Reducing risk with the Total Cost of Ownership (TCO) methodology

As a simple example, consider the price of an airline ticket. Which is less expensive: a £1,000 fully refundable fare or a £500 non-refundable ticket? The answer depends on the likelihood of a change in plans. This is not trivial; airlines make considerable revenue related to change fees. That same risk is generally ignored in Total Cost of Ownership (TCO) studies.

For most companies, TCO is becoming a relic of a simpler time as the cloud makes cost and risk projection simpler and nimbler. Read our white paper to learn more:

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Technology is changing quickly. The way we worked just 20 years ago is practically unrecognisable today. The rates of technology and change continue to increase, yet our decision-making tools and methods have not being adapted. Studies are primarily used to compare capital purchase alternatives. The traditional five-year depreciation schedule was built for fixtures and furniture. A desk depreciates over time, but services don’t.

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What is TCO?

Professionals familiar with the IT capital acquisition process know the importance of conducting a TCO evaluation. TCO, or Total Cost of Ownership, is a methodology that provides an estimated financial analysis of the asset in question.

Unfortunately, this venerable tool can be highly misleading when used to evaluate cloud services. Cloud-delivered services are disrupting many assumptions and practices, and the TCO methodology is one of them. The problem with most TCO studies is they don’t factor risk.

 

So why TCO?

When the TCO concept was popularised in the 1980s, computing choices had become so diverse that initial pricing was no longer indicative of overall costs. PCs were displacing mainframes with lower initial costs, but higher administrative costs.

The output is a best-effort forecast. Its accuracy is as good as the quality of the assumptions that go into it. In the past, these assumptions were applied equally to all options. A material change in assumptions would not only change the TCO calculations but could easily change the preferred solution as well. For example, a growth rate of 10 percent vs. 20 percent could have significant implications for a TCO study.

Although the analysis may not show it, one key benefit of cloud-delivered services is an improved ability to adapt to changes. Cloud services eliminate the risk of outgrowing hardware. They can adapt to location changes associated with new or closed office locations. Further, cloud services reduce the adoption risk of new features by eliminating their upfront costs. Organisations can adjust services and change providers with far greater flexibility than traditional premises-based models allowed – effectively transferring the capital and human risks to the provider.

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10 August 2017 | Jamie Ward

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The views in this article are the personal views of the author and are not necessarily endorsed by Gamma.