Total Cost of Ownership

by Mr. Cheap

One of Microsoft Windows’ competitors is Linux, a free operating system.  Beyond it’s low price, it’s a very stable, reliable system.  If I was playing a game or watching a movie, it’s easier to do so on Windows, but if I’m running a web server or an ftp server Linux is far better.

While competing, Microsoft faced the difficult challenge of going head-to-head with a free product.  The only way to beat them on price was to pay people to install Windows.  Instead, they brought up the concept of “Total Cost of Ownership” (as an aside, people have accused Microsoft of being very deceptive in how they presented TCO comparisons, which I agree with – that isn’t the point of this post).  Their line of reasoning went that although you may pay $400 for a Windows license (and be able to get a Linux license for free), once you’d paid all the costs that went along with running Linux on a computer you’d end up paying MORE than on a Windows system.  One of the big parts of the argument was that Linux system administrators command a higher salary than comparable Windows system administrators and, the line of reasoning went, what you saved on the license you’d more than lose on salary.

While this is an interesting business issue, I think this concept is also highly relevant in day-to-day life.  Often we’re sold things with a set price tag, or with a  set monthly cost, when there are actually a large number of hidden costs behind this.

A prime example is cars.  A Toyota Corolla is a decent vehicle, which can be had for $15,430.  Immediately when you click on the fine print, the cost doesn’t include freight, PDI (whatever that is), license, insurance, registration, taxes, levies and fees.  If we finance the purchase, we then need to add interest onto that.  Once we finally get it home, we get to pay gas, maintenance, and parking (both at home and at work).  Estimates of the total annual ownership cost of various models range from $6K to $16K.

Real estate agents love to advertise an affordable property as “cheaper than rent”.  Of course, the only things being compared are mortgage payments and rent, they conveniently omit maintenance (estimated at 2.5% of the property value per year), property taxes, utilities, insurance, etc., etc., etc.  When you take into account all the extra it would a VERY unusual situation where you could own for less than rent.

Real estate investors are often just as bad.  My post on “Tenants Paying My Mortgage” discusses at length one special case of a lesser price being substituted for the total cost of ownership.  Investors love to talk about “cash flow positive”, but it’s INCREDIBLY difficult to achieve, unless you fudge the numbers (such that you can convince yourself it’s cash flow positive, even when it’s not).

A boat is completely a consumer purchase (and an expensive one at that).  Beyond the purchase price, maintenance, gas and whatnot there’s also additional storage fees (which can be pricey in Canada where the water freezes over).  Many people want a boat, look at the ticket price and don’t think of anything beyond that.

A while back I read a newspaper article (which would make a good post) about how people who live in Barrie and commute to Toronto aren’t saving the money they think they are.  They get a house out in the ‘burbs cheap, and think they’re really benefiting from making a 1.5 hour commute each way 5 days a week, but when you add up the cost of the commute (gas, wear-and-tear on the car and time spent in traffic), it would more than pay a higher mortgage on an equivalent house in Toronto.

The way for dealing with total cost of ownership issues is to always be aware of follow up costs to a purchase.  Don’t be lulled into lazy thinking that you just pay the one price and that’s it forever – almost everything has follow up costs.  Thinking about things in terms of their cost per use, or cost per unit of time (e.g. how much to drive a car for 1 year) is often a more realistic perspective.  I read recently (on some blog or another) that clothes are good to be worn 100-200 times, and you should amortize their cost over the article’s lifespan.  This seems a little extreme to me, but it’s probably a good thing when looking at an expensive piece of clothing to realize you won’t have it for the rest of your life:  it has a number of uses before it’s worn out.

What things have you bought which turned out to have hidden expenses that exploded on you afterwards?

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{ 17 comments… read them below or add one }

1 DividendMan

I think people in general undervalue their time. What are we working for if not to have time to do things we enjoy more than work!

You mentioned the dreaded 400-404 death commute from Barrie to Downtown. 1.5 hours each way (minimum) per day is crazy, even at a low wage. Sure you can’t just turn these hours into money otherwise, but having the hours is worth something.

Linux is only free if your time is worthless. That quote goes for a lot of things.

2 jesse

@DividendMan, I agree that free time is one of the biggest overlooked costs. When I see people investing in property, almost all of them rarely pay themselves for the time they spend managing it, yet they claim “cashflow positive” when a REIT or property investment corporation wouldn’t touch these properties with a 10 foot barge pole.

3 Kathryn

I often base financial decisions on the total cost of ownership. It’s why we bought a new car (gasp!) because we drive them until they are 8-10 years old. When we did the monthly math on how much we spent on our used car over the time period (8 years – the age of the car) vs how much the new car (small, paid for with cash) over an 8 year period, the new car came out at less when we considered the total cost of ownership.

Same with our Macs. (We each have one.) Sure it was more expensive to start but the total cost of ownership is less. They last longer. They come ready to use without needing a lot of extras. No need to buy Norton anti-virus every year. They are already nearly 5 years old and are in perfect shape .. never had a virus, never a problem, never needed a repair and never a blue screen. We only ever had one PC make it to the 4 year mark.

It does sometimes mean spending more upfront but less over the long haul. I consider that good value for my money!

4 James

I think this topic is missing an inherent detail: risk.

