Total Cost of Ownership (TCO): still relevant in a VUCA world?
Updated: Jan 17, 2020
How do you approve your IT Budget Plan? What about the follow-up during and at the end of a year? Has it changed a lot during recent years, and does it provide relevant, actionable insights? Chances are you are going through major changes: business changes, technical changes or organisational changes. Probably "all of the above".
Making the right decision for your IT investments and expenses is crucial. However, the majority of companies do not have a clear definition of what “right” is, nor sufficient insights in how benefits and costs relate to each other. Socrates turns around in his grave, inaudibly yelling “understanding a question is half an answer”.
So, let’s take just a little time to go over some basics again. Specifically, we’ll look at the concepts of Total Cost of Ownership (TCO) and the impact of a VUCA world.
What is TCO?
The obligatory definition quote from wikipedia for Total Cost of Ownership (TCO):
Total cost of ownership is a financial estimate intended to help buyers and owners determine the direct and indirect costs of a product or system.
Note that this can be applied to outsourced projects, software packages you purchase, cloud offerings, own developments, etc., and proves to be valuable in comparing them and supporting decision making.
The follow-up list of what aspects make up direct and indirect costs is non-exhaustive, but already mentions dozens of possible items, some of them easy to understand and calculate, some extremely difficult.
Why this many aspects? Because you need to make an informed decision.
Are they all necessary? That completely depends on your situation.
The important thing to keep in mind is that this is a quintessential tool to make the right decision in terms of how much budget is required for a certain choice, and what the best choice would be. If done right, ‘best’ should be equivalent to ‘lowest TCO’. If it’s not, you are not taking everything into account properly.
Example: comparing software packages
You’re looking for a new ERP system, and have narrowed it down to 2 contestants that offer the same functionality. Software A costs 25K€ while software B costs 10K€.
Easy: Software B is selected.
But wait, what if the renewal of licenses and/or support equivalent is 5K€ (20% of initial purchasing license for a support contract) for Software A, and 10K€ for Software B (initial license is a yearly fee).
Not so easy: if we think we will use this software longer than 4 years, then Software A is the better choice, if that’s uncertain (or best practice within the company is to only take 3 year horizons into account), then maybe Software B is the better choice.
There are a number of ways in which this uncertainty can be translated into numbers. For example, we can apply a yearly 20% decrease after year 3. That gives the following adjustment:
It seems to have very little impact which one is chosen.
But wait, there’s more! In both cases there were some functionalities that are needed, but aren’t present in the software. In other words, custom development is needed. Software A allows customizations in .Net while Software B is written in JAVA, and is best extensible in JAVA. Your company has a clear affinity with JAVA development, so the choice becomes more clear again:
Software B is the better choice.
To put this in numbers you can use estimations. Your internal team estimates they can write the required customizations for Software B for 100K€, while an external partner has offered to write the customizations for Software A for 150K€.
We don’t have to show you the conclusion, you hopefully catch the drift by now. For each situation there are numerous aspects that can be taken into account that provide more information on what ‘best’ (or lowest TCO) means.
Not convinced yet? Infrastructure costs, changing/additional requirements, trustworthiness of vendor, integration possibilities, release roadmap for software, how easy to find experts in the marketplace (locally - in case of hiring - and/or globally - in case of potentially offshoring), … are just some of the aspects that can turn the story around again.
Key take-aways
Total Cost of Ownership (TCO) should have a concrete definition within your company, and you should apply some common sense in which aspects are worthwhile investigating (not every case needs the same evaluation).
Follow Socrates' advice: you understand the question, because you keep in mind that ‘best’ should be equivalent to lowest TCO, and in defining this you indeed are a lot closer to answering (you already know what aspects are the most important to you, how you will deal with risks and uncertainties, etc.).
What about the ‘VUCA’ world?
If you are a manager, you’ve undoubtedly heard of the acronym VUCA, which stands for Volatility, Uncertainty, Complexity and Ambiguity. It comes from the military, where it describes the typical combat situation: you shouldn’t train under set or known conditions, but learn to deal with VUCA situations. Business picked up the similarities of modern day business, and re-purposed the acronym.
At a first glance, embracing the VUCA world seems to imply that we should retire our TCO approach, as everything changes so quickly and we don’t know what tomorrow will bring.
