How to Find the TCO (Total Cost of Ownership) of Custom Software Applications
So you can budget, compare and save.
We have all struggled to find exactly how much it costs to build, maintain, and improve custom software applications in their lifetime. Accounting needs to know in order to budget accordingly, HR needs to know in order to bring the team together, management wants to know the return on investment (ROI) before embarking on implementation. Some applications are easy to calculate and others are not so simple. We all want our software application to be designed, developed and implemented on time and on budget. How exactly is the long-term total cost of ownership or TCO calculated? Do you have to submit “The Price is Right” for applications? Not really, the formula is very simple. When practiced at all times, it will help you budget, compare alternatives, and save while building successful software applications that exceed your customers’ expectations.
THE FORMULA:
First let me tell you a time-tested empirical formula (1),
Long-term TCO = (Fx + Lr) * [1 + (Roi/Qq)]
(Note) 1: Empirical formulas are not scientifically proven, but can be applied accurately to most scenarios.
And now I will explain the 4 simple variables it uses:
1. FIXED COSTS (Fx)
Start with the technical specifications and, better yet, sit down with the technical lead or architect to find out what the fixed costs are. Look at the implementation diagram and find out the cost of each box it shows. Now consider the cost of the operating systems they will run on and the cost of all the tools that will be installed. Here are some tips on what a typical project can incur as a fixed cost:
Hardware costs
Operating systems
Design and development tools
Database systems
Backup systems
Hosting costs
Most recurring costs can be converted to fixed costs by multiplying the cost per cycle by the total number of cycles expected over the life of the application.
The sum of all the above values will give you a total dollar amount, which is your Fx in the above formula.
2. LABOR COSTS (Lr)
Your project plan should have a section on time estimates. Again, your team leader or architect can tell you more precisely how long your application will take to build. Consider all roles and responsibilities, from systems analyst gathering requirements, the engineers who develop them, to QA testing, and everything in between. Calculate all your hours and put them in the following three cubes:
Your own employees
On-site consultants
Offshore and off-site consultants
It is better to multiply the required hours and rate for each individual, but for large teams you can use averages. Adding all three cubes will give you a total dollar amount, which is your Lr in the formula above.
3. PROFITABILITY OF THE INVESTMENT (King)
This is a very important and sometimes difficult variable to figure out the TCO. First of all, you must dollarize the benefits of the application you are building. That means translating the increased efficiency, potential growth or cost reduction, etc. to the dollar amount saved or earned per month. Now calculate how many months it will take you to recoup the cost of building the app at that rate. I say estimate because otherwise it is a catch-22 situation as you are trying to figure out the TCO in the first place. For a series of custom software applications, the Roi is around 12 months. You can add a few different values for this variable and see where you feel most comfortable.
4. QUALITY QUOTE (Qq)
This is where science meets art. We are calculating the long-term cost of ownership of a custom software application, which depends on factors related to the quality of the application. If the application has fewer errors, the cycle from QA to Engineering to QA to Deploy would be short. If the application is well documented, future enhancements will be easier and answers to questions will be faster. Well, you will see that they all affect the long-term cost of running the application. To measure what such unknowns will cost us in dollar terms over the life of the application, I find it most effective to put quality-related issues into the following four basic groups and rate them on a scale of 1 to 4:
Usability
Reliability
Scalability
Compatibility
You can put a number between 1 and 4 for each of them based on your previous experience with the same equipment or software. If you do not have previous data, select a number for each of those that you want your application to have. You can even have your own groups of the four most important factors. Adding these four will give you the last variable Qq needed for the formula.
Although the formula calls for Roi in the months required to recover the cost, the TCO is over the life of the application.
SPREADSHEET:
If you came up with the idea of a formula to find the TCO of a custom software application, let’s do an exercise with your numbers in the right column of the worksheet below:
Our sample data Your data
Fx: $ 120,000 _________________
Lr: $ 300,000 _________________
King: 12 _________________
Qq: 14 _________________
Substituting values in TCO = (Fx + Lr) * [1 + (Roi/Qq)]
TCO = 780k
Therefore, the total cost of ownership of our sample application is $ 780,000 over its anticipated useful life (about 10 years). This figure really helps you budget, compare, and save on custom app development.
About the Author
Mahesh Lalwani is Founder and CEO of Pacview, your partner in custom software and voice applications. Pacview has worked with dozens of companies in the healthcare, finance, technology and telecommunications, education and entertainment industries, helping them create successful software applications that exceed customer expectations. Through Pacview’s expertise in design and development, our clients enjoy the benefits of generating value through successful software applications. Visit our site at www.pacview.com for more information.
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