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Why TCO is not the best way to evaluate IT investments

Guy Cranswick | July 18, 2014
Measuring enterprise technology purchases in terms of investment ratios to operational revenues is not very sound.

There is one more major and critical difference between enterprise technology investments and financial investments. That is time, or the 'time value of money' which is the principle that the purchasing power of money varies over time.

This idea is central to financial investments and the valuation of anything from individual assets, share prices, superannuation and dividends.

The time value of money is completely absent when it comes to doing financial analysis of enterprise technology investments. All costs, whether in a classic total cost of ownership and/or benchmarking analysis, are assumed to be at present value.

The investment analysis, which analyses ratios of IT investments to business revenues, is also achieved implicitly at present value. This occurs even though revenues will be earned over several years, not the same year as the technology investment.

The reason why this is important is that money is worth more now than in the future.

This is true for enterprise technology investments even if they do not hinge on the same metrics of return or use of capital over time that a financial investment would make.

Negotiating the payment timing for a technology asset alone can quickly turn an inefficient investment into an efficient proposition when 'time value of money' is integrated into the analysis.

The benefit of net present value

Discounted cash flow analysis is the method by which to derive the net present value of an investment. In many respects, it is a powerful method to value your IT assets. Using this method, future cash flows are forecasted and discounted to provide their present values.

This method is beneficial because it accounts for the time value of money, and does not depend on other data sources in order to compute outputs. It provides a more realistic evaluation of the value of technology and the efficient use of capital over time.

Ultimately, you need to ask yourself the following questions when you are analysing the value of your technology investments.

  • Which methodologies should be applied given our current requirements? Total cost of ownership or benchmarking or both?
  • Which methodologies are used by our finance department and which are preferred for certain functions?

It's possible to be more precise in the way that you evaluate the cost of technology equipment over time. Implementing better analytical methods is necessary if you are to make good technology investment decisions.

 

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