White Paper - Total Cost of Ownership

Driving the Outcome: A Holistic Approach to Total Cost of Ownership (TCO) 

Your guide to optimizing TCO within the realm of facilities management.

March 2021

PREDICTING THE UNPREDICTABLE

Technological innovations, and their subsequent integration into our daily lives, have helped shape every facet of our society since the man first invented the wheel. Gutenberg's first printing press in 1440 changed the way we communicate and educate. In the 1850s, the Bessemer Process for creating steel helped spearhead an Industrial Revolution. And in 1928, Alexander Fleming – almost by accident – transformed the course of modern medicine through his landmark discovery of antibiotics.

Each of these watershed inventions represented a massive step forward in our linear evolution. But when viewed against the exponential explosion of digital technology we have witnessed since the turn of the century, the pace in which our world was previously advancing seems almost lethargic in comparison.

Over the past two decades, a suite of enabling technologies, from computing capability to data storage to the sheer scale of the Internet, have allowed us to acquire, interpret, and implement new information at the click of a button. But while our technological achievements ensure that almost any detail regarding our past or our present is instantaneously available, the rate at which we’ve evolve digitally has made our future increasingly difficult to predict.

From an economic prospective, business entities rely on forecasting, a strategy of anticipation and estimation. Forecasting provides vital information relating to an organization’s future by collecting data regarding their past and present. The process is invaluable to businesses because it offers the ability to make informed decisions and develop data-driven financial and operational strategies. In short, it allows a company to be proactive instead of reactive.

However, the reality is that inevitable variables to the standard business equation — both naturally occurring and digitally accelerated — all but ensure that our global economic system will forever remain uncertain and unpredictable. The digital transformation of our society will forever pressure business entities to evolve. In order to keep pace, versatile and responsible leadership must continually reevaluate the way in which they prioritize critical assets like facilities, workforce, utilities, and security.

Gone are the days where enterprises could follow a static model for sustained success. In 2021, the most reliable path to consistent prosperity is to fully comprehend the resources and assets at our disposal and utilize them in a manner that optimizes their efficiency, all while determining how best to mitigate the potential risk that unknown variables will inevitably present.

Proactive business entities and real estate industrialists can successfully build and maintain their infrastructures not by attempting to avoid or eliminate unknown variables, but rather by understanding, adopting, and incorporating them into a holistic business forecast. This comprehensive, long-term asset investment strategy is commonly known as Total Cost of Ownership (TCO).

DEFINING TOTAL COST OF OWNERSHIP

While Total Cost of Ownership has broad applicability across business models in any industry, it is particularly relevant within commercial real estate portfolios and facilities management. The overall objective of the TCO approach is to align an organization's mission with its investment strategy by taking into account all related infrastructure and facilities costs, then strategizing and prioritizing these costs against an established budget. The intent is to transform the organization’s entire thought process, moving away from reactionary, single component-decision making to a more comprehensive approach, one that focuses on acquiring and maintaining an integrated system of assets within the organization's real estate portfolio.

In simpler terms, TCO is about looking at the big picture, rather than focusing solely on the immediate need of the moment. This holistic strategy looks beyond the actual (direct) cost of purchasing a product or service and takes into consideration each of the cumulative (indirect) costs associated with that asset’s life cycle. This more comprehensive method requires leadership to make purchase, maintenance, and workforce decisions based on the value of their long-term return on investment (ROI), rather than throwing money or valuable resources toward more imminent needs where the payoff is more tangible and immediate.

THE IMPORTANCE OF INTERRELATIONSHIPS

One should not categorize Total Cost of Ownership as a rigid, defined process, but rather a framework of standards that drives the process forward until it reaches its most optimal outcome. It is an adaptive, customized approach to systemic facilities management. Cost is only one point along the spectrum; this is about preserving harmony throughout the entire lifecycle of a portfolio’s service life, from conception, construction, and installation to commission, operations, and renewal. It is a thorough understanding of the interdependence between critical assets, and how a decision made in one area of operation effects the entire equation. Total Cost of Ownership focuses on balance, on maintaining a ratio. It goes beyond crisis management and examines how each and every business decision made affects the performance and longevity of the entire organization.

