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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