Total Cost of Ownership (TCO) is the sum of all direct and indirect expenses incurred throughout the entire life cycle of owning or using certain large-scale assets. It is sometimes referred to as life cycle cost analysis. TCO factors in costs accumulated from purchase of the asset all the way to decommission. This typically includes costs for installing, deploying, operating, upgrading, building and maintaining the asset. This offers a more accurate basis for determining the value of an investment than the purchase price alone since TCO analysis includes the obvious costs and the “hidden” costs of ownership.
When making a decision about a significant purchase that greatly affects maintenance or operating costs, TCO analysis should be conducted to determine the viability of the purchase. TCO analysis can help determine the best methods of acquiring and planning for a variety of assets, including construction projects, equipment purchases and large-scale lighting applications. Assets that consume energy, such as lighting, can have significant maintenance or operating costs during the life cycle of the asset.
TCO analysis for these types of assets focuses on:
- managing asset life cycle
- prioritizing capital acquisition proposals
- budgeting and planning
- selecting a vendor
TCO in the Construction Industry
The Construction Management Association of America defines TCO in the real estate and construction industry as the total cost of designing, constructing, operating, and maintaining a project throughout its useful life.
Because the construction industry is so fragmented, it has been slower than other industries to adopt integrated design and sustainability. Owners tend to establish minimum design specifications, which can be decided by local governmental bodies. These local codes do not always integrate the most sustainable practices. Another issue is that numerous consultants, sub consultants, contractors, and vendors all work with competing interests.
The “Construction Industry Cost Effectiveness Project” of the Business Roundtable reported the following as far back as 1983:
By common consensus and every available measure, the United States does not get its money’s worth in construction, the nation’s largest industry. The creeping erosion of construction efficiency and productivity is bad news for the entire U.S. economy. Construction is a particularly seminal industry. The price of every factory, office building, hotel or power plant that is built affects the price that must be charged for the goods or services produced in it or by it. And that effect generally persists for decades. Too much of the industry remains tethered to the past, partly by inertia and partly by historic divisions.
These influences impact the measurable life cycle of an asset, including; acquisition, deployment, operation, support and retirement.
Direct & Indirect Costs
The typical TCO model uses two major categories to organize costs; direct and indirect costs. This example uses a construction-related project:
1) Direct costs
These costs typically refer to materials, labor and expenses related to the production of a product. Divide those costs by the expected life of the asset to get an annual figure. This includes the costs of:
- All associated materials (everything from paint, to flooring to lighting)
- Annual maintenance costs
- Operations (labor costs and the fully loaded facilities costs for the appropriate share of the floor space used for equipment and furniture)
- Administration (finance, HR, administration and procurement department costs, plus training)
2) Indirect costs
These costs are less visible and are usually dispersed across the business operations organizations:
- End user operations, such as any ongoing end user support within the organization. These costs are identified as part of the project or investment and are easily tracked and computed.
- End user costs incurred when individuals gradually evolve to become part of the support structure, such as facility maintenance personnel.
- Downtime or when the process is interrupted from the regular work. This occurs when equipment breaks or when there is human error.
Property taxes or some type of usage tax are paid by most equipment owners. Taxes can be calculated by either using the estimated tax rate multiplied by the actual value of the equipment, or by multiplying the tax rate by the average annual investment.
Tools for Calculating TCO
There are a variety of tools available for calculating TCO. These include:
- Software companies
- Companies that provide TCO calculators geared directly to their own products or service offerings
- Specific industries that provide TCO calculators and instructions for their category of business, such as the lighting industry, with organizations including:
Total Cost of Ownership analysis is a critical element when making the decision to purchase certain large scale assets, but there is still more to be considered. Other benefits of doing business, such as acquisitions, enhanced product quality, increased sales revenues, quicker information exchange or an improved competitive environment are not covered. If TCO analysis is the main focus when making the purchase decision, it can be assumed that these benefits are fairly the same for all decision options, and that management choices differ only in cost.
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