Everyone knows that in the best case scenario, a used car is cheaper than a new car. However, you take a risk with it — a used car that dies within 6 months of your purchase is worthless, where a new car will still be protected under warranty. If you’re a car savvy person and/or willing to put the research into learning about cars (as well have a good mechanic, etc. etc.), than you could drastically lower your risk of buying a used car. Otherwise you might probably expect to start paying a lot for the extras (as mentioned above).

For the computer comparison: yes, a non-computer savvy person would benefit from buying a mac. I personally detest them, but would recommend them to anyone who’s unfamiliar with tech. I’m also not sure I buy the Windows is cheaper argument. Companies would greatly improve their security if they used Linux over Windows, which is something that’s hard to put a price tag on.

I play quite a few video games, and recently I’ve found a great way to play a lot of games for cheap is to buy and sell used games via Kijiji or Craigslist. I can often buy a recent PS3 title for around $50, and sell for $40, so the net cost of each game is $10 — sometimes less. I’ve even made profits on certain games, but that’s rare. I do spend more time than the average Joe who buys their game new from Best Buy, as well as I run the inherent risk of a game that I buy not working (no warranty), but who can argue with spending $10 for a game compared to buying a game new for ~$70 (usually $60 + taxes).

Bottom line: a lot of the time, it’s better to pay a little extra for “insurance”. If you purchase something that’s cheaper (used, for example) , you’re generally taking a risk. If you’re willing to spend the time to do research, etc., you lower the risk, but again, that’s costing you time. There’s a trade-off and everyone just has to find their own comfort zone.

5 Financial Cents

@Dividend Man – I agree. So many people in general undervalue their time. Work to live, not live to work….

@Four Pillars – to answer your question, I think any major expense compounds the cost of ownership, whether it be a car, a home, a boat or a sexy, new, shiny laptop. Small material items or consumables don’t fit the equation. It certainly takes a “big picture” thinker to understand the total cost of ownership. That’s not in everyone’s DNA. Insightful article!!

6 Chris

Don’t think I’d give it up, but HD TV turned out to be one of those higher TCO situations than I anticipated. Congratulated myself on getting an HD TV during boxing week a few years ago at a good price, but then I realized you need the HD box from Rogers (extra rental fee), oh and you also realize you’re not getting that many HD channels so you end up getting the HD channel package….so HD turns out to be “the cost that keeps on costing.” But years later I do still enjoy it and it’s one of my few splurges.

7 Neil Murphy

Cell phones, need I say more?

8 Kevin

“Investors love to talk about cash flow positive, but its INCREDIBLY difficult to achieve, unless you fudge the numbers (such that you can convince yourself its cash flow positive, even when its not).”

Not only this, but people often don’t consider the time spent running after tenants, replacing the water heater after they break it, etc…. there are these other things that might not cost you so much in dollar terms, but certainly cost you in terms of lost time, headaches, etc….

“They get a house out in the burbs cheap, and think theyre really benefiting from making a 1.5 hour commute each way 5 days a week, but when you add up the cost of the commute (gas, wear-and-tear on the car and time spent in traffic), it would more than pay a higher mortgage on an equivalent house in Toronto.”

Yep, unless your time isn’t worth anything to you at all, you also have to factor that into the equation. However, some people might also value living closer to nature, and then that also is a non-monetary consideration. In the end these tradeoffs have to be considered… let’s say the normal commute would be 30 minutes, then you have to ask yourself “is this extra 10 hours a week worth the lower mortgage and living so far out?”

9 Al

Printers and ink cartridges. Find the most cost effective cartridge, and then figure out which printer goes with it.

10 Broke By Choice

Very good article on a topic that many are not familiar with. I did strategic sourcing for a major corporation for 3 years and the Total Cost of Ownership is one of the concepts that they made sure we knew and applied to all analysis.

Carring in this concept to my personal finances has helped me make more informed decisions.

I did by a dance costume once for a low price ($150) and forgot to factor in the cost of alterations, time/gas to drop it off and pick it up and dry cleaning expenses. The costume wound up cost just as much as it would to pay for a more expensive one ($240).

11 mariaelisa

I agree that driving 1.5hours is exhausting, but living close to nature is wonderful… for every negative aspect there is a positive one. But, no one mentioned construction season, and how long it takes to get from point A to point B when all the roads are in construction…. it takes equal or more than commuting from Toronto to Barrie!!!!! so, if I will have to drive, and most of my driving will be bumper to bumper, for 1 hour for 12 kms, I’d rather drive 1.5 from Toronto to Barrie and live in a beautiful and affordable house instead of renting a place just for the fact of living “close” to work.

12 Four Pillars

Mariaelisa – if it is construction season then wouldn’t that mean the Barrie to Toronto commute might be affected as well? Ie the 1.5 hr goes up to 2 hours plus?

13 mariaelisa

Oh yes… but in this particular case, I was talking of the construction site in Steeles and Dufferin, which now affects me considerably, turning an usual commute of 20 minutes into one of 1.5hours…

14 Four Pillars

Holy cow! Have you considered renting a helicoptor? That delay is ridiculous!

15 Mr. Cheap

Kevin: Yep. ;-)

16 Kevin@InvestItWisely

Heh, I’m still subscribed to this… :S

17 Mr. Cheap

:-)

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