Total Cost of Ownership: Importance & Benefits

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 why some people and companies choose to use the total cost of ownership when deciding whether to make a purchase or not instead of the purchase price.

Total Cost of Ownership

Imagine that you are buying a car. The purchase price of the car is only $19,272. Sounds like a good price for a good car, right? But wait, that's not what you actually end up paying. Unlike a pen that you pay for once, use it, and then throw it away, a car you need to maintain, add gas to operate it, pay for insurance, take into account depreciation, and pay for interest if you have it financed. All of these costs are necessary to own the car. According to Kelley Blue Book, a car that has a purchase price of $19,272 could very well cost you $35,998 after 5 years of owning it. This cost is referred to as the total cost of ownership which includes the purchase price as well as all the costs associated with the owning of the item. Kelley Blue Book does bring out a very interesting point. Even though this particular car costs $35,998 to own it for 5 years, it doesn't mean that all cars with a purchase price of $19,272 have that same cost of ownership after 5 years. Another car may depreciate more than the one you got. This car then has a 5 year total cost of ownership of $38,368 because it depreciates faster, meaning it's worth decreases faster.

Why It's Important

Total cost of ownership is also abbreviated as TCO. TCO is important because it shows you what you actually end up spending when you purchase something. This is true for things that require maintenance such as cars and machinery. For the most part, it's businesses that use TCO. But, individuals can use it when it comes to deciding whether to make a big purchase or not. If you have a limited income, then it's all the more important to consider the total cost of ownership of an item before buying it. Sometimes, that TCO is greater than what you can really afford.

For example, on a personal level, say you were looking for an apartment. You have a fixed income of $1,500 a month. You also have necessary expenses of $700 each month. That leaves you with $800 to spend on your new home. Does that mean you can spend that $800 on rent? No! That's a big no! See, because you are on a limited income, you need to consider the total cost of ownership of your new apartment. It's not just rent that you'll end up having to pay for. You also have utilities, phone, internet, water, sewer, trash, parking, and cable. All of these items add up. If you live in an area that gets particularly hot during the summer, you could be looking at a cooling cost of $100 or more depending on the size of your apartment. Adding all these costs together, an $800 apartment can turn into a $1,200 apartment. So you'll need to set your sights on a less expensive apartment. Perhaps one that costs around $400 a month to give you a bit of flexibility with your spending after calculating your total cost of ownership.

Benefits of Using TCO

As you can see, using TCO to help you make purchasing decisions is beneficial. On a business level, using TCO before making a purchase is equally important because most likely you are on a limited budget. Whatever you decide to purchase has to stay within that budget.

Using TCO also helps businesses to decide whether to lease a product versus buying it. TCO will show at what point it becomes cheaper to own a product rather than to lease it.

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