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Calculating the Total Cost of Ownership for On-Premise and SaaS Solutions

Understand how software investments work and what can cause costs to change over time

Disclaimer: This article discusses evaluating the total cost of ownership (TCO) for on-premise and SaaS solutions. However, information in this article should not be construed as financial advice.

Six months ago my boss sent me an interactive calculator that the New York Times created to help people decide whether it's a better financial decision to buy a home or simply rent one. He shared the calculator with me because, at the time, we were looking for interesting ways to visualize data and relate it back to our work at Software Advice where we review enterprise software systems and report on enterprise tech trends. More on that in a bit.

Although I wasn't in the market to do either, I found myself adjusting values and playing around with the calculator just to see how long I'd have to rent at my current rate to make purchasing a home worthwhile. In case you haven't seen the calculator yet, here's a screenshot of what it looks like.

After adjusting my monthly rent figures and home prices for a bit, I clicked on Advanced Settings where I got sucked in because the calculator also provided educational information on things like my yearly cost breakdown, average savings each year if I bought a home, and lost opportunity costs. I thought it was a really valuable tool because it took so much of the legwork out of the house hunting process.

What does this have to do with enterprise software?

Well, figuring out whether it's better (financially) to rent or buy a home is, in many ways, like trying to decide whether you should rent or buy software. In other words, it's similar to comparing the costs of purchasing an on-premise system against the cost of purchasing a subscription to a cloud-based solution.

So, inspired by the "New York Times," we set out to create a calculator that would make it easier for software buyers to compare on-premise costs against SaaS software costs, while also educating them about the key factors that influence these costs. But we didn't want to simply compare licensing costs against one another; we wanted to give software buyers an idea of what the total cost of ownership (TCO) - calculating both direct and indirect costs - of their software investment and then make an apples-to-apples comparison between the two deployment models. After six months of work, we finally finished developing a calculator that we think does a good job of helping software buyers understand the TCO of both software models. Here's a screenshot of what we came up with.

I'd like to explain a bit about why we developed the calculator - and how software buyers can use it.

Why It's Difficult to Evaluate the Total Cost of Ownership
As cloud technologies continue to evolve, more and more software buyers are seriously evaluating Software as a Service (SaaS) solutions against on-premise offerings. While there are many factors that influence which deployment model is best for any particular business (e.g., ability to manage IT internally and speed of deployment) the cost of the system is often a key factor.

But comparing the true cost of a cloud-based system against an on-premise system can be time-consuming and is often a complex undertaking. And most of the existing instructional material that teaches software buyers how to come up with these figures is locked up in 15-page whitepapers that can be difficult to understand. Furthermore, average software buyers generally aren't very familiar with all factors that can influence costs.

For instance, most buyers understand that on-premise licenses are typically purchased with a large, upfront investment and SaaS licenses are purchased for a relatively cheaper subscription price. But many forget to consider the total cost of ownership (TCO) of their investment. That is, they don't look beyond the licensing costs to consider how other factors such as the need to customize the software and integrate it with existing applications can influence the TCO of their software purchase.

Even then there are intricacies like maintenance and support and training requirements that can make creating an apples-to-apples comparison of the TCO of on-premise and cloud software difficult. If you're not a seasoned veteran in modeling all these costs, comparing them can become overwhelming.

How Buyers Can Use the Calculator
We built the calculator to help buyers ballpark the true costs of each software model and understand how software investments work and what can cause costs to change over time. We decided that we would model costs over a 10-year timeframe and so broke down costs into what we felt were the eight most important influencers for the TCO of a software purchase.

  1. License and Subscription
  2. Installation and Set-up
  3. Customization and Integration
  4. Data migration
  5. Training
  6. Maintenance and Support
  7. Hardware
  8. Other

Then we created an example case to pre-populate our calculator just to give buyers a sense of what a model of these costs looks like. From there, users can override every value to see the impact that changing any particular value will have on the TCO as a graph at the top of the calculator automatically refreshes after each update.

The calculator then models annual and cumulative costs over this time period and shows buyers at which year of ownership the TCO of a SaaS system will equal that of an on-premise solution, based on user inputs. All of this information gives buyers a good "gut check" as to which system would best suit their financial situation. Importantly, however, the data is still somewhat general and buyers still have to do a bit more work to come up with final figures for the TCO of their investment.

Moving Toward a More Refined Calculation
While the calculator is useful for getting you in the ballpark, it's important to note that any business will still have to perform their due diligence to come up with an accurate figure that reflects their unique needs and situation. There are several influencing factors (e.g., organic business growth) that no general calculator can accurately model. To do that, I recommend consulting a financial analyst or consultant that can help you understand your precise business needs and the costs that you'll likely encounter.

If you'd like to see the live version of the calculator, please visit the Software Advice Total Cost of Ownership (TCO) Calculator. I'd also like to extend a special thanks to Brian Sommer, Founder of Vital Analysis, and Jonathan Gross, VP and Corporate Counsel at Pemeco, for providing feedback and guidance in the creation of this tool.

More Stories By Derek Singleton

Derek Singleton recently graduated from Occidental College with a degree in political science. He writes about various topics related to ERP software and covers the manufacturing, distribution, and supply chain management software markets.

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