Other, Less Obvious Considerations for Calculating the Total Cost of Ownership for ERP

We’ve already covered all of the big costs a business needs to consider when calculating the Total Cost of Ownership for a new ERP solution. However, a full calculation for TCO is not complete without considering all of the less obvious factors that can (and will) play into your Total Cost of Ownership.

The following illustrates various hidden costs and unforeseen considerations that should be part of your ERP TCO calculations.

Capture All the Costs

There are the obvious, reliably estimated and anticipated costs that are clearly identifiable when first considering TCO. Then there are the hidden, unknown, indirect, or unreliably estimated costs that could end up being a material component of the TCO. Ultimately the purpose of a TCO is to provide visibility for decision making, to compare and contrast and decide between different options. As with most data based decisions, the quality of decision can be dependent on the quality (completeness, validity, accuracy, consistency, availability, and timeliness) of the data the organization used to come to that decision.

Understand that TCO calculations can be easily manipulated, either intentionally or unintentionally, by missing material costs or lacking equivalency (required for a fair comparison). Also note that your vendors are not incentivized to provide you with visibility of all costs. Their estimates and quotes often exclude any costs that are not directly revenue to them (like travel/expenses) but are still your costs. It is important to review any vendor-provided TCO calculations in light of this. We would advise starting with as full and complete a list of all costs as possible. Weight the firm, known costs more heavily. Identify contingencies and unknowns, and then exclude them from the numbers, but be sure to notate any analysis accordingly.

Lastly, it is important for the TCO to include a line item for costs that are material and have a medium to high degree of certainty. As with most forecasting however, there will be events that carry a potentially material cost that lack the certainty needed to justify being included as a line item in your calculations. For these costs, a supporting narrative is more valuable, as including material numbers with a high level of improbability will unduly skew the TCO assessment. Also, consider the level of materiality. Line items can be material because of the dollars associated, or they may be material due to their nature. The best option here is to look at the estimated amount as a percentage over the total cost.

Total Cost of Ownership Assumptions

Your TCO will be littered with assumptions. There is no way to avoid this. With lack of certainty, transparency becomes more important, so make sure to list all of the assumptions. When creating multiple TCO calculations to use for comparing options, the most important thing is to ensure the assumptions are consistent across the options.

Certainty, Predictability, and Risk

As with any forecasting activity, there will be numbers that will have a high degree of certainty, and numbers that do not.  How certain are you that your vendor will meet their quote for implementation, and stay on time and on budget?

In the same way, costs that will be incurred sooner will be more easily estimated than costs in years to come. For example, will the software vendor raise the subscription cost of the software after the initial contract period?

Some TCO preparers will look to add contingencies to reduce the risk of underestimating costs. It is useful to keep contingencies amounts totally separate from the firm numbers, so that the element of risk is separately visible in any summary analysis. Consider preparing your TCO with this approach.

Duration of Using the Product

ERP TCO’s typically span multiple years, since the concept of a TCO is based on costs over the “life of the product.” These days, the product life could be virtually “forever.” This is because the new cloud-based SAAS solutions are continually patched and updated, and users are contractually obliged to keep their systems current. SAAS solutions almost guarantee there will be no more “revolutionary” upgrades in the future.

Notwithstanding, most TCO plans for IT solutions go out at least as far as 5 years. This number is generally chosen because 5 or 6 years has historically been considered the useful life of a server, and the TCO needs to capture that on-premise refresh cost. The life of an ERP has oft been quoted as 8 years. However, many industry commentators suggest that historically, the actual number is more like 10 years.

How often an enterprise renews, rebuys, or refreshes their ERP very much depends upon the organization’s growth and development as well as their approach to keeping their original purchase upgraded and well maintained. Considering your organization’s past approach to approving upgrades is useful in working out which period bears the cost. Consider a duration of between 5 and 10 years for your TCO, particularly if there is an anticipated and significant bump in costs in either option in years 6-10.

Opex Costs vs. Capex Costs

When you look at TCO through finance eyes, you look at numbers a little differently than when you look at them from an accounting perspective. If possible, you should collect data sufficiently enough to look at TCO from both viewpoints. For analysis and particularly for calculating an ROI, it is the finance model most often used. For corporate budgeting, the impact on the financial accounts will be required. To ensure coverage of both perspectives, the TCO model should include non-cash impacts like depreciation as well as extended cash impacts such as taxation calculations.

Comparing TCO Results

The difficulty with comparative TCO reports is that at times you find yourself comparing two scenarios that are so significantly different that there is little overlap of data points. Furthermore, when considering TCO for decision making, it becomes obvious that simply comparing the numbers does not give the audience enough information to make an informed decision between various options.

Another aspect to consider is the risk inherent in the numbers, comparatively speaking. What level of likely variability does a cloud subscription to compute resources have compared with a properly serviced on-premise data center? What TCO comparisons you prepare will very much depend on where you’re coming from and the choices you are open to. Invariably one of the options will usually be to do nothing. In this context, this means to NOT upgrade. A fair assessment of the “Do Nothing” TCO is always important for decision-makers, even if they have expressed 100% commitment to an upgrade.

It is also useful to consider preparing a TCO report for various scenarios. Presuming high business growth (say 15%) will create a different TCO than assuming no growth. Presuming that you are “all-in” with your ERP options—including all ISVs, all BI options, and a full roll out—will give you a different result than if you take a more conservative “phased” approach. When deciding how many models to prepare, consider the most likely scenarios as well as alternative scenarios for comparison. This may help you determine a possible TCO range, which is usually more reliable than a single number.

The Qualitative AND the Quantitative

When we talk about TCO, we focus on the cost side of the ledger. And when considering costs (just as we do when considering benefits) it is important to provide a framework to assess the qualitative data that might differentiate the choices. A way to consider qualitative costs—the difficulty finding qualified technical employees, for example—is by identifying the costs and presenting them using impact/cost quadrant graphics. This way, your TCO report can consider costs that are not quantifiable but still could be material to the overall investment.

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