What Is the Total Cost of Ownership? (With Examples)

By Indeed Editorial Team

Published July 18, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Total cost of ownership (TCO) refers to the comparison between a product's outright costs and its long-term value. Businesses of all types and sizes rely on TCO calculations to make important decisions about asset managing and production. Understanding what TCO value is and how to determine it is an essential skill to everything from logistics to accounting. In this article, we define total ownership cost, explain how to calculate it, discuss how it applies to various industries, and share examples of this important metric.

What is total cost of ownership?

The total cost of ownership (TCO) is a financial approximation that businesses use to assess the value of a product through its entire life cycle. By accounting for all phases of ownership, you can evaluate the total term and cost of owning an asset. There are several ownership phases, including acquisition, operation, repair and maintenance, upgrades, documentation, and training.

Assessing all aspects of ownership allows you to create thorough and categorized reports. TCO informs both short-term financial choices, through things like acquisition and operations. It also considers long-term matters, including training employees, and maintaining the asset over time. This enables companies to create financial plans for both immediate and future considerations.

Read more: Guide to Basic Accounting (With Concepts and Explanations)

How to calculate TCO

Total ownership cost calculations are the long-term value of assets by considering more than the immediate cost of the product. Totalling the direct and indirect costs enables businesspeople to calculate the return on investment. The lower the TCO, the higher the value of the product. When accountants gather all the relevant information for total ownership costs, it considers many variables, such as:

Acquisition

The acquisition costs a company incurs are the upfront investment it makes into a product or service. Purchasing a commodity requires consideration, meaning the exchange of funds or something of equal value. When the business reports the direct costs of acquisition, it refers to the after-tax expense of the product.

Read more: Guide to Understanding Acquisition Cost (With Examples)

Operation

The operation costs that contribute to the total expense for ownership refer to the daily costs a company pays to use the item it purchases. Within operational expenses is the cost of goods sold (COGS), including the general considerations such as storage. It also factors in the price of selling the inventory and administrative expenses associated with those transactions.

Read more: Understanding Operating Efficiency Definition and Factors

Maintenance and repair

Repair and maintenance represent the expense a company incurs to keep its assets in functioning condition. These costs can range from preventative maintenance on machinery to the expense of security software for a server. While it doesn't show in the cost of ownership right away, calculating its expense before purchase is important. It provides an understanding of the full expenses a company can expect to incur over the long term.

Read more: What Are Maintenance Costs (With Definition and Examples)

Upgrades

When companies consider total ownership cost, the lower the overall expense, the better. Upgrades are important because the return on investment is usually consistent and long term. Examples include building improvements, retrofitting plumbing, and integrating renewable energy sources. In some situations, the acquisition cost can appear high, but grants and incentives for upgrades can reduce the ownership expense.

Read more: Opportunity Cost Formula (With Definition and Example)

Training

When companies integrate new systems and machinery, it can often require significant employee development. Consider a warehouse that changes its manufacturing processes to integrate newer technology. Anyone working with those machines requires information, and that time has an associated cost. Training also considers the expenses of potential errors during the learning process. It represents the expense a company incurs to integrate a new process or system with its human resources.

Read more: What Are the Differences Between Hard Costs vs. Soft Costs?

Documentation

The purchase and accounting of any good or service requires documentation. This aspect of cost of ownership refers to bank and legal expenses that an item costs a company. Initially, the documentation costs include independent legal counsel (ILC) for contracts and accounting costs. If the item requires inspection or ongoing documentation, such as a fire truck, the administrative expense of that paperwork contributes to the ownership cost over the long term.

Read more: What Is Project Documentation and Why Is it Important?

How TCO applies to different industries

Almost every sector uses TCO as a way of assessing whether an investment is worthwhile, either manually or through the use of software. The following industries use total ownership cost calculations:

  • Manufacturing: In the manufacturing industry, the cost of ownership includes the machinery, buildings, products, human resources, and transportation.

  • Architecture: These companies incur significant costs during the development of a building, so calculating the ownership costs of equipment, materials, and land is integral to maintaining a proper budget.

  • Government: Federal agencies use cost of ownership analyses when managing Crown land, during the calculations for grants, and when it hires contractors to for everything from land maintenance to building repairs.

  • Capital investment: Firms analyze the total ownership costs of shares in a company when determining where to allocate funds to optimize the return on interest (ROI).

  • Financial services: These businesses rely on total ownership cost calculations when evaluating credit for borrowers, because the long-term value of a product, such as a loan, is paramount for a financial service provider to generate a profit.

  • IT: Information technology requires an understanding of the long-term financial implications of adding a new service, such as a payment add-on or a new version of a device.

Read more: Examples of Office Job Titles Across Various Industries

Examples of TCO analyses

The following examples represent situations where companies determine the TCO of an asset, then use that information to make a decision:

Investing in software updates

Consider a company that runs 20 offices across the country, each requiring a new accounting software:

The business receives an upfront discount offer of 15% on its acquisition costs on a service, but it has a reputation for lacking user-friendliness. To determine the total ownership expense, the company considers the upfront cost of the technology and calculates the amount of training time it's likely to take to integrate the new system and determine whether the discount outweighs that expense.

The business considers the regular operating expenses, such as requiring more power, time, or data. Another consideration is the maintenance and repair. Because the company sees that the warranty covers any maintenance for five years, it shows a low long-term ownership costs. Because of the efficient document management system, low cost, and positive financial structure for repairs and upgrades, it shows significant value over time. The highest cost is the training expense, and the company determines that it's a worthy purchase after determining the TCO.

Read more: What Is an Independent Software Vendor (ISV)? (With List)

Corporate social responsibility initiatives

Most companies engage in corporate social responsibility (CSR) initiatives. There are several approaches, such as ecological improvement plans and contributions to local food banks. When companies implement CSR initiatives, the expense of the plan is a major consideration. In this case, the CSR is the product. As with other ownership cost analyses, the company seeks a low total. For example, consider a paper company that's choosing between two CSR options:

The first is a reforestation project, with an acquisition cost of $20,000 for affiliation and has operational costs of $45,000 per year, for a total cost of $65,000. Its other CSR option involves medical research, where the total affiliation and operational costs are identical to the reforestation expenses. With an incomplete cost of ownership, they can appear of equal value. Total cost involves the company considering the value of goodwill, branding, and grants for the industry. The company approximates this at $15,000. This reduces the total cost to $50,000, making reforestation the better initiative.

Read more: Understanding Corporate Responsibility (Types and Examples)

Providing delivery services

Here's an example of a company deciding whether to outsource or begin to offer in-house delivery:

The company estimates that it can earn approximately $200,000 per year through delivery orders. It calculates the cost of vehicles, insurance, and training. The business also assesses the maintenance and repairs the vehicles are likely to require within the next three years. Using these calculations, it determines that the total cost of owning an in-house delivery service is $85,000, for the vehicle, driver, insurance, and maintenance. Next, the business compares it to a to major service providers.

To engage in an agreement with third-party delivery services also requires the cost of ownership calculations. The company calculates that a standard delivery services cost an average of 25% of the total delivery sales. Of the $200,000, the acquisition cost of the service is $50,000, and it no longer incurs vehicle expenses and employee wages, resulting in a total ownership expense of $50,000, versus the $85,000 cost of an in-house solution. As a result, the company sees the lower cost of ownership of a third-party service and opts for that solution.

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