BY THE NUMBERS

Total Cost of Ownership = ∑Ci + ∑Cm + ∑Cu + ∑Cr + ∑Ce

Where:

Ci= Initial Asset Costs

Cm= Operations and Management Costs

Cu= Utilities Costs

Cr= Capital Renewal Costs

Ce= End of Life Costs

*APPA TCO 1000-1-2017 Total Cost of Ownership for Facilities Asset Management (TCO) - Part 1: Key Principles

At first glance, the above equation may appear completely linear, even simple within the context of a larger, holistic strategy. But in reality, the complexity of the approach lies not in the components themselves, but in their critical relationships to one other. Let’s take a look at each in further detail.

Initial Asset Costs

This refers to any expenses related to the planning, acquisition, and design of the initial build-out of a facility, or the renovation of an existing one. These one-time costs include items associated with construction, installation, and loan financing. It also encompasses anything related to the commissioning of the building, assuring that building systems and operations are properly set up, tested, and implemented.

Operations and Management Costs

These are recurring costs that will be repeated throughout the entire lifecycle of the facility. Examples may include leasing fees, maintenance and operations expenses, and ongoing overhead and administration costs such as salaries, wages, and commissions. It is important to understand the difference between proactive maintenance (repairing an asset once failure occurs) and reactive maintenance (avoiding repairs and asset failure through preventive and predictive methods), as both must be incorporated into the TCO model.

Utilities Costs

Also recurring over the life of the facility, utilities costs include money for the building’s electricity, natural gas, and water expenses, but can also relate to necessities such as heating and cooling services, storage, and renewable energy.

Capital Renewal Costs

These costs are incurred through the planned, cyclical replacement or refurbishment of assets toward the end of their functional life, in order to maintain a state of good repair. These expenditures typically refer to repairs on both real property (infrastructure) and physical property (machinery and equipment).

End of Life Costs

This refers to expenses incurred due to an asset reaching the end of its lifecycle. These can include, but are not limited to, monies for the sale or re-sale of equipment, removal of equipment or waste, demolition and disposal, and any cost involved in site restoration or remediation.

By defining each of the components within the equation, we can begin to understand how each relates to one another as part of a balanced, fully functioning facilities infrastructure. When confined within the limits of a pre-determined budget, adding or subtracting from one component means altering the path of another. Through the lens of Total Cost of Ownership, facility managers can learn to support the organization’s mission not only by sustaining and enhancing their general sites, but by optimizing the infrastructure of the facilities portfolio while balancing the budget they operate within.

THE CONCEPT OF TCO IN MOTION

In order to place the concept of Total Cost of Ownership comfortably into context within the realm of facilities management, let’s look at the fundamental theory TCO through a more relatable scenario. Rebecca is the facilities manager for a six-story office building on the north side of Chicago. Her responsibilities include supervising staff, managing budgets, ensuring that basic facilities are well-maintained, and overseeing any repairs or renovations, just to name a few. Rebecca has built a solid reputation for her work ethic, and her ability to react swiftly when complications arise.

Rebecca is hyper focused on keeping her corporate clients happy in their work environment, which goes a long way toward ensuring that they will consistently renew their leases. Because of this, she does what she can to comply with their requests. At a recent tenant meeting, several client representatives requested an upgrade to the elevator system. While the system was only installed five years prior, the building’s population has increased significantly over the past 12 months, resulting in employees occasionally experiencing a short wait to board the elevator.

A decision is made to add an additional car to the elevator system. This is a pricey renovation, but Rebeca believes that it is in the best interest of keeping her tenants happy. As she is operating on a pre-established budget, she decides to delay several planned expenses to the following year, including minor roof repair, window insulation, and the installation of an addressable fire alarm panel.

The elevator renovation goes smoothly, and employees respond very favorably to Rebecca’s efforts. Unfortunately, several months later a large fire breaks out in the building’s basement, and the fire department is not called until visible smoke is detected by a member of the custodial staff. While no structural damage occurs, the resulting smoke damage renders the first floor of the building uninhabitable, and several long-term clients are forced to find a temporary alternative. Complicating matters even more are the resulting expenses necessary to repair the basement and first floor, which result in further delay for necessary maintenance to the roof and windows. Rebecca is now wildly over budget, and has more than a few very vocal, very unsatisfied corporate clients.

