- The total cost of ownership, or TCO, for software, is critical to estimating the ROI of a technology purchase. Despite this, the TCO is often overlooked or greatly underestimated during the purchasing process because it’s challenging to nail down.
- Research evaluating software costs is typically biased, vendors often only publish partial TCOs or provide information that encourages businesses to underestimate the lifetime costs, and custom calculations often exclude critical expenses.
- Using online calculators and outside software selection experts can lead to more accurate TCO estimates and better software purchasing decisions.
Introduction to Why TCO is Critical for Estimating the ROI of software
Enterprise companies often look to estimate ROI before every significant purchase. When it comes to enterprise software selection, calculating the total cost of ownership, or TCO, is critical for evaluating different products and estimating the ROI for a purchase.
Unfortunately, companies looking at migrating to new software often accept promotional figures for TCO provided by technology vendors or consultants who have partnership relationships with them. That’s because calculating the TCO for enterprise software is challenging, and often businesses that take the time to calculate it sorely underestimate the lifetime costs.
To help you make better-informed software purchasing decisions, below is a list of challenges to determining the TCO of enterprise software and tips for overcoming them.
Research Evaluating TCO is Often Biased
Many people in enterprise businesses often don’t realize that software vendors pay popular software research companies such as Gartner. This can lead IT leaders in companies to over-rely on research that has a hidden bias.
Just because research companies present a side-by-side analysis of competing software vendors, doesn’t mean that the information presented is 100% objective. Often software companies that pay for research end up having the lowest TCO in these studies.
When relying on studies for TCO calculations, do your homework on the organization behind the research to identify any potential business partnerships that could lead to biased findings. If possible, hire an independent company to evaluate the TCO for software products your company is considering.
Vendors often publish “partial” TCOs
An accurate estimate of the TCO for software should include both direct and indirect costs associated with the use of the product. Despite this, many software vendors will leave out critical indirect costs to make their TCO appear lower in advertising materials. At Brightwork, we often call this figure the “PCO,” or Partial Cost of Ownership, because critical variables, like post-go-live functionality improvements, are often left out.
When evaluating a software vendor, ask the sales consultant for a breakdown of what costs are included in the TCO. Estimates should go beyond the upfront software cost, user licenses, and maintenance, and include implementation and training costs. Software vendors providing TCO estimates that don’t account for functionality improvements after post-go-live are probably being a little too rosy in their calculations.
Vendors and Sales Consultants Encourage Underestimating
Along the same lines, software vendors often encourage partner consultants to use formulas or information that leads companies to underestimate the TCO.
Take SAP’s HANA software, for example. The software is sold on a per Gigabyte (GB) basis, meaning it’s priced based on the size of a business’s database. As covered in our article, How To Understand Pricing of S/4HANA and HANA, the information SAP provides for determining database size often leads firms to initially underestimate the number of GBs they’ll need. Companies that purchase HANA often go over initial budget estimates when they are forced to buy more GBs of HANA after implementation.
The strategy behind this is, again, to make the TCO look a bit rosier than it is to make the software a bit of a more comfortable sale. Unfortunately, blowing estimates for the TCO hurts company profit margins and jeopardizes resource allocation in other critical aspects of the business.
A way to avoid falling into this trap is to work with independent consultants who don’t accept software sales commissions and have experience working with the products that your company is considering purchasing. These experts, firstly, will only have one financial incentive — to help your company make the most informed decision. And, secondly, they’ll know the specific “surprise” costs that come up after a particular purchase of software, so you can make sure to budget them into your TCO calculation.
Custom TCO calculations Often Leave out Critical Variables
Businesses that decide to go beyond vendor-provided figures and calculate the TCO of the software in-house will often leave out critical variables, or expenses. Or, they may not have enough knowledge of the software to predict the surprise above costs.
When calculating the TCO, businesses should sum up the costs associated with the software and user licenses, hardware for on-premise products, implementation, maintenance, and lifetime improvements like new functionality.
Additional variables that should be considered include the cost of data migration, initial training and future training for new employees, potential downtime costs, upgrades for on-premise software, and application security.
Conclusion: Start with a Calculator and then Bring in an Outside Expert
With so many variables to consider, it makes sense to start with an online TCO calculator for a ballpark figure and then bring in an expert to fine-tune your estimate.
Brightwork has independently developed TCO calculators for over 50 of the most famous enterprise software applications. These calculators, which only require essential inputs, are free to use. Each calculator has been thoroughly tested and validated by companies implementing the software.
That said, it’s essential to consult with an enterprise software selection expert to ensure that you get the most accurate TCO possible. Our calculators incorporate average business costs for variables such as implementation. Still, every company will have different expenses depending on external costs and the number of internal resources that can be applied to new software migration.
Additionally, these experts can help you analyze the less tangible benefits, such as cost savings your organization can achieve from increased productivity and efficiency with new software.
When faced with a decision on where to invest millions of dollars over a 7-to-10 year time span, there is a clear ROI for outside expertise that helps a company overcome the challenges of determining TCO and purchase the right software.
The Necessity of Fact Checking TCO
Software vendors and consulting firms do not want buyers performing a TCO estimate — unless they can be crowned as the TCO champion. This is the research result of our book on software TCO.
We ask a question that anyone working in enterprise software should ask.
Should decisions be made based on sales information from 100% financially biased parties like consulting firms, IT analysts, and vendors to companies that do not specialize in fact-checking?
If the answer is “No,” then perhaps there should be a change to the present approach to IT decision making.
In a market where inaccurate information is commonplace, our conclusion from our research is that software project problems and failures correlate to a lack of fact checking of the claims made by vendors and consulting firms. If you are worried that you don’t have the real story from your current sources, we offer the solution.
Getting to the Detail of TCO
The Mechanics of TCO
- Understand why you need to look at TCO and not just ROI when making your purchasing decision.
- Discover how an application, which at first glance may seem inexpensive when compared to its competition, could end up being more costly in the long run.
- Gain an in-depth understanding of the cost, categories to include in an accurate and complete TCO analysis.
- Learn why ERP systems are not a significant investment, based on their TCO.
- Find out how to recognize and avoid superficial, incomplete or incorrect TCO analyses that could negatively impact your software purchase decision.
- Appreciate the importance and cost-effectiveness of a TCO audit.
- Learn how SCM Focus can provide you with unbiased and well-researched TCO analyses to assist you in your software selection.
- Chapter 1: Introduction
- Chapter 2: The Basics of TCO
- Chapter 3: The State of Enterprise TCO
- Chapter 4: ERP: The Multi-Billion Dollar TCO Analysis Failure
- Chapter 5: The TCO Method Used by Software Decisions
- Chapter 6: Using TCO for Better Decision Making