How to Understand the Basics of Software TCO

Executive Summary

  • Brightwork Research & Analysis has observations regarding software TCO.
  • This article is an overview of how to leverage TCO.

Introduction

Total cost of ownership, or TCO, is the complete cost of owning something. TCO can be rearward looking—an accounting of what a purchase actually cost. However, in most cases a TCO analysis results in a forward projection or forecast. TCO for enterprise software is the overall sum of the costs of the four main TCO categories:

  1. Software Cost
  2. Hardware Cost
  3. Implementation Cost
  4. Maintenance Cost

TCO is discussed in the abstract as a “good thing” but is rarely calculated in reality. If you think back upon all of the purchases you made throughout your life, how many of them included the TCO on the price tag, along with the actual purchase price? There is a good reason (or good reasons) for this and they go by the names of sales and marketing. The last thing a company wants is for their prospective customers to know the total cost of an item. The one exception to this rule is if the vendor has a study that shows their product or service has a lower TCO than that of a competitor’s product or service. TCO is the base value for ROI: it is the “I” in ROI. A TCO must be calculated before an ROI can be calculated. ROI is the formalized analysis of the universal ratio between costs and benefi ts, which I referred to previously, and is focused on both the revenue and the costs of an investment.

Determining the ROI of Enterprise Software

Determining the ROI of enterprise software is quite difficult because it means estimating the financial returns from software, which is a complex endeavor. Therefore, instead of producing ROI estimates, Software Decisions applies a rating system to the application, which is used in conjunction with the TCO estimate. This still allows the value of the software to be estimated, but without the necessity for an ROI calculation. Correct TCO analysis requires effort; getting into the real detail of the costs and benefi ts of applications requires a combination of first-hand implementation experience as well as the analytical ability to perform the analysis. This analysis should be built from a level of detail such that the TCO flows naturally from the more thorough analysis. While most software vendors hide their pricing information, all software vendors still like to discuss TCO in abstract terms as a “good thing.”

Virtue Signaling with Being in Favor of TCO

Being in favor of TCO is like saying you are in favor of the American flag or apple pie; you’re in favor of “goodness.” You can’t actually find anyone who opposes TCO in principle. But the devil is in the details. As long as nothing is quantified or the TCO studies are rigged, all vendors can say they have the lowest TCO. Most software vendors are not only against publishing TCO estimations, but are even against publishing pricing information for their applications on their websites. Software vendors cannot be relied upon to produce TCO estimates, and the best move is to disregard the software vendor’s estimate.

Secondly, no TCO study that is performed by a third party, but which is funded by a software vendor can be considered reliable. This should be obvious, but I have read the TCO estimates performed by third parties, which were funded in exactly this way, so someone is funding this work for a reason, and it is evidently convincing to someone. Behind many poor decisions is a lack of proper TCO analysis, many consulting companies are also behind poor decisions. Consulting companies don’t share the economic benefit of their clients’ good decisions, and therefore are not incentivized to promote good decision-making on the part of their clients. If the consulting company is involved in the implementation (and almost all of them are), then having the consulting company performing the TCO violates the rule that was described in the beginning of this book, which is that any TCO analysis—or in fact any analysis—is that the entity performing the analysis must not have a vested interest in its outcome.

The Behavior of Consulting Companies and TCO

Consulting companies are constantly putting out falsified information about the cost saving benefi ts of both ERP and outsourcing—which is not surprising as they are knee deep in selling these services. Software vendors and consulting companies are not the only entities that seek to suppress TCO estimations, but IT analysts and buying companies often have little interest in this information, as well. 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 is infl uential in the area of enterprise software decision-making—is Forrester, the IT analyst fi rm. In the field of enterprise software, one of the most amazing stories of the past several decades is the mass purchasing of ERP systems—purchases made without the customers searching for evidence that ERP systems are good investments.

If they had looked, they would have found that the logic presented to sell ERP systems had no evidence to support it. Costs are often described in general parlance as the amount that we pay for things. However, economists look at costs quite a bit differently. Promoters of ERP tend to present any benefi ts of ERP without acknowledging that the time and effort spent on the ERP project could have gone into other initiatives. The comparison should be between the gains from those systems versus the gains from ERP systems. Multiple estimations from software vendors cannot be simply accepted, but must be blended with experience in implementation. Many software vendors quote a 1:1 ratio between software costs and consulting costs. However, this is not the extent of implementation costs. Software vendors only consider their consulting costs (although sometimes they add in training) and do not include internal resource costs for the implementing company. Generally, consultants from the software vendor provide the best consulting value. As soon as an outside consulting company is involved, the costs of the implementation go up. Therefore, to account for all of this, Software Decisions uses higher multiples if a client states that they are using a major consulting company, and companies performing TCO analysis themselves should do the same. Most vendors would not be happy with the implementation duration estimates developed by Brightwork Research & Analysis. However, these estimates are based upon years of analyzing how applications are actually implemented, which is far from the optimum values that are often quoted. We have performed the research, and the statistics are clearly on our side—enterprise software implementations take much longer than is generally assumed, not only by the software vendor, but also by the project management of the implementing company. If sixty percent of ERP implementations fail, and if the vast majority of ERP implementations miss their deadlines by signifi cant durations, why are TCO estimates still based upon assumptions that do not include these very critical factors? Ninety-six percent of ERP implementations include moderate to extensive customizations.

