particular item through their knowledge of how much customization can be expected on the project. Furthermore, a noncustomized TCO value probably would not make a lot of sense. It appears that this is an argument against non-customized TCO calculations.

“The implementation process is another major factor that adds to the problems with using TCO as a vendor selection tool. Implementation costs figure as one of the largest single expenses in enterprise software, and yet they are neither standardized nor consistent from one vendor to the next or one implementer, or implementation, to the next.”

TCO Estimation

While true, this can easily be accounted for in the TCO estimation, so it is difficult to understand the exact concern. Yes, implementation times can be adjusted for TCO estimations. And that is not the end of it; maintenance is quite different from one software vendor to the next and we adjust the maintenance costs per software vendor. If the implementation involves a large brand-name software vendor, we again extend the implementation timeline. For example, when we develop estimates for software vendors like SAP (which is neither designed to be easily implemented or easily used), we impose higher costs than any other software in the enterprise market. SAP takes longer to install, which means implementation costs are high, as are maintenance costs. This is why it is so important to check that the software functionality is reliable and usable; not only is the application more effective, the cost of the implementation is reduced, thus reducing its TCO and increasing its ROI.

Conclusion

Companies that implement enterprise software often skip TCO evaluations because they require effort and would get in the way of making trendy purchases. Most executive decision makers tend to believe in safety in numbers, and that means buying and implementing what other companies are buying and implementing. As for consulting companies, because they are surrogate software sales entities (that is, their interests are aligned with software sales because these sales drive consulting revenue), they are not oriented to the consumer or purchasing side.

Custom TCO Estimates and Consulting

  • Want Help with TCO for your Business?

    It is difficult for most companies to estimate TCO without outside advice. Vendors and consulting companies do not want their customers to know what they TCO is. Getting TCO advice from consulting companies leads to underestimated TCO. We do offer remote unbiased multi-dimension TCO estimation.

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References

http://www.forrester.com/TCO+Is+Overrated/fulltext/-/E-RES44545?docid=44545

TCO Book

TCO3

Enterprise Software TCO: Calculating and Using Total Cost of Ownership for Decision Making

Getting to the Detail of TCO

One aspect of making a software purchasing decision is to compare the Total Cost of Ownership, or TCO, of the applications under consideration: what will the software cost you over its lifespan? But most companies don’t understand what dollar amounts to include in the TCO analysis or where to source these figures, or, if using TCO studies produced by consulting and IT analyst firms, how the TCO amounts were calculated and how to compare TCO across applications.

The Mechanics of TCO

Not only will this book help you appreciate the mechanics of TCO, but you will also gain insight as to the importance of TCO and understand how to strip away the biases and outside influences to make a real TCO comparison between applications.
By reading this book you will:
  • Understand why you need to look at TCO and not just ROI when making your purchasing decision.
  • Discover how an application, which at first glance may seem inexpensive when compared to its competition, could end up being more costly in the long run.
  • Gain an in-depth understanding of the cost, categories to include in an accurate and complete TCO analysis.
  • Learn why ERP systems are not a significant investment, based on their TCO.
  • Find out how to recognize and avoid superficial, incomplete or incorrect TCO analyses that could negatively impact your software purchase decision.
  • Appreciate the importance and cost-effectiveness of a TCO audit.
  • Learn how SCM Focus can provide you with unbiased and well-researched TCO analyses to assist you in your software selection.
Chapters
  • Chapter 1:  Introduction
  • Chapter 2:  The Basics of TCO
  • Chapter 3:  The State of Enterprise TCO
  • Chapter 4:  ERP: The Multi-Billion Dollar TCO Analysis Failure
  • Chapter 5:  The TCO Method Used by Software Decisions
  • Chapter 6:  Using TCO for Better Decision Making

How It Works

How It Works

Each TCO calculator is self-service allowing you to continually change different elements in order to see the impact on costs. They are designed to adjust to the specific project factors such as the number of users, the general level of customization, the number of post go live adjustments to the application, etc..

The TCO calculators can improve your ability to plan your purchase.

How It’s Unique

How It’s Unique

Our self-service calculators have been developed through detailed analysis verified by many years of project experience combined with all the available research – all in order to develop a series of uplifts to costs based upon inputs. The formulas used are nuanced, and do not simply “scale” in direct proportion with changes to the inputs.

  • Our TCO calculators are designed to scale to any sized implementation and different levels of implementation complexity and customization.
  • We offer a true TCO by estimating internal costs (such as the time spent by internal resources on implementation and support) as well as the external costs. In comparison with the very limited TCO studies that exist on enterprise software, our TCO calculations are easily the most comprehensive.
  • Having performed this analysis for many applications, we have brought key observations between these applications as well as between various software categories.

What Is Included

What Is Included

Each package is a combination of two analyses. The first analysis is the interactive TCO Calculator which is provides a total TCO based upon the individual costs of software costs, hardware costs, implementation costs, maintenance costs as well as Lifetime Improvement Costs (the costs of the estimated improvements and adjustments to the application over its lifetime). Both these individual component costs as well as the aggregate of all the costs constantly change given your input to the calculator.

What It Is

What It Is

This offering provides buyers with the detailed information they need to for both the total cost of ownership of a single application, as well as the comparative total cost of ownership between multiple applications. This is the only self service TCO calculator that exists on the Internet, and it is available currently for 57 of the most well known enterprise software applications. This calculator receives input from you and automatically adjusts the costs so that they are customized for your intended way of implementing and using the software.

Transforming a Complex Analysis into a Simple Cost Breakdown

Even though all of the calculations behind each TCO calculator are complex and have been extensively tested and validated, they are easy to use. All that you need is basic information about your project such as the number of projected users, whether the implementing is more simple or more complex, etc..

Each package covers a single application including a comprehensive total cost of ownership analysis that takes into account the following costs:

  • Software Costs
  • Hardware Costs
  • Implementation Costs
  • Maintenance Costs
  • Lifetime Improvement Costs