TCO for ERP Systems

When my CFO clients here in Orange County ask me to help them with a system selection one of the elements that enters into the decision is Total Cost of Ownership (TCO).  TCO is a term popularized in 1987 by the Gartner Group and continues as a valid measurement of any Enterprise Resource Planning (ERP) system.  Some of the elements that should be reviewed in looking at the total cost of a new or existing ERP system would include the following:

Computer hardware and programs

  • Network hardware and software
  • Server hardware and software
  • Workstation hardware and software
  • Installation and integration of hardware and software
  • Purchasing research
  • Warranties and licenses
  • License tracking – compliance
  • Migration expenses
  • Risks: susceptibility to vulnerabilities, availability of upgrades, patches and future licensing policies, etc.

Operation expenses

  • Infrastructure (floor space)
  • Electricity (for related equipment, cooling, backup power)
  • Testing costs
  • Downtime, outage and failure expenses
  • Diminished performance (i.e. users having to wait, diminished money-making ability)
  • Security (including breaches, loss of reputation, recovery and prevention)
  • Backup and recovery process
  • Technology training
  • Audit (internal and external)
  • Insurance
  • Information technology personnel
  • Corporate Management time

Long term expenses

  • Replacement
  • Future upgrade or scalability expenses
  • Decommissioning

The time frame is an important consideration when looking at the TCO of an ERP system.  Most Companies will select a new system every seven to ten years.  If you do a TCO analysis on a three year time frame then you may be missing the key benefits or costs that will be experienced over the longer term.  One example would be the current craze to move to cloud solutions.  Most ERP vendors offering cloud solutions will show you a TCO analysis based on their product that is no longer than three years.  There’s a very good reason for the three year time frame.   When calculating the price that the vendor will charge for the monthly usage versus the price that would have been charged had you purchased the licenses directly most build in a three year payback.  By doing this the software vendor can provide a low enough price for the monthly usage and still get the same return over the three year term.

Using a three year analysis for TCO is not a valid comparison for a seven to ten year investment.  If you do this then you could end up with a much more costly system then the longer term comparison would generate.  In a five year comparison of ERP systems the in house system will always be the winner when looking at the same software via the cloud or in-house.

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