Hidden elements in Total Cost of Ownership

The software solutions space has introduced a concept of cost called Total Cost of Ownership [TCO]. It was first introduced by IBM and now is being used throughout the industry. The cost of any service related product or service oriented product has to have this concept. The price or cost at the time of buy is much less than the recurrent cost that incurs annually. What is annually accrued is much more in types and nature. Many other factors add to the total cost which is incurred in intermediate periods within one year.
The set of annually charged costs that one gets aware, because they are published are:

• Annual license cost
• Annual maintenance cost
• General upgrade cost with documents and write ups
• Cost for extra documents and cost of special access to company resources on-line or off-line.
• Upgrade cost from a lower version to upper ones.
• User addition cost
• Storage addition cost
• Cost of ancillaries or cost of corrupt files resolved through sending patches.
• Specialized support cost
• Customization cost.
• Cost of integration with other products.

Some of these costs may be clubbed with the primary cost at the time of buying. In any soft-solution case the cost of all these after-sales elements add up much more than the prime cost. There are companies who lower the sale-time-cost and cover it up through these elements once the customer becomes captive. In the old fashioned price benchmarking these companies would declare their one-up-man-ship through this machination. TCO gives a comprehensive quantitative measure of the buy. This way the customer and the seller would be in a better transparent mode conducting business.

A more accurate TCO from economic accounting point of view is to rationalize the future costs down to the present value at the time of buying. If a product is targeted for three to five years [ in normal accounting terms a ICT hardware is deemed to be used only for three years and therefore the depreciation per year for any machine is 33%] then the cost at the end of each year has to be rationalised to present value and that cost is the corrected or adjusted TCO.
Comprehensive but not quite complete

There are other costs- hidden as they are never published and more challengingly they are not standard. These costs may not be charged by the seller company but would be incurred at the buyer’s end. The present day concept of cost is that portion which is charged by the buyer from the seller and is taxable. The cost that is incurred at the buyer’s end is an expense account and does not attract any sales tax or regulatory taxes. This is the missing link. Typical of these costs are any combination of the following:

• Cost of upgrade in terms of re-education or re-training cost for the users.
• Cost of loss of productivity during the training period.[cost of familiarization]
• Cost of loss of productivity [ negative opportunity cost] of the time required by the users to come up to the pace commensurate with the previous version or to the optimum pace under the circumstances [cost of productivity]
• Cost of co-ordination with new employees on board or new set of employees who have joined the group [cost of orientation]
• Cost of change management. [any change within a corporate structure requires a system change of work-flow, many explanations and hand-holding is needed between the consumers of the output, stakeholders, users and other systems.
• Differential cost of utilizing support tickets, time, effort etc for this upgrade.

These elements are more or less universal incurring periodically or with any change. Added to this cost is another set of hidden cost and that is the cost of attrition. Software industry is known for its high attrition- software skills in use and development will always be less in supply than it is needed. Staying 5 years with the same company is a tall demand. Attrition can happen at any time and since this is a soft skill and hi-tech no sort of bonds or restrictions can get the fullest productivity from any employee if restricted or forced. So people fly to better opportunities. Acquiring new employees is a huge cost. The new employee needs to be oriented, trained, acclimatized, gelled with the group and then brought to the pace – this is time consuming and therefore cost incurring. Acquisition of any employee from the market has its own set of costs in terms of searching cost, cost of outsourcing the recruitment, cost of probable relocation etc. All these are tangible costs and companies do have thumbnail figures with respect to the skill set and the salary value of the company. Then the biggest chunk is the addition of one more employee in the insurance basket. The regulatory payments for a leaving employee need to be paid in cash, this was not demanded when the employee was working. Thus the total cost of change of employee is a composite figure and comes up to be really high. The profit of software industry was being eaten up by attrition; it was never directly and immediately felt because of the accounting practice or the accrual basis of accounting.

A new skill or a changed skill-set often demands exodus of the previous set of employees either in bulk or in streams. This becomes painful if the change in software culture is quite drastic. If the change is to a generally available in the market the effect may not be that acute and receiving people may not be that sharp, but on the counter-foil the attrition rate would be high. So it is a very tricky tight rope walking.

Buyer companies hardly have any choice- they cannot decide for a serious enough time periods not to follow through, because the selling company would stop supporting older versions. This therefore is a major drain. Fast obsolescence thus is always a big drain from the coffers of the buyer. This is therefore one crucial factor in the make-or-buy kind of decision matrix for a software tool. Again on the flip-slide to get people to work for a niche and highly customized tool would be very challenging. Incumbents may not be interested to work for so niche a company, and therefore their prices would be prohibitive. This differential of a specialized person from the general market value of a popular software is a veritable cost element.

Rate of TCO over time
Generally the TCO element reduces over years or over time. Every software has its own set of life-lines or life-times, incidentally it is not singular but plural. A software may go out of vogue in the general market in some finite number of months – say X, the seller company may have already moved over to the next version and that may be in Y months. In general as in today’s fast-forward age Y < X. But then the user company owing to their own rationale may want to use the software for Z months- and in almost all likelihood Z is >X>Y. these three numbers form a vector for the product’s life-time. Z-X is usually beneficial to the user company if the user company may resist or avert attrition. If attrition hits in between the user company is in for a disaster! One cannot make any average of these three periods and get a meaningful estimate- it would not make much sense! The Z value actually is to be decided more or less during the time of buy and there lies the acumen of the decision makers. The cost of ownership however goes down with growing years.

The rate of Total Benefit of Ownership however goes up with the years within the number of finite years of lifetime. The optimum level of benefit is generally [as found in studies] is about ¾ the total life time that is the Z value. After this time the value addition or the Benefit obtained dips down with a very fast rate.

The net added value in any time is the TBO-TCO, this ratio has to increase with every passing year [ the first derivative of this value I,e ∂(TBO-TCO)/∂t has to be positive throughout the allowed life-time] for a negative value the software needed to be commissioned out.

Commissioning out a software tool is another cost. Though every company commissions out a version or a software tool in parallel to the running of the replacing tool or version- this duplication of job will have a cost associated. This cost has to be factored in [another element of hidden cost] . De-commissioning cost is a composite cost that has no standards and will vary from firm to firm in types, numbers and quantity. Error in the actual versus the previously estimated is a challenge that will be revisited every time there is a de-commissioning event. The error factor is another cost and should therefore be very carefully estimated. If the estimated value is more than the actual then the gain amount will hit the profit and loss account as a gain and will incur a tax – that again would be a cost and a drain. The challenge is most crucial in any quantitative change management.

Closing statement
With more complexities in the market and with more competition rising and with more number of years through which the industry matures the hidden elements of TCO would increase. A business decision maker’s keen business sense is put to test in such crucial moments in the life time of the product solution. A mere awareness is not enough, the culture need to be habituated in and in due course the industry some day would come out quantifying and comparing numbers.