However, giving it a bit more thought, quite the opposite seems true. HOW we go about calculating TCO may need to change significantly, but finding a suitable way to gain sufficient information (being well-informed) to make the right decisions is arguably more important than ever in this VUCA World.
Taking the example discussed in the above section; applying the uncertainty degression after 3 years does not really seem suitable in a VUCA World. Knowing how many years to consider for your sector, your compelling events, your disrupting competitors and your transformation is more important than ever to make the right decision, not despite the VUCA World, but because of it.
The IT Ecosystem as basis
Let’s focus for a moment on the C of VUCA: Complexity. Certainly many - if not all - aspects of your business have become more complex. Disruptors in your sector (or constant fear for the first disruptor), more partners, more expectations, faster delivery and diversification of products and business (operation) models are just a handful of complexity examples that keep many managers awake at night.
This overall growth in complexity typically results in an even faster growth in complexity of your IT Landscape. But let us quickly check …
Quick Poll: do you believe that in the VUCA world it is a possibility for you to maintain the complexity level of your IT landscape (to what it was 5, 10,... years ago), or even simplify it?
Of course there are exceptions, but the vast majority of companies (or leaders at those companies) should answer that question with a resounding ‘no'. Sadly, that still seems to be one of the problems we face; that nostalgic yearning for simpler times, where your trustworthy AS/400 solved all your problems (maybe it still does).
If you answered ‘yes’, consider this: are you also that person that swore never to own a smartphone (or even a mobile, for that matter)? Just admit it, you have one now, don’t you?
But seriously, in our experience, it is far safer to bet on a certain level of complexity, instead of hoping that a simple IT landscape is still feasible. Note this:
It is good to try to aim for the simplest solution that suits your needs, just don’t expect that solution to be very simple.
Take a good look at your own company and tell us if we’re wrong… (if you need help seeing how complex your IT is, you can get some inspiration from this method).
It is a general trend that companies who embrace a more complex event-driven, loosely coupled, micro-service oriented ecosystem prove to be better prepared for the future. Accepting the Complexity of IT is not enough, you'll have to recognize that this complex ecosystem is a key enabler to deal with the Volatility, Uncertainty, (Business) Complexity and Ambiguity that will be thrown at you.
Compare it to this: no one will argue that a swiss army knife is the best knife, but in a situation where you don’t know what you’ll need (knife, bottle opener, saw,…), a swiss army knife is often a good choice. The basic foundation allows many tools to be harbored in a standardized way. In the same way, looking at a typical ecosystem setup from a limited use case gives a distorted view, although the overall picture may be very much in favor of an IT ecosystem (e.g.“our legacy monolith could just 'save' something, now we have to consult 20 services in an async manner”).
Bringing it together
The conclusion is fairly straight forward: preparing for a VUCA world means embracing a real IT ecosystem as basis quintessential enabler of your digital transformation. This in turn means acknowledging that a certain complexity (within reason) is necessary. More complexity means more components (cf. more ‘moving parts’), so making right choices at the right time becomes more critical than ever. This leads to the final conclusion and first point of this article: having a good grasp of your TCO is key to your success.
Gaining a better understanding of your TCO also allows you to monitor and evaluate your evolution throughout the years. A very interesting (yearly) study on this topic is conducted by the good people of Computer Economics.
Next steps
Although it is clear that larger budgets are spent on IT, and on top of that, a larger portion of that budget goes to IT Operations, there are some positive effects to offset the increasing complexity and associated costs. One that comes to mind (and you can clearly see the impact in the Computer Economics study) is the general adoption of cloud as infrastructure and application provider.
“Virtualization, the cloud, and other technologies are lessening the need for capital expenditure growth even when times are good.” - IT Spending & Staffing Benchmarks 2019 - (c) Computer Economics
At kuori, we go one step further, and offer a data-driven integration platform as a managed service. This is a next logical progression from the cloud model and complex eco-systems. To keep your TCO under control, and keep a larger portion of IT budgets available for innovative change projects (supporting the Digital Transformation in a VUCA World), these hybrid offerings are a crucial part to consider.
In next installments of this blog series we will delve deeper into some aspects of TCO, and will demonstrate how they can be kept in check. Stay tuned!
If there are specific topics you would like to see covered, let us know in the comments.