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- March 16, 2015
- Amit Duvedi
- Business Strategy
Last spring, I bought a Tesla. You’re probably thinking two things. First, “Cool!” And second, “Expensive.”
Right on the first count, but wrong on the second. I’m not saying a Tesla is cheap, but you have to look beyond the price tag to understand its cost, and value, relative to competing cars.
This is what I do in my professional life: I help companies understand the business value and total cost of ownership (TCO) for enterprise software.
Hidden costs can make a product with a lower price tag more expensive in the long run. A higher-priced product may deliver a better result, yielding greater value and costing less over time, therefore justifying a higher initial price point. My job is to study at all of these factors and make detailed estimates so that customers can make a decision based on a multi-year TCO and value delivered.
Naturally, I did this exercise for myself before buying my Tesla. I’m not a wealthy enough guy to just say, “I want it” and go out and buy it. I had to convince my inner TCO guy.
Calculating TCO is hard for most of us. Two natural human tendencies get in the way: Short-term focus on up front costs, and the assumption that the value of all options will be equal. To overcome these tendencies, you need a disciplined process that is much the same for anything you buy. Here are five steps for calculating TCO like a pro.
1. Compare apples to apples
The goal of TCO analysis is all about drilling down to get as close as wecan to an apples to apples comparison, but you still have to be comparing products in a similar class.
The Tesla isn’t going to be for everyone; you have to be able to pay the up front costs and wait for the savings to fully phase in. If you’re in the market for a Camry or Kia there’s no way this comparison is going to work.
For the TCO calculation for my Tesla, I looked at the total cost of ownership over a five-year period as compared to other new luxury cars such as BMW, Lexus and Mercedes.
If you’re comparing software, you have to be comparing software in the same class as well. For that, you have to define your top success criteria and success metrics. After that, you need to compare only those technology solutions that help you achieve your goals in your desired timeframe.
2. Look for hidden costs
Hidden costs don’t appear on the price tag, but are incurred during the transaction or over the life of the item you’re buying. For cars, hidden costs include repairs and maintenance, taxes, licensing fees, interest on financing, insurance and fuel. In the case of the Tesla and other alternative fuel vehicles, you get tax rebates, so I guess you could call that a hidden benefit.
When you add these other costs projected out over time to the sticker price of the car, you get the estimated total cost of ownership for a given time period. Even two cars with the same sticker price will usually have a different total cost of ownership.
It’s the same with enterprise software, although it can be harder to find the hidden costs. People tend to assume that since they’ve given each vendor the same RFP or list of needs, every option will address those needs the same way. But, hidden fees for implementation, training, upgrades, customizations, ongoing support and additional seat licenses are common and usually have a material impact on TCO. You have to especially watch out for hidden costs that might kick in after the first one or two years.
One more aspect of hidden cost is the opportunity cost of different options. If you’re looking at two comparable technology solutions, and Option A delivers the intended value faster than the Option B, then the latter should be associated with a higher opportunity cost/penalty in your TCO analysis. Time to value matters and it should be a part of every comparative analysis.
3. Is the future cloudy?
Because of the cloud and the rise of the Internet of Things (IoT), products are no longer static. There’s now the possibility that even mundane products like thermostats and appliances will actually get better.
That’s true of the Tesla; it’s a cloud car and part of the IoT. It’s always hooked up to the wireless network at home, and every few months there's a software upgrade that happens overnight. In the morning, voila, a new feature is there.
For example, the Tesla has regenerative braking, without the traditional “creep” feature. If I take my foot off the brake, it doesn’t move forward like most cars do. But, if you come to a stop climbing a steep hill, the car used to behave like a manual transmission car, rolling backward when you took your foot off the brake.
Based on feedback from the user community, they did a software upgrade and the Tesla now has a feature where the car holds in place for ten seconds, long enough for the driver to move his or her foot over to the accelerator. The car got better, without drivers having to buy the next model.
The cloud has now become an important consideration for buying enterprise software, for the same reasons. Time horizons for innovations and upgrades are much faster, and they’re delivered automatically to all the owners of the product. The product roadmap is more compressed, and there’s an opportunity to deliver more value on a continual basis.
4. Account for the intangibles
It’s not possible to put a number on everything, for the car or the software, but intangible benefits should still be accounted for.
For example, I get to use the diamond lane in my Tesla, which saves about half an hour a day for my particular commute. I could calculate a dollar value for that based on my wages, but really what it does is give me back some more time to spend on my family or my health. It’s hard to put a dollar value on that, but it’s definitely a benefit.
I also like the idea of no emissions coming from the vehicle itself, but I think the jury’s still out on the environmental aspect—the batteries cause some pollution that may cancel out reduced emissions, so I left that out of the calculation.
If I were building a business case for enterprise software though, I would consider including the financial impact intangibles such as reduced processing times, which could free up people to be more strategic, or the ability for users to configure software themselves, which cuts down on the need for IT support. I’d also look at usability and user adoption and estimate the positive impact on end users.
5. Do the math
The Tesla is pretty cool, but a TCO guy can’t allow himself to be distracted by coolness. After you do all the research, you need to actually do the math.
Obviously that’s a more complicated equation for the software than the car. The Tesla community has created a number of TCO calculators specifically for the Tesla, so I was able to cheat a little bit. Repair and maintenance costs are already in there, so I really just needed to plug in my personal mileage estimates and electrical rates.
After all was said and done, the five year TCO for the Tesla came out comparable to buying luxury sedan whose sticker price was significantly lower, with greater savings if I hold the car even longer. That sealed the deal with my inner TCO guy, and I’ve never looked back since.
Amit Duvedi is Vice President, Business Strategy Value Management for Coupa.