How to Use TCO for Better Software Decision Making

Executive Summary

  • Brightwork Research & Analysis creates TCO calculators to help enable better decision making.
  • This is a critical point in how to use TCO estimation.

Introduction

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. This is best explained with an example, and one came up while I was writing this book.

Example: TCO and Continuous Improvement

I was developing a proposal for an audit of an application that was already installed and live. This audit was designed to offer areas of improvement in the application. To provide some context, the following text was used on one of the slides from my proposal presentation:

“In software implementation, much of the focus is on the initial acquisition and the implementation. However, the measurement of optimal usage and received benefi ts can be a tricky proposition. To do this requires seeing the application in a variety of environments, and comparing the confi guration and planning the outcomes. The audit provides important feedback toward the software implementation’s current usage and potential areas of improvement.

1. Some functionality may not be working exactly as desired.
2. An unknown feeling as to how much and/or well the investment in the application is being leveraged.
3. Issues with, or concerns that, the application may not be optimally integrated (both technically and process–wise) to the other applications in the company.”

Many companies are interested in such an audit if produced by an objective source. However, the question of the price eventually comes up, and while a consulting rate can be fiddled with, the biggest issue is the duration of the audit project. Previous audits/evaluations I had performed typically ranged from one week to three weeks. However, those who wanted a shorter audit based their logic upon the idea that the cost would be too high, as the audit would cost between $12,832 and $14,560. There was no way that some of the companies that had spent roughly $100,000 for both the software and the implementation (this was inexpensive enterprise software) would be willing to spend what could be close to $15,000 for an audit—or what amounted to fi fteen percent of the total cost of the software and implementation.

Overfocusing on the Software License

However, the problem with this way of thinking is that the cost of the software license and implementation is not the company’s TCO for the life of the application and therefore should not serve as the estimation of its investment. The TCO studies at Brightwork Research & Analysis show that the software and implementation costs for the application in question represented only about thirty percent of the application’s TCO. Other costs included hardware and maintenance. We can estimate the TCO for customers who spent $100,000 for just the software and implementation (consulting), and this is done in the following spreadsheet.

From this analysis, it does not seem as if the company should be so concerned about the audit’s cost. The cost of an audit is not fi fteen percent of the customer’s cost, but would be between 3% and 3.4% of the application’s TCO. This is a far more logical context within which to make a decision about seeking advice about a solution. Of course, this says nothing about the quality of the audit; this TCO analysis simply provides a context within which to perform the cost-benefit analysis.

The Results of an Audit

The audit can provide good results or bad results depending upon the knowledge level and incentives of the individuals performing the audit. After TCO is developed, it can be put to use in supporting decision-making in a variety of ways, as shown in the example above. 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. When executives state that they want to leverage ERP by utilizing more of that ERP system’s functionality, exactly what is being leveraged should be understood. In fact, the only thing that is being leveraged is the software license fee, possibly some hardware cost and support fee—but not the implementation costs, some of the hardware cost, and not overall maintenance cost.

However, if the hardware cost is taken at a fifty percent value (which either way is a minor portion of the TCO), then the average costs for the license fee, hardware costs, and the support fee across a wide variety of applications come to roughly fifteen percent of the TCO of any new application implementation. And this means not using an application, which would win in a software selection, rather this is simply using the application that happens to be “around.”

Overall, “leveraging” any current software, be it ERP or other software that the company owns, will not typically save the company more than fifteen percent of the TCO of the functionality in that area. Depending upon the situation, there can be more integration costs. However, while the company saves roughly fifteen percent on the TCO of the new functionality/application, making this decision will, in most cases, greatly reduce the ROI of the initiative.

Reducing ROI Through Lowered Functionality

How easy is it to reduce the ROI on a software project by at least fifteen percent? By using software that is not particularly adept in an area compared to competing options, not only is it easy—it is almost assured. According to statistics that are commonly quoted, software implementations have a success rate of roughly fifty percent depending upon how the question in the survey is asked. By our estimates, this is too high, for several good reasons. Some companies that deem the solution to be a success do not know the software area well enough to know how little the application offers over previous approaches to solving the same problem. Off the top of my head I can recall a number of projects where the application does very little to improve on the previous solution, but that truth is hidden from the client by the consulting company or by their own IT department. The business users know, but the executives—who mostly fi ll out the success/failure questionnaires—would not know.

So, trying to save fifteen percent on the cost of the implementation with absolutely no consideration for the potential ROI (which is the dominant approach to software selection and decision making in US companies) is one of many factors that keep the success rate of IT implementations so low, and probably lower than the commonly quoted statistics would lead one to believe. In fact, with IT implementations as risky as they are, the implementing company needs every possible advantage it can get, and trying to save fi fteen percent in what is just one category of costs is not the way to do it. Choosing the best application for the job is the first step in increasing the likelihood of a project’s success.

The End Result of Not Using TCO to Inform Decision Making

Deciding to leverage what is “already purchased” (a misleading term as it should be rephrased as leveraging what is “already fi fteen percent purchased”) will most often mean taking a major hit in functionality and in the ability of the users to perform the activities in the system that the company is asking them to perform. Furthermore, this line of thinking assumes that all other costs—that is the other eighty-five percent of costs—are roughly equivalent. However, they are anything but equivalent. On a direct functionality-to-functionality basis, ERP systems are the most expensive systems to implement and to maintain. This is demonstrated by the TCO studies at Brightwork Research & Analysis. ERP systems are almost always combined with customization, estimates range from 87 to 93% of ERP implementations have from moderate to extensive customization.

This customization lengthens out the implementation timeline, which results in increased implementation costs and higher long-term maintenance costs. This is a primary reason why so many companies have continued to implement uncompetitive functionality in their ERP systems when so many better solutions were available in the marketplace, they are attempting to utilize their pre-existing investment in their ERP system. However, research at our companion site Software Decisions demonstrates that this is a faulty logic as companies can only expect to save 12.5% of the application’s TCO by leveraging the sunk cost of a previously implemented ERP system. Other applications that are specifically designed to meet business requirements (aka best of breed) have better ratings in a variety of compensating criteria. Because of this, it is a simple matter to exceed this cost savings with an increased likelihood of the following:

  1. A Longer Implementation
  2. More Customization Expense
  3. A Higher Risk Implementation
  4. Lower Functionality/Worse Fit of Functionality
  5. Lower Usability
  6. Lower Maintainability

Conclusion

TCO calculations can be used to improve decision making. Making decisions without an honest TCO calculation and estimate is like flying blind. Both consulting companies and software vendors want to their customers to stay as far away from TCO estimation as possible. This allows customers to me moved to the highest TCO solutions which benefit consulting companies and software vendors the most.

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

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