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Total Cost of Ownership in Software Outsourcing

by David Burkett, Dec 12, 2016

Having sophisticated business software is indispensable for maintaining a competitive edge in contemporary organisations. This is one of the several reasons why organisations choose onshore or the more risky route of offshore outsourcing. High-end services require heavy investment and lead to recurring ongoing costs across the duration of software use. However, when purchasing new software, businesses often expect their software-related costs to be limited to the initial purchase. This is not the best approach because the ongoing expenses incurred during its use go unaccounted for.
Gartner, one of the world’s leading technology research and advisory companies, defines total cost of ownership (TCO) as a comprehensive assessment of information technology (IT) or other costs across enterprise boundaries over time.
While TCO is an important aspect to be considered for return on investment (ROI) calculations, it is often not considered in ROI evaluations. This is because managers fail to recognize that new software is rarely a one-time cost. They don’t acknowledge the elements of the cumulative expense that could be incurred over a period of time, leading to ‘surprise’ costs along the way.
Therefore, it is essential for companies to quantify the financial impact of deploying a product through its life cycle by (1) planning ahead, and (2) considering costs beyond the immediate hard purchase. Total software development costs, whether development occurs through software outsourcing or in-sourcing, can be broadly divided into three categories: startup costs, operational costs, and retirement costs.

1. Start-Up Costs

Start-up costs vary on both the type of the software and the pricing model that a business chooses. For off-the-shelf a business needs to shell out software license and subscription fees, while for custom-made software such costs are higher. Start-up costs also include implementation costs such as installation and set-up costs, costs involved in testing, configuring the software to accommodate the business processes, and even hardware costs for legacy software.

2. Operational Costs

These are the ‘in-use’ costs which are involved in the day to day running and maintenance of the software to ensure smooth functioning. They comprise of scaling costs, back-up and data migration costs, as well as compliance and license tracking costs. Off-the-shelf software often requires overhead expenses towards its customization to ensure that it caters to the business’ requirements.
Even the most sophisticated software would fail to yield business results if the company’s employees are unable to use it. Therefore, an organization needs to invest towards employee training to ensure that they are able to use it smoothly. Further, there may be additional costs when new employees are added, and this cost depends largely on the software pricing model.
Another set involves the maintenance and support costs which could be charged for ongoing updates, bugs, issues, and costs for software flexibility and expansion. SaaS vendors often bundle the basic support charges into their subscription model, however, organizations end up paying extra for more sophisticated maintenance issues.

3. Retirement Costs

The total cost of ownership is not limited to start-up and operational costs, there are also financial and psychological costs involved in switching from one system to another. The financial costs pertain to software replacement, upgrade, and even cancellation, while the psychological costs pertain to the potentially reduced employee productivity when accommodating to a new software, employee discomfort etc. Moreover, there may be high costs involved in employee training for the new software.

Navigating Through Total Cost of Ownership in Software Outsourcing

The understanding of these costs has some important implications for managers. Firstly, it can help them quantify the financial impact of deploying a software by planning ahead, and considering costs beyond the immediate hard purchase.
Secondly, it can enable them to make more informed and long-term decisions when choosing a pricing model, such that it best meets their business needs as well as their financial capabilities. Such a decision can be made based on the business’ flexibility, its long-term growth trajectory, its past experience, as well as an understanding of potential dynamic requirements.
For example, custom-made software may be costlier at the onset, but could also prevent flexibility-related costs in the future, when the firm grows in size. Similarly, an organisation can decide whether owning a software would cost less and be more profitable based on their long-term growth goals. Alternatively, they can explore cost-cutting measures if the business requirements favour a subscription-based software. Therefore, it is imperative for businesses to conduct a TCO analysis to gauge the expected investment and budgeting requirements. 

Custom Software Development

Agile software development companies such as WorkingMouse, understand the dynamic needs that come with the growth trajectory of start-ups, as well as the complex requirements of large businesses when it comes to having a control of their software. Our custom software development services is grounded on iterative design principles, such as sprints and regular engagement with clients, and allows businesses to maximise their growth potential and explore new avenues.
While custom solutions incur some risks, there is also a set of risks associated with off-the-shelf solutions. Moreover, in terms of costs, neither is as simple as is commonly perceived, and there are several dimensions to the total cost of ownership. 
If you want to read more on how you can manage your software costs, check out Eban's article How to Accurately Estimate The Cost of Software.