The hidden treasure that lurks within a TCO

A few weeks ago I had the pleasure of spending time with about 20 CIO's ranging from multi-national organisations to local USA health providers, together with a number of CTO's from large software vendors. The subject of ROI and TCO came up in the context of which desktop model is the most cost effective in terms of justifying increased capital expenditure to enable desktop virtualisation.

I was slightly surprised that only two CIO's could state their TCO, but on reflection should I have been? The sad fact is that many organisations have lost sight and control of their IT estate. The continuous drive for new products and services at a pace that is set to beat the competition at the expense of infrastructure efficiency is all too well known by CIO's and CTO's. You only need to keep upper most in your mind that we virtualise because we have servers that are underutilised. I think the figure is still sub 10% utilisation for server's pre virtualisation. How many CEO's know they have capital tied up and not making a return? Not enough in my opinion!

So to the subject of money, ROI and TCO, which one should we focus on? One of the group, who is an analyst, and ponders these things for a living, believed that we should focus on ROI, but my view is that you need to focus on both, as TCO is an element of ROI. However there is more to this than an academic debate about method and calculation. Consider this hidden box of treasure:

TCO = SUPPLIER BASE COST multiplied by a

SUPPLIER EFFICIENCY FACTOR to which you add an

R&D FACTOR as well as a PEOPLE INVESTMENT FACTOR and the PROFIT MARGIN

Then multiply this by a RISK FACTOR (you will be seen as a risk by the supplier in some shape or form)

And then modify up or down depending on how tough the competition is or soft you areJ

Many people I talk to do not give a second thought to the overall efficiency of the supplier they are buying from and even less thought to the efficiency of their supply chain. In my simplistic view as detailed above if we could work out what the base cost of a supplier was we would modify this up or down depending on how efficient, or inefficient they were. Again we need to consider if a supplier is investing in R&D (assuming they need to) and importantly are they growing the skills of their people to fulfil the demands their clients are putting upon them. In moments of madness I do compare and contrast what salesmen are attempting to sell me (me being Government rather than me being an actual buyer) and what is actually being bid. It might surprise you to know that invariably what is bid is a lot more mature, polite for old. We shouldn't be surprised as our suppliers are full of people like you and me, all working hard to do a good job, but skilled in what the business needs today, not what the business might need in a few years time. After all would you look to sell something that wasn't your core competence and something that you were not particularly experienced in?

The red herring of the profit margin, yes red herring. Many a time I have split my sides guffawing at procurement experts haggling over a 1% reduction in profit margin, although the bulk of the TCO is in the suppliers base cost, the supplier's efficiency, the suppliers R&D etc. It's the table magician trick of deflecting the eye from the hand that is doing all the workJ finally to the final two elements, risk and competition. In terms of risk suppliers rightly have to ask themselves if the client is going to increase or decrease the risk of the project. If you give the impression of being disorganised, if you have a track record of failure, or are always changing your mind, it would be right for suppliers to factor this into their costings, after all time is money. I know we get agitated every time a supplier raises the change control card, but that is what it is there for, it is a valid control point, but be under no illusion an element of risk will be in the TCO somewhere. Finally in the TCO there is always an element of judgment in the price. Some of this is driven by how stiff the competition is. Suppliers don't bid on the basis that they want to lose. Bidding costs money, someone has to pay for it, but suppliers won't throw away a deal for a small shift in the overall TCO calculation.

That's a lot about TCO, but what about ROI. Well for me this is simple, well not that simple but we will keep it high level. Basic ROI is about ensuring that the overall benefit you are getting from the investment you are making is greater than the cost. TCO is just an element of the cost of a project but important to know if you really want to drive ROI. I have never brought the idea of an IT project; every project is there to deliver a business outcome whether it is customer driven, or internal efficiency or effectiveness. It just so happens that today a lot of projects are fundamentally underpinned by the use of IT. Our jobs as CIO's is to help the business deliver its objectives at the most appropriate capability for the most appropriate price.

Comments

[Tim]

I don't think that the tco calculation is as simple as you're implying as it implies that the supplier's delivering what you need (unless that's in your risk factor).

From what I've seen across many market segments and geographies, the gap between what one has and what one needs for ICT dominates any cost equation.

[Bala]

The Dynamic Redhat TCO Calculator is very useful.I tried this out.Math is very simple and looks great

[Umesh Harigopal]

TCO, ROI are always top of mind as you figure out how to manage your top and bottom lines. As a CIO looking to make a difference for your company, your IT desktop investments is surely one area to focus on, more so given your decisions on Windows 7 and Office 2010 migration initiatives.
Probably many of you might have seen the IBM Client for Smart Work announcement that hit the press yesterday. One of these solutions is on Red Hat Enterprise Linux desktop software. Is it just 50% reduction in TCO. Actually a lot more.
Check out this dynamic TCO calculator from Red Hat here:
http://www.compariv.com/lotusonredhat
The math is simple. You start seeing results by just entering the number of users. Do the math. Share it with your CFO. Save the results if you want to get back to it later on.

Best Regards,
Umesh Harigopal
Ecognize LLC
http://www.compariv.com

[John Suffolk]

Hi Paul a couple of things:

Firstly I wasn't trying to detail all the gubbings behind a TCO, just bring out a few points, so this does cover the supply side. If you are outsourced it can go a fair way to show you the TCO of the service though.

You may not be missing anything as all I am trying to bring out that lurking within a TCO (or the cost a supplier is looking to charge you) is a wealth of knowledge that will help you make a better informed decision.

So where you quote you would select a supplier on the basis of the benefit received per pound spent, all you really need to know is how will you put a cashable amount on the benefit, as you can't calculate a positive ROI without one, and secondly the pound spent, is that fair value? It might be the lowest quoted but that does not mean it couldn't be 50 pence.

Tell me something, do you think we should be doing a better job having this information at our fingertips, rather than crafting it everytime we do another bid?

John

[Paul Johnston]

Sorry to comment again, but clearly your post puzzled me and I am keen to understand where you are coming from. Let's see if I can explain what I don't understand and then you can set me straight! Suppose you had 3 suppliers: Supplier A where the price charged is 10% Research; 80% "inefficiency" and 10% profit; Supplier B where the price charged is 80% Research; 10% inefficiency and 10% profit; and Supplier C where the price charged is 10% R&D, 10% inefficiency and 80% profit. Which supplier would you be inclined to favour? My initial answer would be: on the basis of the information given so far, I have no basis for choosing between them. My choice would entirely depend on which supplier was offering the most benefit to my organisation per pound I spent with them. I suppose I might have a slight preference for the one doing all the R&D spending on the grounds that there are more likely to enhance their products in the future and I suppose you could a preference for the high profit margin supplier on the grounds that it is unlikely to go bust and leave you with a product that is unsupported! However, none of these are very strong arguments and it would make more sense simply to adjust the initial calculation of benefits per pound spent by something factoring in likelihood of future product enhancements (which may or may not related to R&D spending) and likelihood of long term (and good quality) product support (which again may or may not related to profit margin!). So I am back to thinking that issues such as R&D spending, "efficiency" and profit margin have no direct relevance for my purchase decision with R&D probably having some indirect relevance but the other factors no relevance at all. So what am I missing?

[Paul Johnston]

A fascinating post, but you seem to be mainly talking about total cost of supply or something like that. what about total cost of ownership? What are your views on that?