In Pursuit of Cost Drivers

January 24, 2005 by admin

The term “Total Cost of Ownership” (TCO) refers to the sum total of costs that are incurred in operating a corporate software solution for a specific usage period. The TCO is usually several times higher than the pure procurement costs. In addition to license costs for the software, it is also necessary to consider hardware costs, maintenance fees, personnel costs for implementation and operation, and expenses for user training.
The calculation of the Total Cost of Ownership provides important information for planning and implementing projects and consolidating system landscapes, that is, optimally combining components from different scenarios and integrating them on one physical server, as far as it is possible. Indeed, it is precisely because of such increasing cost pressures that it makes sense for companies to merge systems, data, applications, and access to programs, and thereby achieve corresponding savings.
Various models for calculating the TCO exist. They include those devised by consultancy firms Gartner and Meta Group, which each take different costs into account. The Gartner model, for instance, calculates the total costs incurred annually for an IT system, while the Meta Group model includes additional expenses that are not part of the running costs, such as the cost of personal e-mails sent by staff. The common goal of all TCO models is to split up the total costs into various blocks and to identify the cost drivers within the system landscape. This enables tightly calculated budgets to be managed efficiently.

Costs and benefits – two sides of the same coin

The more complex an IT solution is, and the greater the break with the solution used previously, the more difficult it becomes to determine the TCO exactly. For instance, the procurement costs of implementing Customer Relationship Management (CRM) solutions are by their very nature far higher than upgrading an office application. Further, hidden costs often arise that can only be located and factored in by a thorough analysis of the TCO. These include additional expenses for troubleshooting or downtime. It is also much more difficult to plan the duration of projects of this type.
For a realistic assessment of the total costs, the flipside of the coin – the Return On Investment (ROI) as a result of improved business processes, optimized customer dialog, and increased customer satisfaction – also needs to be considered. Further, a broad spectrum of future deployment scenarios for the new software, as well as the processes from implementation through to maintenance, must also be included in the plan.

TCO models do help

TCO model

TCO model

In order to record and measure the total costs in a as structured and uniform manner as possible, a cost model that can be adapted to the specific conditions within the company is used. It divides the total costs into seven categories. Six of these cover direct (budgeted) costs, and one is for indirect (non-budgeted) costs. Direct costs are hardware and software investments, costs of implementation, running costs, costs of optimization projects, and upgrades. The economically productive use of the software by the user, known as the “end user usage”, represents the – often-underestimated – indirect costs block. These arise as a result of inefficiencies caused by system unavailability. The cost categories can vary and may be influenced by a range of factors, such as different user populations or company departments.
The TCO model from SAP runs from planning the application via implementation right through to support and maintenance, and thus covers the entire lifecycle of an installation. The above diagram shows the first levels of the cost categories. These are used as the basis for the assumptions in the following sample calculation.

Example: TCO calculation for a portal implementation

The first step in calculating a TCO is to define the assumptions and framework conditions for the project. This will be demonstrated here using the example of a portal implementation. The example deals with an SMB from the automotive industry with user numbers between approximately 500 and 1600. The company needs its customers to be able to reach it at any time if it is to reinforce its global positioning in future. It therefore wants to set up an easy-to-use and intuitive portal to provide its customers with comprehensive information concerning products and configuration options. After logging in, the customers should be able to access all services, such as viewing products, combining individual parts, performing price calculations, or querying product information about varied combination options via a knowledge base. Further, the portal should also enable internal information such as faxes, e-mails, or documents to be stored and exchanged, and support collaboration spaces.
The SMB already has experience of an SAP system landscape. An implementation of SAP Enterprise Portal, including the Knowledge Management and Collaboration solutions, would therefore be suitable. Further, the company can use CRM functions such as marketing, sales, and service via the portal to implement its complaints management process, for example.
The processes within the CRM and portal scenarios need to be analyzed in order to investigate the TCO concept in more detail. CRM is a fully integrated, customer-oriented approach to company management. From the SAP point of view, CRM supports and improves all business processes in which customers and external business partners are involved. As a comprehensive product for all users with customer contact, mySAP Customer Relationship Management (mySAP CRM) comprises solutions for sales (SAP Sales), service (SAP Service) and marketing (SAP Marketing).

