What is the Total Cost of Ownership?
In addition to total ownership costs, you’ll also find out why they are so important and how they can be reduced!
What is the Total Cost of Ownership (TCO)?
Why are total ownership costs so important?
How do implementation costs affect TCO?
How to reduce total ownership costs?
Summary
The total cost of ownership takes into account the cost of implementing the technology, its maintenance, development, hosting, and licensing, as well as the cost of fixing errors.
TCO is most often presented within several years’ perspective (for example, from a 5-year perspective), which allows for a detailed comparison of the implementation costs and the total ownership costs of technology over several years.
In the rest of the article, I will provide a detailed picture of the Total Cost of Ownership and outline sample ways to optimize these costs. I will also discuss two perspectives that appear in almost every organization and how they approach managing the total cost of owning a given technology. I invite you to read further.
The first step is considering total ownership costs when choosing a given technology. We should be fully aware of their amount to make the most advantageous decision for our business.
To illustrate this, let’s look at a short example.
Assume we run B2B ecommerce on Magento, which launched on October 1, 2023. Here, I present the Total Cost of Ownership for 2023-2027.
Let’s imagine that today is January 1, 2023. Firstly, in the first year, we have the implementation costs of this technology, which amount to 116.480 EUR. The implementation takes 9 months. Moreover, from the perspective of 5 years, we will pay almost 532.000 EUR for this technology. Of course, this includes all costs, such as maintaining the technology, developing the website, updating Magento versions, and hosting fees. There is also the anticipated average annual inflation, which will also affect the total ownership costs.
Let’s look at this website’s maintenance and ownership costs in 2027. We are taking inflation into account and the fact that we allocate 20 hours per month for maintenance and 60 hours for development. In 2027, we will pay 104.580 EUR/USD for maintaining and developing the ecommerce technology.
This shows the costs, which changes the perspective and allows us to approach financial planning differently.
We implemented Magento in the open-source version. We don’t pay for the license, so it would seem that the maintenance and development costs are small however, as you can see—not quite.
The first conclusion is that you should know the total cost of owning the selected technology.
The second is about optimizing technology-related costs. You should rather optimize total ownership costs, not just the cost of implementation.
Why? Because over a few years, the cost of implementation will not have as much impact on the total ownership cost. If you optimize the implementation costs incorrectly, it will reflect high total ownership costs.
Let’s look at an example. Suppose that the implementation cost is 116.480 EUR. However, you may be wondering how to pay less for implementation. Let’s say you would like to pay not 116.480 EUR for implementation but 97.720 EUR.
The natural way is to reduce the number of features, but we assume that you want to maintain the same scope of functionality in the implementation while paying less. How do you achieve this?
It is possible by using third-party modules. Installing a larger number of third-party but medium-quality modules on Magento can reduce the cost of implementation. After all, instead of writing a given code from scratch, a developer uses what already exists, and there is no need to write it from zero.
However, there is a problem. If you use many third-party modules, you will have to spend more hours on maintenance and solving problems (incompatibilities) and less on development after implementation.
You will not allocate the same number of hours monthly as in the previous case. As a result, instead of implementing 3 to 5 new features per quarter, you can only release one. The reason is that out of 80 hours spent on development work, you will devote as many as 60 hours to maintenance and only 20 to implementing new features.
So, you will save 8.400 EUR over 5 years but slow down the growth of the service three times!
The question is whether this is the right way to optimize total ownership costs. In my opinion—not. 1.680 EUR savings a year for three times slower development. It’s not the deal of a lifetime.
In the case of using an extreme number of third-party modules to reduce the implementation costs from 116.480 EUR to 78.400 EUR, I guarantee that you will have to devote most of the work time of your ecommerce agency to solving problems.
In such a case, we devote 0 hours to development. While solving problems, bugs, and errors, we allocate 85 hours a month. This is, of course, a simplification, but it well illustrates the phenomenon.
Ultimately, we paid 526.680 EUR over 5 years, saving only 2.240 EUR compared to the initial scenario. Implementation costs are lower, amounting to 78.400 EUR, compared to 116.480 EUR. The problem, however, is the lack of development of our website.
For 5 years, there has been no development. Is this the proper way to optimize costs? My suggestion is that it’s better to invest more at the beginning, which will allow for more efficient system development. Because after implementation, we will not be spending money just on fixing the entire system and solving constant bugs.
As I wrote earlier, by saving 8.400 EUR over 5 years, our service develops three times slower. Saving only 2.240 EUR over 5 years, our service has not developed at all.
One of the smart ways to reduce costs is to find another ecommerce agency with lower hourly rates (but offers the same good quality of work and code—which is difficult to check at the stage of choosing an agency).
For example, instead of 70 EUR, the rate is 64.4 EUR per hour, which allows you to save about 28.000 EUR over 5 years.
