Key Factors in Total Cost of Ownership You Must Know

We know how important it is

Whenever your business is making a purchase, you need to focus not only on the immediate price but also on analysing its overall cost across the whole lifecycle.

It's the best way, after all, to make sure you are keeping things profitable.

But what's the best approach to guarantee you are considering your spending levels in the long term?

Start with a TCO (total cost of ownership) analysis

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What's the Total Cost of Ownership?

Let's start with a simple question. Would you buy a car without checking the cost of repairs and maintenance?

No, right?

Well, TCO works similarly; it looks beyond the upfront price to understand the actual cost of a purchase your business makes.

For procurement, this is absolutely important because it helps you to avoid wasting money on an option that, while at first can look attractive, quickly becomes an expensive headache.

For example, a lower purchase price might feel like a win for your business, but if the product is of poor quality and requires constant maintenance, you could end up spending way more than planned.

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Key Components of TCO

As we've mentioned above, to really get a sense of what the total cost of ownership entails, you must look at factors that go beyond the immediate price of a product.

Here are the most important:

Acquisition costs

Whenever you are considering a purchase, what's one of the first things you consider? 

Pricing?

There's a high chance your answer is yes. 

But once you've looked at the price tag, what's left to consider?

• Shipping fees are especially relevant if shipping overseas.
• Installation costs are included in the price?
• What about if you need to customize the product?
• It's easy to understand or would your team need some specific training? 

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Operational costs

Okay, so let's say that you've purchased the item.

Now it's time to figure out how much is going to cost to keep it operating.

This could mean paying for:

• Energy consumption, should that be the case. 
• Additional materials like ink or replacement pieces.
• Labor costs, in case additional staff is required.

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Maintenance

Here's the thing: nothing lasts forever. Depending on what type of purchase you've made, there's a chance that you're going to run into needing to repair it once in a while.

Ask yourself these questions: 

• How reliable is this product for the planned use?
• What's the expected cost of repairs?
• Is technical service included in the price?

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The final expenses 

At some point, you’ll need to upgrade or replace what you bought. 

That comes with its own costs, such as:

• Disposal fees, some products require special handling to get rid of.
• Resale value, can you sell it, or is it worthless?
• If it’s software, is there a fee to migrate your data?

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Importance of TCO for Procurement 

Do you want to know what makes a purchase successful over time?

Looking beyond first-glance pricing.

Bargains make everyone excited, but for businesses?

It could mean tying yourself to a terrible deal.

You can make better choices 

At any moment, your company could require you to acquire new software. Technology, after all, is here to make our businesses more effective, but what happens if you find yourself torn between two options?

For example, option A has a higher price than option B. The cheaper option might seem like the best fit until you realize it requires costly updates or that you need to invest a lot of money in training your team. After a few years, you’ve actually spent way more than if you had gone with the pricier option.

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Prevents surprises in your budget 

Budget management is crucial to keeping your company's financial value on the positive side. So making a purchase without noticing the TCO can threaten the stability of your budget. Maybe it's because of a machine that constantly needs repairs or software that requires expensive add-ons.

TCO helps you plan ahead, so you’re not blindsided by hidden expenses.

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Financial planning 

And speaking about finances, businesses that focus only on what happens in the short term are prone to make decisions that don't weigh in the impact on the future. 

Considering the TCO of a purchase, on the other hand, allows you to truly assess all the possible if-scenarios so you can deal with fewer financial issues.

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Better supplier relationships 

Yes, for real.

When you understand TCO, you can ask the right questions before signing a contract. 

Instead of just getting excited over the sticker price, you can negotiate on things like:

• Can the supplier offer a better service package?
• Will it save money on electricity over time?
• Is that included, or an extra charge?

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How to Calculate the Total Cost of Ownership 

Alright, now that you know why knowing the exact TCO matters so much , let’s talk about how to actually calculate it.

If you want to keep things simple, you can just follow the following formula: 

TCO = Acquisition Costs + Operating Costs + Maintenance Costs – Residual Value

But what does each concept mean?

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Add up the acquisition costs 

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We start with something pretty easy to do, to know the actual acquisition cost, you have to not only include the initial price but also consider things like: 

• Purchase price
• Taxes and fees
• Shipping and delivery
• Installation/setup costs
• Initial training costs (if applicable)

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Operating costs 

Once you own the product, you need to keep it running. Ask yourself:

• How much does it cost to operate? Think electricity, water, fuel, or software subscriptions.
• Are there consumables? Like ink, filters, or replacement parts.
• Does it require additional labor? Will you need to hire or train staff to use it?

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Maintenance costs 

Every product or service requires upkeep. A piece could be missing a part, or the software could crash. Some questions to consider:

• How often will it need repairs?
• Are spare parts expensive?
• Is there a warranty or service contract?
• What happens if it breaks down? How much downtime will that cause?

Residual value 

Not everything you buy is worthless at the end of its life. Things can be resold, recycled, or traded in. If what you’re buying will have value later, subtract that from your total cost.

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For example, if you buy a piece of equipment for $50,000 and can sell it for $10,000 after five years, your TCO is reduced by that amount.

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Look beyond the numbers 

Do you want to understand what’s moving procurement in the right direction these days?

Start by focusing on things like overall value instead of obsessing only about the price. 

Value-based procurement takes this a step further and considers factors like quality, sustainability, or compliance to ensure that you are purchasing the right product. 

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Pay close attention to:

• Reliability: Will it break down frequently?
• User satisfaction: Is it easy to use, or will employees hate it?
• Environmental impact: Does it save energy or create waste?
• Regulatory compliance: Will you face unexpected fines or legal issues?

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Best Practices for Using TCO in Procurement

Okay, so up to this point, we’ve learned how important TCO is and the simple steps you can follow to get it right, but when procurement becomes an absolute priority and things become a bit messy, you need to rely on the best tips to make the most of the total cost of ownership, right?

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Start early 

For real, this is one of the most common mistakes some business leaders make when they are just starting in the market,  if you don’t become familiar with how procurement works and the relevant TCO has, you are preparing yourself for problems later on. 

Make TCO a core piece of your purchasing processes from the early days. 

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Set standardized processes 

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Procurement is already a complex activity; why would you make things even more difficult?

If different teams use different methods to calculate TCO, you’ll end up with inconsistent and unreliable results. 

Keep it simple and standardize your approach

You can use a general formula for all of the purchases, regardless of its department, and define clearly which costs must be included. 

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Technology, because…it’s obvious. 

Same principle as above

The good part?

Technology like AI and machine learning can reduce the time your team wastes on manually tracking and calculating the TCO of all your company’s purchases, removing potential errors along the way. 

You can benefit from technology by:

• Using procurement software to track costs across suppliers.
• Working with  AI and analytics tools to predict long-term expenses.
• Implementing asset management systems to monitor usage and depreciation.

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Collaborate with different teams 

No single team has the full picture when it comes to costs, so it’s important to bring everyone to the table. Your finance team can help with budget forecasting and depreciation, while operations knows the real-world maintenance and usage costs. 

IT can give you a sense of long-term software and hardware expenses, and end-users? They’re the ones who can tell you how much training time and productivity impact really matter. 

The more perspectives you gather, the more accurate your TCO analysis will be.

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Update your TCO models if needed 

TCO isn’t a once-in-a-while calculation. Market conditions change, new technology emerges, and supplier pricing evolves. Make TCO analysis a regular habit to stay ahead.

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• Review TCO on past purchases to learn from real-world data.
• Update calculations as costs shift over time.
• Look for new cost-saving opportunities, like bulk purchasing, contract renegotiation, or switching suppliers.

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