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Total Cost Of Ownership Definition
The sum of total price of an asset and the operational costs of owning it gives the ‘Total Cost of Ownership (TCO)’. Asset purchasing decisions should take into account not only the sale price of an asset but also the expenditure that will be required to keep the asset operational. This is the long term cost of an asset and a better measure of the actual price of an asset over time.
A Little More on What is the Total Cost Of Ownership
Investors and companies carefully consider TCO before parting with their funds. These costs are mentioned separately on company expenditures and financial statements. Businesses analyse TCO to gauge the actual price of an asset to balance expenditures and calculate the actual value of business deals. TCO of both direct and indirect purchases is accounted for. A comprehensive analysis of assets and investment TCO can significantly impact the outcome of business transactions.
Example of Total Cost of Ownership in Business Investments
An IT business looking to upgrade to a new server system for its database management needs to consider the TCO of all alternatives available in the market. Some systems might have the most affordable initial purchase price but require excessive expenditure to stay operational for the next few years. While other options might have higher price tags yet require minimal upkeep over the years. Before switching over to the new servers, businesses study the TCO of each option for the next few years and make a purchasing decision that costs less over the long term.
On a much smaller scale, individuals should also consider the TCO of a product before purchasing it. A cheap pair of shoes at $20 needs to be repaired every 2 months for $5. The long term cost of owning the shoe for a year adds up to $50. A decent pair of shoes at $45 need no repairs for two years. So the seemingly cheaper option actually has a much higher TCO than a currently expensive option.
Another example where careful consideration of TCO saves you a lot of money is in the purchase of a car. A cheap car that requires frequent repairs ends up costing you a pretty penny over time whereas a well made car with a higher sale price might need little in maintenance costs.
References for Total Cost of Ownership
Academic Research on Total Cost of Ownership
Total cost of ownership: an analysis approach for purchasing, Ellram, L. M. (1995). International Journal of Physical Distribution & Logistics Management, 25(8), 4-23. This paper explains the concept of Total Cost of Ownership and provides an analysis of this approach for making purchasing decisions.
Total cost of ownership: elements and implementation, Ellram, L. (1993). International journal of purchasing and materials management, 29(3), 2-11. This paper studies the purchasing habits of 9 different firms who implement the TCO approach in balancing their expenditures.
Supplier selection problem: a comparison of the total cost of ownership and analytic hierarchy process approaches, Bhutta, K. S., & Huq, F. (2002). Supply Chain Management: an international journal, 7(3), 126-135. This paper examines the TCO approach in the problem of supplier selection in light of its critical importance to the success of organisations.
An evaluation of vendor selection models from a total cost of ownership perspective, Degraeve, Z., Labro, E., & Roodhooft, F. (2000). European journal of operational research, 125(1), 34-58. This paper evaluates the different vendor selection models for a ball bearings firm in light of TCO.
Total cost of ownership: a key concept in strategic cost management decisions, Ellram, L. M., & Siferd, S. P. (1998). Materials Engineering, 288(288), 288. This paper explains the concept and strategic advantages of TCO in effective management decisions.
Total cost of ownership models: An exploratory study, Ferrin, B. G., & Plank, R. E. (2002). Journal of Supply chain management, 38(2), 18-29. This study explores the concept of TCO in depth.
Purchasing: The cornerstone of the total cost of ownership concept, Ellram, L. M., & Siferd, S. P. (1993). Journal of business logistics, 14(1), 163. This paper highlights the significance of purchasing in the understanding and implementation of TCO.
A framework for total cost of ownership, Ellram, L. M. (1993). The International Journal of Logistics Management, 4(2), 49-60. This paper analyses the trends in the application of TCO by organisations and provides a standard, eight stage framework for TCO implementation.
A taxonomy of total cost of ownership models, Ellram, L. (1994). Journal of business logistics, 15(1), 171. This paper studies different TCO implementation models.
Effectively selecting suppliers using total cost of ownership, Degraeve, Z., & Roodhooft, F. (1999). Journal of Supply Chain Management, 35(4), 5-10. This paper gauges the influence of TCO in the effective selection of vendors and suppliers.
Supplier selection problem: integrating DEA with the approaches of total cost of ownership and AHP, Ramanathan, R. (2007). Supply Chain Management: an international journal, 12(4), 258-261. This paper examines an integrated TCO approach along with Analytical Hierarchy Process (AHP) with the application of Data Envelopment Analysis (DEA) in the problem of supplier selection.
The adoption of total cost of ownership for sourcing decisions––a structural equations analysis, Wouters, M., Anderson, J. C., & Wynstra, F. (2005). Accounting, organizations and society, 30(2), 167-191. This paper analyses the adoption of the TCO approach in sourcing decisions with mathematical models.