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Total Cost of Ownership: Definition, Components & Examples

Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

After reading this lesson, you'll understand how you can use total cost of ownership to help you decide whether or not a particular purchase is worth it in the long run.

What is Total Cost of Ownership?

In business, there is a concept called total cost of ownership or TCO for short. It's different than the simple purchase price of an item. For example, imagine that you are the business owner of a flower company. You are thinking of purchasing a brand new flower delivery vehicle complete with refrigeration so the flowers don't wilt during delivery. Instead of relying on just the purchase price when considering whether to purchase this truck or not, you use the total cost of ownership. This cost includes not just the purchase price, but also all related ownership costs such as insurance, registration, maintenance, and repairs.

The TCO of a vehicle includes things such as insurance, registration, maintenance, and repairs on top of the purchase price
total cost of ownership

Total cost of ownership includes different things for different products as different products are used in different ways and so have different ownership costs associated with them.

Components of TCO

Even though TCO includes different things depending on the product, there are some basic components to TCO.

  • Purchase price
  • Maintenance cost
  • Repair cost

It is up to each individual business to decide what needs to be included in the TCO of any product they are considering purchasing. For example, to own a car, a business has to maintain it, keep it registered and licensed, keep in insured, and repair it when things break. On the other hand, to own a computer, a business has to install antivirus software, have an IT team to take care of technical issues, and perform routine backups and maintenance to keep the computer running smoothly and to keep data safe. For products with recurring costs, it costs more the longer you keep an item. Even if a product doesn't seem to have a recurring cost associated with it, you still have a storage fee if the product is kept in a warehouse.

Calculating It

Let's look at how you calculate the total cost of ownership of a possible product you are considering purchasing.

Going back to the flower business example and you deciding on whether or not to purchase a new flower delivery truck with refrigeration, let's look at what your total cost of ownership for this truck will be. For cars, TCO is usually calculated over a 5 year period.

The purchase price of this truck is $120,500. To insure it costs $2,130 each year. Maintenance costs will average $1,000 each year. Repair costs over the 5 years is expected to be $4,000. Registration costs are $257 each year.

The TCO for this vehicle is this.

  • $120,500 + $2,130 * 5 + $1,000 * 5 + $4,000 + $257 * 5 = $120,500 + $10,650 + $5,000 + $4,000 + $1,285 = $141,435

Your TCO for this truck is way different than your purchase price. If you had used just the purchase price in your analysis, you would not have seen that you needed an extra $20,935 over the course of 5 years of ownership. If your company didn't plan for this extra spending, you may very well not be able to afford the truck. But with TCO analysis, you get to see just what costs are associated with a particular purchase. And from there, you'll be able to decide whether or not you really should purchase that particular product.

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