Whether you’re purchasing new office equipment, business software, or an industrial production line, a customer’s first question is, “How much will it cost?” While this question may seem obvious, it can be one of the most costly financial mistakes a company can make. The true measure of an asset’s economic value is not the purchase price, but the total cost of ownership .
Total cost of ownership (TCO) is an analytical concept and strategic approach that considers all direct and indirect costs associated with the acquisition, use, maintenance, and disposal of assets throughout their entire life cycle. This concept reveals the financial reality of our decisions and helps avoid costly surprises.
What are TCO and why is it dangerous to ignore them?
Total cost of ownership (TCO), a concept first proposed by Gartner in the 1980s, has become the gold standard in financial management and procurement.
Let’s consider a simple example: Suppose you buy a printer. Printer A costs 500,000 tomans, but its cartridges are expensive and have a low capacity. Printer B costs 1 million tomans, but its cartridges are affordable and have a high capacity. Considering only the purchase price, Printer A appears cheaper. However, when calculating the total cost of ownership (TCO) over a year, Printer B is the cheaper option.
This simple example illustrates the principle of total cost of ownership: Reducing acquisition costs does not necessarily lead to a reduction in operating costs. Neglecting total cost of ownership can lead to:
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Loss of productivity and increased downtime
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Unforeseen expenses for maintenance and repairs
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High energy and resource consumption
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Low customer and employee satisfaction
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Ultimately, profits will be smaller and losses will be larger.
Components of the total cost of ownership (TCO)
To calculate the total cost of ownership, identify and classify all costs incurred since determining the asset’s useful life. These costs can be divided into two categories:
1. Purchase price:
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Purchase price: The initial cost of acquiring an asset.
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Shipping and handling costs: Costs for delivery, insurance, installation, and setup.
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Financing costs: These include interest and fees if the purchase is made through a loan or lease.
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Training costs: Training users in the use of new assets.
2. Operating and maintenance costs:
This part forms the basis of the total cost of ownership and is often the most expensive, but is often overlooked.
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Energy costs: the property’s consumption of electricity, fuel, water or natural gas.
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Maintenance costs: These costs include regular repairs, scheduled maintenance, spare parts purchases, and professional labor costs.
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Productivity costs: Costs associated with equipment downtime or failures that result in production interruptions, lost revenue, and wasted employee time.
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Rental costs: The cost of renting or using the space in which the asset is located.
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Insurance and taxes: Property insurance and related taxes.
3. End-of-life costs:
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Selling or disposal costs: the costs of dismantling or transporting the equipment to a landfill or recycling facility.
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Costs of recycling or disposal: in accordance with environmental legislation.
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Residual value: The proceeds you would receive from selling the asset as scrap or used (the negative number in TCO calculations less the total cost).
How do you calculate and analyze total cost of ownership?
To calculate total cost of ownership, you need to collect data and create forecasts. The general steps are as follows:
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Determine the time horizon: First, you need to determine the useful life of the asset (e.g., 5, 10, or 15 years).
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Identify all costs: Using finance , technology, and operations, list all cost components for this period.
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Quantify costs: Assign a monetary value to each cost item. For future costs (e.g., repair costs in year five), use forecasts and historical data.
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Calculate the time value of money (NPV): Since the value of money today differs from its value tomorrow, use the discount rate to convert all future expenses into their present value (NPV). This significantly improves the accuracy of the analysis.
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Summarize and compare: Add up all discounted prices to determine the final total cost of ownership. Now you can compare the total cost of ownership for different options.
A simplified formula for total cost of ownership (excluding the time value of money):
TCO = هزینه کسب + (هزینه عملیاتی سالانه * تعداد سال) + هزینه پایان عمر - ارزش اسقاطی
Real TCO cases in various industries
Example 1: Company car
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Option A: Buy a car worth 800 million tomans that has high fuel consumption and is expensive to repair and replace.
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Option B: Buy a car worth 1.2 billion tomans with very low fuel consumption (hybrid), long warranty and low maintenance costs.
A five-year total cost of ownership analysis shows that the more expensive car (option B) is cheaper in the long run due to fuel savings and lower maintenance costs.
Example 2: Selecting a storage tank (as described in the previous article)
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Option A: Steel tanks, although less expensive, require regular painting and cathodic insulation, but are subject to corrosion and must be replaced after 10 years.
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Option B: A fiberglass tank, which has a higher purchase price but requires no maintenance, is corrosion-resistant, and has a lifespan of up to 20 years.
Over a 20-year period, the total cost of ownership of a fiberglass tank is significantly lower than that of a steel tank because there are no maintenance costs, no downtime, and no premature replacement.
Example 3: Customer Relationship Management (CRM) software
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Option A: On-premises software with high initial licensing costs and the need for a dedicated server and IT staff for support and updates.
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Option B: SaaS (cloud-based) software with a monthly subscription fee, hosted and updated by the provider, easily scalable.
For small and medium-sized businesses, cloud software is often significantly more cost-effective because it eliminates significant infrastructure and personnel costs.
How can total operating costs be reduced? Practical solutions
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Focus on quality and reliability: Invest in high-quality equipment that has less downtime and requires fewer repairs.
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Pay attention to energy efficiency: Choosing appliances and machines with high energy efficiency (e.g. with energy label A) can lead to significant savings in total operating costs.
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Preventive maintenance program: Regular maintenance can prevent serious and costly failures.
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User training: Trained users use the equipment correctly, reducing wear and tear and downtime.
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Consider the final cost when purchasing: choose products with a high recycling rate or a high scrap value.
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Leveraging technology and the Internet of Things: Real-time monitoring of plant performance can predict failures and optimize energy consumption.
Conclusion: Total cost of ownership is a strategic necessity.
In today’s competitive world, smart managers focus on total cost of ownership (TCO) rather than acquisition cost. TCO goes beyond information technology. It is a competitive advantage and a decision-making culture that ensures optimal resource allocation, greater profitability, and financial sustainability.
The next time you’re planning a major purchase, ask yourself and your procurement team, “What will the total cost of ownership of this solution be over the next five years?” The answer could change your company’s financial trajectory. With a total cost of ownership approach, you’re investing in the future, not the present.