Written by Marijn Overvest | Reviewed by Sjoerd Goedhart
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Total Cost of Ownership Model (TCO) — Your Procurement Guide for 2025

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Key take-aways

  • The total cost of ownership model aligns purchases with company goals and objectives, improving finances through better decision-making.
  • The TCO model considers all costs, promoting better procurement practices and driving stable cash flow. 
  • The TCO model also helps assess suppliers, improve efficient practices, and effective product lifecycle management.

The total cost of ownership model is an upgrade for your procurement operation needs. Unlike the traditional procurement ways, which focus on initial purchases, the TCO model considers the whole package. 

The TCO model ensures your decisions check with your goals and have a stable cash flow in the organization. Procurement teams use it to optimize product operations and dodge bullets in finances. It helps you have a system that goes through the long haul. 

In this article, we’ll learn about the total cost of ownership model. How it matters in procurement, and how it works with purchasing examples.

I have created a free-to-download editable cost price breakdown template. It’s a PowerPoint file, together with an Excel file, that can help you analyze your total cost of ownership. I even created a video where I’ll explain how you can use this template.

What is the Total Cost of Ownership Model?

The Total Cost of Ownership (TCO) model is a comprehensive approach to evaluating and understanding costs accompanying the procurement process. 

Mainly, the traditional process focuses solely on the initial purchase. However, the model considers other factors such as administration, risk, and disposal costs.

Essentially, TCO provides a more factual representation of product and service costs. This estimation helps organizations make decisions based on better expense understanding. 

Moreover, this model considers both direct and indirect costs. Doing so helps understand product traits like lifespan, downtime, and quality concerns.

Incorporating TCO analysis in procurement decisions helps optimize purchase strategies, find potential suppliers, and align business goals through data-driven decisions. 

 The approach enhances cost-effective perspectives that help contribute to better financial performance in the long run.

The TCO Formula

The model calculation considers all direct and indirect costs associated with a product’s entire cycle to provide an accurate value. There are various components in calculating TCO, especially with organizations having specialized procurement processes. But for an easy understanding, you can calculate TCO as:

TCO = Purchase Price + Maintenance Cost + Operating Cost + Risk Cost + Training Cost + Downtime Cost + Misc.

Each expression in the formula represents different costs. Organizations can adjust the TCO model formula in consideration of their specific needs. More so, it is a comprehensive formula that can adapt to the particularities of organizations. This process helps them improve their overall analysis.

In short, companies must identify and assess all crucial costs with their products and services, especially their life cycle, to create an accurate model.

Why is the Total Cost of Ownership Model Important?

The TCO model is vital in procurement because it provides comprehensive detail on financial data, which helps better understanding. The data includes product management and acquisition and services assessment. 

It accounts for the entire product lifecycle, which expands the organization’s understanding of crucial procurement data. Moreover, it helps procurement teams make better decisions driven by data.

The model enables a fuller assessment of the impact of a procurement decision in an organization by considering various factors. 

These factors include expenses such as maintenance, risk, operating, training, and downtime costs, among others. This approach helps companies dodge possible pitfalls, from maintenance issues to operational delays and potential risks. 

Moreover, it provides a proactive approach to procurement, promoting value and better decision-making.

Companies can use the model to optimize allocation and enhance spending strategies. Additionally, it can help them select better value suppliers and improve product lifecycle. 

This model effectively supports sustainable procurement practices and opens cost-effective opportunities for better financial positions.

How Does the Total Cost of Ownership Work?

The TCO model in procurement serves as a framework for a comprehensive cost evaluation. The approach considers the costs that contribute to the overall product cycle.

Ultimately, the process follows a formula to create better decisions in procurement, leading to a robust and competitive market performance. Below are its five functions in procurement:

1. Cost Component Identification

Teams can assess and categorize crucial costs accompanying the organization’s product or service needs. This assessment accounts for the TCO formula to provide comprehensive data for organizational use.

Recognizing cost components is crucial for presenting accurate data, which helps create data-driven decisions.

2. Product Lifecycle Analysis

The TCO model considers how to optimize the product or service lifecycle to ensure maximum value. The model includes pre-purchase planning and decision-making, continuous expenses, and eventual disposal costs.

Ultimately, it aims to gather data on how the product/service lifecycle can economically impact the procurement process.

3. Cost Quantification

Each cost component considers the monetary value that affects the operational flow. This function involves future cost estimation and accurate quantification. More so, various departments like procurement, finance, and operations collaborate to provide accurate data.

Having cost assessments helps better allocate the finances of the company. Additionally, financial activities can expand without being too conscious about how the procurement team spends it.

4. Mitigating Risks

The model accounts for risks that help companies assess the financial impact of uncertain issues like inferior product quality, supply disruption, and market trend changes.