The question is whether a team with a lower hourly rate is as good as one with a higher rate. It is worth considering whether the saving is worth a potential drop in service quality.
Choosing such an agency is advantageous provided that we are sure of the high quality of their work and the software created, but if there are doubts about the quality of their services, it is worth pondering twice whether saving 28.000 EUR ( for 5% less of TCO) compensates for the risk. The final decision depends on the individual approach to risk, and I don’t have a good answer here. Instead, in one of the following posts, I will describe how to check an ecommerce agency before deciding to cooperate.
Another approach is to save on pre-implementation analysis. However, I always emphasize that it is a very important stage.
Let’s assume that instead of spending 16.800 EUR on pre-implementation (business) analysis (see Graphic 1), you only spend 5.600 EUR.
However, if the analysis is less precise and does not accurately reflect the expected final result, coding the online store or B2B ecommerce will simply cost more.
Situations may arise where something was not precisely described in the pre-implementation analysis. A programmer programs something you check it, evaluate it, and decide that it is not what was intended. Changes are reverted, something is done anew, and you settle accounts in the Time & Materials model, meaning that you pay according to the agreed hourly rate for all this work.
Implementation costs more with low-quality pre-implementation analysis.
Let’s assume that we saved 11.200 EUR on the analysis, but the cost of implementation increased by 25% (this is rather an optimistic assumption because it’s not hard to imagine that the cost grows by 50% or 100% if we describe the scope in the business analysis as “a system calculating individual discounts for a Client.” With such a description of functionality, everyone can imagine something different.
The golden rule is that you imagine a quite advanced mechanism of discount calculation, and the agency has something very simple implemented with a module. To sum up, if you save too much on pre-implementation analysis, you will pay more for implementation.
As a result, instead of 532.000 EUR, the total ownership costs amount to 541.240 EUR in the considered case. So we saved on pre-implementation analysis, but the total ownership costs increased for us.
Here, I will use the example of Magento because that is my daily work. I’ve identified 5 elements that affect the reduction of total ownership costs of a given technology.
The first of them is to choose Open Source instead of licensed versions.
If all the features you need can be obtained in Magento Open Source, or by adding a little, we can make up for the missing functionalities in Magento Open Source, then this is a better solution than paying for a license that can cost tens of thousands of euros or dollars annually.
Imagine adding tens/dozens of thousands of EUR annually to 532.000 EUR.
The second element is to reduce the scope of functionality during implementation.
Often, functionality scopes are too large, containing very interesting features that do not significantly impact the conversion rate or average order value and, therefore, do not have a major impact on the revenue generated by ecommerce.
In such a case, we should look for savings by reducing the scope of functionality, not by shortening coding time by the ecommerce agency. Doing so will affect future maintenance costs, and instead of developing the service, we will have to patch errors.
Another aspect that will allow you to better plan the entire system architecture is that during the Magento implementation planning, PIM, integrations, and various tools such as OMS and WMS are often implemented.
However, these elements can be arranged differently to achieve the same functionality. In this way, instead of integrating everything with everything, you can use intermediaries, reduce the number of integrations, and thus lower the costs of implementation and later maintenance. It is also worth having at least one person with the Adobe Certificate: Adobe Commerce Architect Master in the company you plan to hire for Magento implementation. It does not give a guarantee, but it increases the probability that the Magento system will be better thought out and arranged.
The fourth way, which I always recommend, is to conduct a thorough pre-implementation analysis.
If you perform a solid pre-implementation analysis, the estimate at the analysis stage is likely to match the actual implementation costs. However, if the analysis is poorly done and does not accurately describe the expected final effect, then costs will increase during coding.
Instead of implementing what we agreed upon, we will have to make changes and revert some things because not everything was thought through, and functional conflicts appear. Therefore, it is always better to do a precise pre-implementation analysis and not overpay at the implementation stage.
The last thing that affects the total maintenance and ownership costs of a given technology is finding a company with equally good experience and a team but a lower hourly rate.
If you have a company offering an hourly rate of 80 EUR, but on the other hand, you have a company offering an hourly rate of 70 EUR. It is equally a good team that you are 100% sure of, so there is no sense in spending an extra 10 EUR for each hour worked by the ecommerce agency
Total cost of ownership, i.e., TCO is the total costs associated with owning and maintaining a given technology. They include the costs of implementing technology, maintenance, development, hosting, fixing errors, and licenses, in other words, everything we will pay for this technology to be with us and work.
We usually express it over a time perspective, saying, for example, that the total ownership costs for the next 5 years is a certain amount.
An important aspect you should remember is that cost optimization should not be limited to implementation costs alone. Of course, they are important, but you should focus on optimizing total ownership costs from the perspective of management, owners, or ecommerce directors who care about the company’s interests.
You can do this in several ways. I have presented you with 5 options that I consider very good.
