TCO vs. ROI – Which one to use?

Firstly, I’d like to outline the basic definitions of the two measures.

  1. Return on Investment: This is calculated by the basic mathematical equation:
    ROI = (Gain from Investment – Cost of Investment) / Cost of Investment
    It is defined by “a performance measure to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments” (Investopedia, n.d.). An important note here is that the ROI calculation can be modified to suit its situation, you may include the running costs in as the cost of investment (Investopedia, n.d.).
  2. Total Cost of Ownership: “In general, the purchase price of an asset plus the additional costs of operation” (Investopedia, n.d.).

Personally, I prefer the Return on Investment approach. While it is inherently not 100% accurate due to the fact that we cannot predict the exact gains from the investment, it will give us not only the negative aspect of the investment, but also allows us to compare it to the financial gain the investment offers.

In my opinion, a Total Cost of Ownership has the potential shock value that may scare off investors due to it only showing the capital layout as opposed to the potential benefits.

Nash (2008) conducted a study that surveyed 225 technology managers with a result showing that 59% of the managers reported that ROI calculations influenced whether they pursued a project in the past 12 months compared to 41% reporting that TCO justified their decision. Nash’s article (2008) goes further to quote a CIO who states “ROI has to be the answer. TCO only looks at one side of the equation”. As per my comments above, I concur with this statement whole heartedly.

My experience in my career has been involved in mostly development of business tools for companies. Management reporting, investment reports etc. and I have not come across a single project that has required a TCO report, but many that have requested ROI’s. I see the place of a TCO report being more of an investigation into areas of business that do not necessarily return an investment, or hold ‘asset’ value; such as weighing up the costs of ‘perk’ items for employees to see if the business has enough excess profit to justify the expense incurred.

References

Investopedia (n.d.) Return on Investment – ROI [Online]. Available from: http://www.investopedia.com/terms/r/returnoninvestment.asp (Accessed: 19 December 2010).

Investopedia (n.d.) Total Cost of Ownership – TCO [Online]. Available from: http://www.investopedia.com/terms/t/totalcostofownership.asp (Accessed: 19 December 2010).

Nash, K (2008) TCO versus ROI [Online] CIO.com. Available from: http://www.cio.com/article/331763/TCO_versus_ROI (Accessed: 19 December 2010).