Bundling business process features

List of criteria

List of criteria

The company’s specific criteria need to be taken into account when calculating the TCO of the portal implementation. For this purpose, criteria lists are drawn up for the various portal scenarios that contain the main features for representing business processes. This enables a customized business concept to be developed. The features are included as corresponding assumptions in the calculation. The list of criteria opposite shows various categories with their criteria for the CRM and portal scenario.
Once a list of criteria has been drafted for each portal scenario, for example “Collaboration” or “Knowledge management”, the features can be bundled for purposes of comparison to enable a methodical approach. The scenarios are subdivided into three categories. Category A contains the benefits, category B the increase in profits, and category C the value-added for the company. The correct storage strategy can therefore provide a clear benefit for the company as it enables the most up-to-date information to be available without users having to spend time looking for it. In the TCO phase of cost type “implementation” (process analysis, process design, system planning, system introduction or business blueprint), the sample company would implement an integrated search engine. The criteria, such as “integrated search engine with own classification and text-mining functionality”, should be combined with potential business processes, such as “Collaboration” in order to establish a reference to the cost model and the TCO phases.

Defining assumptions

For each TCO phase, assumptions for the cost model need to be made as regards the observation period, the annual percentage increase in user numbers, and the importance of the individual phases of the TCO model.

Software and implementation

Software and implementation

For our sample calculation, an annual user increase of x percent is assumed over a five-year period. This is because the project takes in more and more departments that previously did not have a computer workstation. This means that the software license costs per user are incurred once only in the project preparation year. Due to the large scope of portal implementations, the company employs extra staff in the first year and also calls in external consultants. This coupled with new processes and application scenarios increases the costs in the first year. The capital costs, depreciation and interest charges must be taken into account when making the assumptions for the hardware and software investment costs. In the “Operations” category (maintenance, running costs), the focus is on technical aspects, such as system monitoring or software change management.
The following assumptions apply in our sample calculation, which shows just an extract of a cost analysis (other factors, such as the detailed process of arriving at hardware costs complete with risk factors and discounts cannot be factored in as they lie outside the scope of this article): the software procurement costs for the portal implementation are 352,000 Euros, which needs to be paid once only up front. These costs are consequently not incurred again for years one to five. The implementation costs, 26,000 Euros in the planning phase and 323,000 Euros in the first year, include the cost rates for the internal and external consultants, the corresponding departments, such as logistics or marketing, and the number of applications and third-party systems that need to be integrated into the landscape.

Training costs

Training costs

In the case of the training costs, both actual training costs for employees and project teams and the cost rates of the trainers and course participants need to be considered. As regards hardware, the factors of risk or high availability should also be taken into account. Depending on the infrastructure, percentage risk surcharges may also apply. Performance in the production sector in particular must be sufficiently consistent to ensure that no downtimes occur.
In the support and maintenance area, annual maintenance charges amounting to x percent of the license volume need to be calculated. Maintenance charges also apply to hardware. The cost rates of the employees also need to be included.

The table of total costs provides an overview

Table of total costs

Table of total costs

The table of total costs for the portal implementation combines all TCO phases. Clear increases can be seen in the first and fifth years. This is partly to do with project start-up problems, with the increase in user numbers, and with the expiry of service and support agreements. Such exponential increases can be prevented for instance by using service and support portfolios that are not limited to five years, but instead provide ongoing support.
The ROI can also be demonstrated by means of a benefit model. In this example, for instance, it was shown that the savings due to ROI were twice as high in the second to fourth year as they were in the first and fifth year. Considerable savings can be achieved from the reduction in interfaces, and from automation and component consolidation.
In the example, implementation, hardware, and support and maintenance were identified as the largest cost blocks, and the growing number of users was a not inconsiderable factor. As the total cost analysis shows, high procurement costs are incurred in the first year of the system being introduced. The complexity of the applications means that high levels of expenditure are also required in the operations area. From a long-term perspective, comprehensive processes provide more flexibility, mobility, and integration. Timely maintenance and support measures increase effectiveness and produce an increase in profitability in the following three years. In the fifth year, the costs increase exponentially as new acquisitions become necessary and service agreements expire.
Because there are many ways of defining assumptions for the TCO model, it is important to define the specific cost framework beforehand and to perform the calculations based on the prevailing circumstances.

Tatjana Ullerich

Tatjana Ullerich

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