Calculating Software TCO (Total Cost of Ownership)

What is Software TCO?

Total Cost of Ownership can be defined as an all-inclusive assessment of IT and related costs of a software/solution, including hardware, software, maintenance, management, communications, support, training, opportunity costs due to downtime and productivity losses. It includes all the direct and indirect costs of implementing, maintaining and supporting a software.

Investing in enterprise software can be a huge expense so businesses need to know the true cost to avoid getting into ineffective and costly solutions. Knowing the TCO is essential for calculating the lifetime cost of a software (but it should not the treated as the only thing to consider during the planning and budgeting phase).

Determining the lifetime costs of a software with accuracy can be challenging, especially without the help of technical experts. However, there is still a lot businesses can do to get a fair idea of how much a software solution would cost in the long run, whether on-premises, cloud-based or a hybrid solution.

TCO vs. Price

Price in the software industry generally refers to the upfront or purchase price. TCO on the other hand takes into account all the costs and expenses related to purchasing, deploying, managing and supporting a software solution. TCO includes the complete software lifecycle starting from the time of purchase. TCO not only helps determine the total cost of a particular software, but also helps understand the cost of a comprehensive tech stack.

For example, let’s assume annual subscription of a CRM costs $300. In this case, $300 would be the subscription ‘price’. To calculate the TCO, you would also have to consider all the additional expenses related to implementing and managing the subscription. This includes onboarding, data migration, training, ongoing support, upgrade costs and more. The TCO also encompasses financial and productivity losses due to downtimes or other issues.

Why is TCO Important?

TCO not only helps in budgeting and planning, but it also helps determine the ROI (Return on Investment). Inaccurate calculation of TCO could affect ROI as a business might end up paying much more than their purchase price. Knowing how much a software would cost over time makes it easier to filter out the software that offers the best ROI.

TCO helps businesses avoid unwanted surprises down the road and make smarter buying decisions. A startup might think it’s OK to go for a free CRM in the beginning. But as the number of users increases and more functionality is needed, it has to start all over again with a new CRM. Wasted valuable data means it has to start from scratch and spend more time and money in the long run.

Calculating TCO

The three main costs related to purchasing, deploying and maintaining a software solution are acquisition, operating and resources costs. However, businesses should also take into account other contextual factors, including existing ecosystem and infrastructure, functionality and community support and development.

Acquisition Costs

Software and Hardware

The most obvious acquisition cost is the cost of the software itself and any additional fees/taxes. The acquisition cost of the software can be anything from one-time license/perpetual license and monthly or annual subscription.

Hardware isn’t usually an issue when it comes to cloud-based software, but it’s a huge cost for businesses that plan on building/hosting a software solution themselves. Many cloud-based services providers offer separate license for each user so businesses have to consider the total cost with respect to the total number of users.

Implementation and Customization

Implementation costs include everything related to setting up the solution. Software customizations are usually referred to as extra developer costs and considered as custom implementation cost. It covers customizations that businesses need to make according to their own unique business requirements.

Data Migration and Training

Data migration can turn out to be an additional and unexpected expense in some cases. It’s better to confirm from the provider if it’d charge separately for migrating the existing data to a new system. Some vendors offer free data migration services, but you’d want to confirm in advance how they do that. Training can be another huge acquisition cost, especially when most of the users are not familiar with the software.

Integration and Other Development Work

Businesses that want integration with other enterprise systems require extra development work. That’s especially true if the software they are purchasing does not support the required integrations out-of-the-box. That’s why it’s recommended to pick a solution that offers better integration support even if it initially costs more than other solutions.

Operating Costs

Software Maintenance and Support

Operating costs refer to post-acquisition costs. While many providers don’t charge separately for upgrades and maintenance, businesses need to take into account the costs related to maintaining the software and upgrade plans.

Same is the case with support and additional resources as many businesses have to hire an admin to manage and maintain the software. Data center and security costs are usually not relevant to cloud-based solutions, but they can be huge if you are maintaining and managing the servers on your own.

Additional Licenses and Ongoing Training

Additional licenses are needed when a new employee joins so you have to consider additional costs related to hiring of new employees. New users mean more expense each month, especially for enterprises that don’t want to cut costs on user licenses.

New employees can also translate into extra training hours, while existing employees might also want to expand their knowledge or get training on a specific feature/functionality. Additional integrations can be another operating cost when more integrations are needed down the road.

Downtime/Opportunity Cost

Although the chances of regular downtimes are low when working with a reputable cloud services provider, it can still happen. Costs due to downtime or other issues are considered as opportunity costs. That’s why businesses have to factor costs related to downtime, including loss of productivity, customers and other ‘opportunities’.

Resource Costs

Businesses have to take into account costs such as salaries of additional team members or consultants who have to manage the software. These costs can go higher if you have a custom software as additional IT staff is needed to secure and maintain the software. You might also need to hire a strategy/process consultant if the provider does not offer adequate resources.

Although consultants can fill this gap and prove to be highly beneficial in the long run, businesses have to hire them for a specific purpose, which makes hiring them an additional expense. Some service providers also offer consultation services. This is a better financial option in most situations as their recommended consultants are more familiar with the solutions.

TCO Calculation Missteps

Focusing only on short-term costs

Many businesses make the mistake of only considering the short term and initial deployment costs. TCO covers the entire software lifecycle and helps businesses plan for the long run. Factors such as ongoing training, employee turnover, future customizations and upgrades must also be considered to get a clearer financial picture.

Not Engaging Experts During the Planning Phase

Individuals with technical expertise should be engaged in the budgeting process for a thorough and accurate IT budget. Businesses that do not have such in-house professionals can hire services of a consultant who has the expertise and experience needed to develop a funding proposal. Similarly, organizations should also spend time with the users to carry out and continue user research throughout the project lifecycle.

Overlooking Costs Unique to a Project

Not all projects are equal and some might have unique costs associated with them. Sure, you might have completed a few projects and already have an idea about the costs involved. But you might not be able to get a complete picture if you are treating all the projects the same way. TCO should be established keeping in view the current ecosystem, market situation and other contextual factors.

Cost Management

While TCO can help a lot in the budgeting and planning phase, managing and controlling costs remains an important element of the software lifecycle. A lot needs to be done to ensure that everything remains in the budget, including educating users of the damage/usage policy and encouraging them to stay vigilant with the hardware and software.

Wrap-up

TCO helps determine an accurate ROI and is especially useful when comparing in-house and cloud-based solutions. TCO goes far beyond the initial price to provide a clear financial picture of a software purchase and helps clearly differentiate ‘the price’ and the long-term cost. There are many online tools available (most of them are free) that help determine the TCO over the years. Such tools can be a good starting point, but they certainly cannot replace the expertise and professional services of the IT staff/consultants.

Vendors tend to manipulate the true TCO, which also varies by installation. That’s what makes doing your own home work so important and enables businesses to drive the agenda. Costs such as opportunity and risk are hard to define and vendors often use this to their advantage by trying to make other providers seem riskier. Each solution has its own sets of pros and cons, but a thorough analysis makes the choice easier and ensures that you get the best value for your long-term investment.