Customization and TCO

Customization results in high implementation costs, high continuous improvement costs, and high maintenance costs. Other software categories have various degrees of customization— almost always less than ERP—so ERP should receive the highest bump for coding-related implementation costs. All TCO estimations are based upon some type of duration, that the company uses the application. While different software categories have different average usable durations, there is really no perfect way to estimate this value, and it is diffi cult to know how long the application will be in use in the company. Furthermore, an application that does not work very well can be kept too long—often for political reasons—while an application that is working well can be replaced due to issues that are related to what happens to be popular at the time. Support resources include everyone required to support the application: technical, functional and management. It should never be assumed that the support “load” on internal resources is equivalent, even between applications in the same software category. There is a marked difference between vendors—and the degree to which the applications have been designed to be maintainable. This maintainability can be everything from how easy the application is to use (its usability: more usable applications require less hand-holding to accomplish tasks) to how straightforward it is to update its master data.

Specific Versus General TCO

Developing the TCO estimations is the difficult part. The more interesting part is actually using the TCO, as there many varied uses. TCO can be used specifically or generally. For instance, once one has a handle on TCO for an application area, the TCO can be used to make future decisions after the purchase has been made. After TCO is developed, it can be put to use in supporting decision-making in a variety of ways. Companies should really have TCO analyses performed for all of their applications. It is quite common for companies to make decisions to extend use of their ERP system in some area, usually functionality that is known to be mediocre; however, the decision is driven by the desire to “get more value from our ERP system” or to “leverage our ERP investment.” These can seem like desirable goals, until one begins to look through the lens of TCO. Overall, “leveraging” any current software, be it ERP or other software that the company owns, will not typically save the company more than fi fteen percent of the TCO of the functionality in that area.

Strangely, companies do not estimate their probability of success prior to deciding which project to fund. Instead they take the naive assumption that all projects will succeed, even though IT projects have a high failure rate, even if the exact failure rate and the definition of failure is most often not specified.

Cloud TCO

To make the SaaS TCO estimation fit with the on-premises TCO estimations, it is necessary to add cost categories, which allows both TCO and on-premises solutions to be compared side by side, even though they do not have the same cost components. Simply comparing total costs for each delivery method is the most important issue. Effectively comparing on-premises solutions to SaaS solutions will be an important goal in the future as SaaS increases in popularity. In fact, our view is that a primary reason why SaaS is not more popular is that companies simply are not aware of the substantial cost benefi ts to SaaS-delivered solutions. There are signifi cant differences in how long it takes to implement various applications. Some applications are naturally easier to set up. Other applications are simply designed to enable the vendor to say they have certain functionality. Instead of relying upon good software design, vendors rely upon aggressive sales, paying off Gartner for a good rating and/or their partnerships with consulting companies to get their software sold. Therefore, any TCO evaluation means spending time with the application, either implementing the application or using the application in a real-world setting such as testing the introduction of new master data into the application and rating the diffi culty, or asking the vendor to demonstrate specific functions, which can prove out the implement-ability and usability of the software. One of the most commonly underestimated areas of TCO is the internal maintenance costs. The same issues that apply to the training apply here. Software that is diffi cult to implement is also diffi cult to maintain and vice versa.

The Dominance of Maintenance in TCO

Companies that breathe a sigh of relief after a difficult implementation probably shouldn’t because the implementation difficulty is often—although not always—a good indicator of how much work will be required to maintain the application. Adjusting for the number of users is, of course, extremely significant for any TCO analysis, because the number of users is one of the most important drivers of cost. Applications scale in cost as the number of users increases. Therefore, a TCO that assumes 100 users will be higher with only 10 users—although the costs will not scale in a linear fashion. In fact, other things being held equal, the higher the number of users, the lower the user cost per user. However, the per user cost is not helpful for making value comparisons between software categories, because different applications vary quite significantly based upon the type of application. For instance, the categories of software that are most broadly used are ERP systems and reporting/business intelligence systems, while the categories of software that are used most narrowly include specialty applications such as supply chain planning.

Conclusion

This highlights a main theme of the book that while one TCO study can be useful—which is how TCO is primarily used—its usefulness increases greatly when TCO is performed for many applications and for many software categories. The most important conclusion from the research for this book is that companies do not do anywhere enough to leverage the power of TCO for their decision-making.

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.

    This article is free, we do not answer questions for free. Filling out this form is for those that have a budget. If that describes you, just fill out the form below and we'll be in touch asap.

References

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