Total cost of ownership (TCO)
Summary definition: A financial metric that calculates the full cost of a product or service over its entire lifecycle.
What is TCO?
Total cost of ownership (TCO) is a financial concept that captures the full cost of a product, service, or investment over its lifecycle, not just the upfront purchase price. It includes all direct and indirect costs incurred from acquisition through ongoing use and eventual retirement.
Key takeaways
- Total cost of ownership (TCO) is the total cost of a product or service over its entire lifecycle, including upfront, ongoing, and indirect expenses.
- Focusing on an item’s overall cost of ownership helps organizations compare options more accurately by taking a more holistic, long-term perspective when examining expenses.
- As such, understanding and using a total cost of ownership analysis supports better financial planning and smarter, value-driven investment decisions.
Why is total cost of ownership important?
By evaluating both direct and indirect costs, the total cost of ownership model helps organizations plan more accurately, compare options more effectively, and avoid unexpected expenses.
This, in turn, also supports better long-term decision-making by highlighting the fiscal impact of ongoing operations, maintenance, and potential inefficiencies, allowing businesses to choose solutions that deliver the greatest overall value.
What factors determine overall cost of ownership?
Total cost of ownership analysis combines upfront costs with ongoing and hidden costs that accumulate over the product or service's lifespan. While the exact factors vary by use case, the final cost of ownership is typically influenced by:
| TCO factor | What it includes |
|---|---|
| Acquisition costs | Purchase price, licensing fees, setup and implementation costs, hardware or software investments, and other upfront capital expenses. |
| Operating costs | Ongoing expenses, such as IT labor, administrative time, utilities, subscription fees, and day-to-day operating costs. |
| Maintenance and support costs | Repairs, maintenance, upgrades, vendor support, and training. |
| Indirect costs | Downtime, productivity losses, errors, rework, and process inefficiencies. |
| Opportunity costs | Lost or missed revenue, delayed projects, and limited scalability. |
| Financing and lifecycle costs | Financing or interest costs, long-term upgrades or replacements, and end-of-life or transition costs. |
How to calculate TCO
The total cost of ownership formula identifies and combines all costs incurred over the asset’s lifecycle:
TCO Formula
TCO = Acquisition costs + Operating costs + Maintenance costs + Indirect costs + Lifecycle costs
For this TCO model calculation, organizations sometimes use a TCO calculator or estimator to compare multiple options, project long-term costs, and perform a more detailed analysis over a defined period (e.g., three to five years).
TCO Analysis Example
Suppose a company needs to compare two payroll systems over a three-year period to determine which is less expensive.
Option A costs $15,000 in upfront expenses but also requires $4,000 in annual support fees and $2,500 in manual administrative labor. Moreover, it also requires $2,000 in annual indirect costs from the added utilities (e.g., increased internet/cloud subscriptions).
Combining these together reveals Option A’s ownership cost as $40,500.
Option A TCO
TCO = $15,000 + ($4,000 × 3 years) + ($2,500 × 3 years) + ($2,000 × 3 years)
$40,500 = $15,000 + $12,000 + $7,500 + $6,000
Conversely, Option B requires $25,000 in upfront costs but only $3,000 in annual support and maintenance, as several lifetime services (e.g., system maintenance, support, updates, etc.) are included with the initial purchase price. This option also, however, requires $2,000 in annual indirect costs, the same as Option A.
Therefore, Option B’s ownership cost is only $37,000.
Option B TCO
TCO = $25,000 + ($2,000 × 3 years) + ($2,000 × 3 years)
$37,000 = $25,000 + $6,000 + $6,000
Thus, despite requiring a greater initial investment, Option B has a lower TCO, meaning it’s ultimately the less expensive choice.