It is easy to read the above scenario and think that Rebecca made a foolish error in judgement. But in reality, she simply engaged in the very human behavior of basing her decisions on a single-line perspective. She was not incorrect in prioritizing her clients’ needs, however, she failed to properly interpret the interconnection between a functioning elevator system as an asset and the other factors at play in the grand scheme of her budget. By applying so much of her money and resources toward one component of her business equation, she directly contributed to the down-cycle of several others.

THE VALUE OF PERSPECTIVE

Today more than ever, facility budgets face extreme cost imbalances and volatility due to changing external drivers. Rising construction and operational costs, increasing competition to attract and retain talent, changing workplace programmatic needs, more complex health and sustainability requirements require more flexible and agile workplaces. Tasked with accepting these challenges and managing the opportunities is CRE leadership or the facilities manager, with one eye on asset strategy and the other on a pre-determined budget. Luckily, TCO can provide all the tools needed to find harmony between the two.

Total Cost of Ownership is not a new concept; in fact, the TCO vision has been implemented across multiple industries for decades. So the question is, why don’t more commercial real estate entities incorporate the Total Cost of Ownership approach when making purchase or management decisions?

One explanation may be simple short-sightedness; many businesses are very focused on the moment, and the immediate impact of a purchase on their current cash flow seems negligible in the grand scheme of their fiscal year. But another contributing factor is a lack of defined standards for the capture and quality analysis of data, which is the key to the successful implementation of the TCO model. When you combine these factors with a lack of integration with the overall commercial real estate strategy, it is easier to understand why such a proven and consistently successful method is not more prevalent in today’s business world.

In order to provide sound guidance and financial strategy within the spectrum of the TCO model, you must establish and adhere to a series of best practices that transcend budget limitations, industry variations, or geographical positioning. The foundation of (company name removed)’s own unique TCO framework is itself built on three critical pillars:

People and Process

As with most critical business operations, success lies in aligning the right personnel with the proper procedure. It takes individuals with experience and expertise to successfully transition TCO strategy from the data collection and analysis stage to implementation. With the right TCO framework, standards, and training, a facility’s existing operations can be adapted to routinely capture data at the point of creation, and then apply it throughout the lifecycle of the asset. Total Cost of Ownership is enabled when everyone involved thoroughly understands the model, and is held accountable for capturing the right data.

Advanced Technology

In order to create a cohesive, comprehensive cost management strategy, you must be able to configure technology to capture consistent, accurate, and relevant data in real time. Advancements such as artificial intelligence and predictive modeling can reveal, deep, dynamic infrastructure insights, providing senior leadership with the ability to move from insight to action, and drive revenue and asset lifetime value.

Critical Data

To properly implement the TCO approach, a business entity must be able to properly review and analyze its full complement of cost and asset data. More importantly, it must be able to view this information in the proper context. Trust in the data requires accurate, justifiable, and reliable reference costs that may vary based on time, location, and complexity. Buzzwords and unnecessary complex computations have no place here – this is about transparency and ensuring that the right data is presented in the right light to those with the power to make decisions that affect the bottom line.

CONCLUSION

Provided TCO standards are consistently and thoroughly applied, CRE leadership will undoubtedly see a dramatic and positive improvement to the performance of their real estate portfolio, and a substantial increase to their ROI. The application of TCO helps both owners and occupiers manage their investments to support Just-in-Time decision making, in order to maximize their investment in a particular facility or asset.

In times of uncertainty, it is vital that organizations take stock of the assets they already possess, while enhancing the utilization of the variables within their control. The Total Cost of Ownership concept is an impactful step forward for enterprises because, when applied properly, the approach transcends volatility, and remains unaffected by marketplace trends. It was created to inspire confidence in investment decisions and decision-making, and allows business entities to realign their entire investment strategy not by reducing costs, but by optimizing those costs in a manner that clearly aligns with their each of their investment initiatives.