Defining and Measuring Total Cost of Ownership
Total Cost of Ownership
Total cost of ownership (TCO) is a common term in facilities management, and on the surface, it seems straight-forward enough – but not always. Referring to the total cost of owning an asset, it can, in one sense, mean the general cost of maintenance, or more broadly, every expense from design and sourcing to disposal or demolition. This may be where the confusion comes in.
TCO is extremely basic in definition: the sum of costs to own and operate a facility. The definition from APPA 1000, the Nation’s first standard on TCO, is ‘A holistic approach to maximizing return on investment of managed physical assets that includes the summation of all known and estimated costs to include first, recurring, renewal/replacement and end-of-useful life costs revised at critical decision points to aid in life-cycle asset management decisions.’ Where people aren't clear is how that is calculated. There are varying methods.
Many times, people look at total cost of ownership in a narrower lens, what we would call life cycle management, which ignores the cost of building or buying the asset or disposing of it, and simply focuses on the activities and costs in the middle.
Some managers may go to the other extreme and over-stuff the TCO by including not just the total cost to own and operate a facility but also include the activities within the facility. While that may have merit for some, it skews the equation in my humble opinion. Some activities that have nothing to do with the built environment are simply more expensive than others. By boiling the equation down to the common denominator of the cost to operate the facility, and not what goes on inside, is, I feel, the best way to benchmark against your peers and get to a real comparative metric.
As TCO is meant to assess the total lifespan of an asset, it has both retrospective and predictive qualities. It can predict capital needs for the future while managing current spend. It can be used to look back at expenses accrued in a past year as a metric for budgeting for the next by taking not just the big picture but the biggest picture into account. It is ultimately a means of determining good business decisions, for the short and long term.
TCO decisions are investment decisions, as the aim is to invest in the asset with the goal of keeping that asset running in as close to like-new condition as possible. Does the asset live up to its purpose? Do the maintenance costs and depreciation overwhelm the profitability? Determining TCO can assist in answering these questions, providing a framework encouraging facilities managers to make good decisions throughout the asset’s lifetime. “I believe that most of us will agree that there is never enough budget for the needs. This is why we prioritize based on criticality. But how can we do that without an understanding of the needs? Asset management and TCO are learning tools as much as they are analytical tools.”
When an asset is acquired, there is an expected continuum of how the asset is expected to perform, but the assumptions are not always correct. For example, if a piece of equipment was expected to last decades, but failed in a few years, this updated adjustment to TCO can be crucial information for budgeting any other locations with similar equipment.
Setting a Standard
Because TCO is such a common term, with multiple applications, a need arose to establish standard definitions, a common framework for facility managers and their colleagues in other roles, to facilitate continuous and clear discussion on a peer-to-peer level. Most facilities operations have silos separating asset management, planning, design, construction/operations and maintenance. A fully implemented and integrated TCO strategy, by necessity, breaks down those silos and gets these groups talking. The data is nice to have but the real power of TCO is the communication it fosters.
Published standards on TCO were released by the APPA, a few years ago and I was honored to be part of the development team. The TCO standard titled APPA TCO Full Standard-Parts 1 and 2 is available at the APPA bookstore, along with many related publications.
APPA Total Cost of Ownership (TCO) Part 1: Key Principles | APPA
R Ledbetter & Associates (RL&A) is a strategic consultancy firm specializing in Higher Education Facilities Management (FM). We focus on this market and area of expertise because it's what we know best. Our team has worked in the industry for years, and that experience has prepared us to help you elevate your FM organization’s performance.
Contact me at: Randy@rledbetter.com