For Chief Technology Officers (CTOs), grasping the Total Cost of Ownership (TCO) of digital products is a strategic necessity that underpins informed business decisions.
Defining the CTO role is challenging, as its responsibilities are complex and multifaceted. Originating from R&D departments in the 1980s, the CTO’s role was to align R&D investments with business strategy. Initially, this role wasn’t intended for smaller organizations, and as we delve deeper into strategy, clarity tends to diminish.
However, one critical yet often overlooked element in a CTO’s strategic arsenal is the concept of TCO. This two-part blog series aims to shed light on this vital business concept.
Understanding Total Cost of Ownership
TCO encompasses all costs associated with acquiring, deploying, using, and eventually retiring a product or equipment. It accounts for the entire lifecycle costs of a product, providing a more comprehensive view of an investment’s value than just the purchase price.
For CTOs, strategy involves cost-benefit analysis and return-on-investment considerations. TCO extends beyond cost-benefit analysis by revealing hidden costs and ensuring decision-makers are aware of the full costs as a product develops and matures.
Why TCO Matters for CTOs
In the digital realm, software often constitutes a significant portion of a business. The projects CTOs oversee contribute to a company’s valuation, affecting all aspects of the business, including management, capital structure, and future earnings. The technological decisions and leadership of a CTO can either enhance or diminish a company’s value.
From my experience as a CTO, technical due diligence often reveals surprising accumulations in TCO. Such revelations are crucial, especially when companies face in-depth technical evaluations for funding rounds. Being prepared for these assessments is beneficial.
Neglecting TCO can lead to:
– Adjustments in company valuation and sale price due to due diligence findings
– Warranty demands from buyers for potential reputation loss (if security is overlooked)
– Acquisition cancellations (if information systems are mismanaged)
– CTO replacement post-deal (due to inadequate positioning)
While TCO is a foundational concept in industrial and manufacturing sectors, this discussion focuses on TCO as it pertains to digital products.
Cost Estimates Included in TCO
TCO should encompass all costs, direct and indirect. For digital product development, this includes:
– Development (team management, product ownership, quality assurance, DevSecOps)
– Technical Debt (mismanagement can lead to complexity and competitive losses)
– Technology stack mismatch (poor solution choices)
– Licensing & tooling
– Running infrastructure
– Support & maintenance
– Incident management
– Security breaches (reputation loss and recovery costs)
– Business continuity and disaster recovery
– Regulatory compliance
– Audits
– Training (for new users)
– Governance
– Decommissioning
TCO Estimation Model
Estimating TCO isn’t straightforward, but it’s manageable. Below is a model I use with my teams, refined through iterations:
Evolving Product Costs
These costs, sometimes called acquisition or initial costs, accumulate during active value creation and optimization.
Evolving Product Costs vs. Maintenance Costs
Distinguishing between costs for product evolution and maintenance is common. However, from a lean development perspective, transitioning a product from active development to maintenance signals a decline. A shared maintenance team is often an ineffective way to maintain system functionality.
Maintenance Costs
Once a product enters maintenance, the original development team is usually no longer involved, and the product’s value ceases to be optimized. Costs continue to accrue for maintenance.
Operational Costs
These include licenses for integrated libraries, backups, platform subscriptions, and third-party service fees.
Support Costs
Support costs, regardless of level, and the infrastructure and tools needed for support processes, also accumulate here.
Decommissioning
Often overlooked in initial estimates, decommissioning can be complex and costly, involving data cleaning, server shutdowns, and operational adjustments.
The next blog will discuss preparing for TCO, how CTOs can approach TCO differently, and the advantages of incorporating TCO into strategic thinking.