Consequently, the model provides crucial data to formulate strategies that prevent these concerns from happening. It enables opportunities for making better decisions and helps avoid problems as much as possible.

5. Organizational Development

TCO encourages continuous development by providing ways to improve company procurement processes. These improvements include streamlining information flow, accurate cost assessments, and better trend analysis. 

The insights from procurement teams, which TCO fosters, provide a more efficient and cost-effective process over time. Ultimately, it helps an organization remain competitive amidst the fast-paced procurement environment.

What Purchases Benefit from the TCO Model?

The model helps improve various purchases, especially those with product lifecycles that extend beyond their initial purchase price. To refresh how it works, any purchase with significant ongoing costs, like maintenance and operations, benefits from the TCO. 

The approach helps companies make procurement decisions that align with their goals and objectives and can deliver the best value from their purchased products.

Below are three purchase types that can benefit from the TCO:

1. Information Technology or IT system

IT systems require continuous hardware support, infrastructure, and software solutions. These processes usually involve substantial costs, like maintenance, upgrades, training, and downtime. 

Using the model optimizes the operations when investing and maintaining these products and resources. Doing so can help with current and future costs.

2. Manufacturing

Machinery manufacturing possesses substantial upfront costs, which can affect company finances if not planned carefully. 

The TCO model can optimize machine selection to maximize efficiency and avoid potential disruptions. Additionally, it helps foster a steady financial position and align strategic objectives.

3. Office Resources

In procuring office items, organizations can use the TCO Model to optimize how to purchase them. 

Furniture and equipment like chairs, desks, cabinets, and computers have initial costs. However, the model also considers maintenance, upgrade, repair, and disposal costs.  

The analysis helps the organization select cost-effective furniture and better equipment that can last longer. Buying better equipment can improve the work environment and help with overall productivity.

TCO Model Real-world Examples

A Keen understanding of the Total Cost of Ownership Model can help you navigate through the difficulties of procurement decision-making.

Using real-world examples can help define how the TCO model helps analyze the whole product or service lifecycle.

Activities like aircraft acquisition and software implementation require TCO to make better decisions.

Below are three real-world examples of the model in action:

1. Commercial Aircraft purchase

Airline companies may choose aircraft for their initial price. However, it is crucial to factor in various aircraft expenses, such as repair, crew training, maintenance, and fuel costs. The TCO analysis helps the company select the best value for its daily operational process.

For example, Delta Airlines uses the TCO analysis to know which Aircraft can provide the best value for their money.

2. Software Acquisition

Companies that enhance their software protocols focus on the initial licensing fees. With TCO analysis, they can extend their insights with customization, change resistance, system integration, maintenance costs, and continuous support.

The model provides crucial procurement data for the organization to make informed decisions regarding this step. Microsoft, for example, uses this model to understand system integration expenses and customization costs for their software.

3. Solar Panel Installation

A company incorporates solar panels for efficient energy generation and sustainable procurement initiatives. They must use the TCO analysis, which expands efficiency, maintenance, upgrade, and life span. It ensures the best value for using Solar Panels for better productivity.

Google’s commitment to sustainability helps them decide on the best solar panel using the TCO model. It helps them understand cost factors such as installment, investment, and repair costs.

Conclusion

The Total Cost of Ownership model helps procurement teams make better decisions for their companies. This model helps incorporate additional approaches to ensure the maximum efficiency of product lifecycles. Moreover, it creates stable finance flow and consistent process optimization. Procurement teams that harness the model can craft resilient systems that can go on par with the competitive environment.

As we push deeper into the complexities of the TCO and how it works, we can understand its comprehensive performance. It provides a holistic view of the company’s finances, product lifecycles, and accurate data representations. The model’s proactive approach helps foster development, minimize risks, and promote value-driven and sustainable practices.

Whether the activity was acquiring aircraft, implementing brand new software, or installing software panels, the TCO helps companies make the best decision. It is a reliable tool that promotes financial responsibility and opens cost-effective opportunities.

Frequentlyasked questions

What is the Total Cost of Ownership?

The Total Cost of Ownership (TCO) model is a comprehensive approach to evaluating and understanding costs accompanying the procurement process.

Why is the Total Cost of Ownership Important?

The TCO model is vital in procurement because it provides comprehensive detail on financial data, which helps better understanding.

What is the formula of the TCO model?

The Formula of the model is Purchase Price + Maintenance Cost + Operating Cost + Risk Cost + Training Cost + Downtime Cost + Misc.

About the author

My name is Marijn Overvest, I’m the founder of Procurement Tactics. I have a deep passion for procurement, and I’ve upskilled over 200 procurement teams from all over the world. When I’m not working, I love running and cycling.

Marijn Overvest Procurement Tactics