Definition of TCO & ROI
Every product has a cost associated with it. But it's not only the money you pay for it when you buy it. If it's a capital or long-lasting item, it'll have additional expenditures during usage and operation, such as maintenance, repairs, operating materials and energy, training, disposal, or return.
Not just the purchase price should play a role in determining which product is the most advantageous over the whole life cycle before making a purchase. All costs incurred by the product during the course of its useful life must be compiled and examined. Analyze the total cost of ownership to do so (TCO).
The Total Cost of Ownership (TCO) refers to the cumulative costs, that a DP structure causes. It includes the acquisition costs of soft- and hardware, initial installation and introductory costs (planning, consulting, training etc.) as well as running costs for support and updates.
There are systems that do not have acquisition costs (e.g. Open Source), but there are no DP systems, that do not entail running costs. For the investment into a DP system to pay off, the running costs have to be considerably lower than the profit.
The savings potential calculated against the TCO over a certain time reveals the ROI (Return on Invest), the profit a company makes through the DP system.
Since the initial investment is higher - in comparison - than the running costs, the point of time at which the investment into a DP system starts to pays off for a company can be calculated – this is called the payback period. This time is obviously shorter for DP systems with a low initial investment than for systems with a high initial investments.
What are the advantages?
The evaluation of all probable expenses across the course of a commodity's or capital good's whole service life is an important decision-making tool. This allows you to choose the most cost-effective or profitable solution. Anyone acting on a cost-cutting basis must conduct adequate analyses. Investment and profitability estimates must be supplemented to account for the complete life cycle of a product as well as the complete duration of usage from the perspective of the customer and user.
The following examples demonstrate the importance of total cost of ownership in purchasing decisions. As a result, many solution ideas, products, or supplier services have emerged.
- a variety of buying prices
- different performance characteristics and application options
- different expenses for the client during the course of usage
However, the expenses are either difficult to calculate or are forgotten throughout the period of use. They're also known as "hidden charges" because of this. These costs are shown in the total cost of ownership analysis and are factored into the profitability calculation.
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