Low-Price and the TCO of Services

by Chris Arlen on June 22, 2015

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Low Price Leprechauns and TCO of ServicesTotal Cost of Ownership (TCO) should be a factor in all B2B purchase decisions – you take a rough cut at TCO, rationalize suppliers’ pricing with that cost-adder during bid evaluations, and voila! A smarter buy is made.

Why not? It’s common in many situations, such as buy-versus-lease for vehicles, or buying an on-premise software system versus Software-as-a-Service (SaaS).

But try and apply TCO to the purchase decision for a service, especially any facility service, and things get wacky fast – like buying from a leprechaun where:

You buy a service with pennies at the contract’s signing, and then end up paying in dollars over the term of the contract.

With all due respect, many buyers are fantasists when it comes to evaluating purchases of services. Here’s why.

  • Buyers want to believe in leprechauns
  • Service costs accrue over the contract’s term
  • Quantifying Service TCO: hard to do, but not impossible

Buyers want to believe in leprechauns

Buyers, in general, assesses a service’s value only during a contract renewal process. Rarely, if ever, quantifying TCO over the contract’s term.

And that’s a shame because it means buyers can only focus on the difference between the new and old purchase price – and typically choose the lower of the two.

Without the reality of a Service TCO, buyers are blinded by the siren’s song of the low-price leprechaun in RFP bid evaluations.

Service costs accrue over the contract’s term

Services aren’t delivered all at once; it takes time to realize the full cost of the original purchase decision.

Because services are intangible and differ in each instance, they can fail at any time, generating costs above their purchase price.

Therefore, quantifying Service TCO requires catching costs over the contract’s term and from many areas affected by a service failure.

Whenever a service fails, and it will, costs may include one or all of the following:

  • Regulatory fines
  • Lost product/delayed production or shipping from the service failure
  • Excessive vendor management time to ensure service quality & delivery
  • Lowered productivity/morale/retention of your employees from repeated service failures

Quantifying Service TCO: hard to do, but not impossible

There are two types of costs that contribute to Service TCO: hard & soft.

Regulatory fines are hard costs that are relatively easy to quantify – if the service failure is the primary contributor to the regulatory penalty. And lost product/delayed production or shipping from the service failure can also be measured as a hard cost.

But soft costs are more difficult to determine – and more likely to be the big, added cost in the TCO of a service. Think about the costs associated with spending too much time managing a lowest-priced supplier, or the lowered productivity and quality from repeated service failures, especially from support areas that are supposed to keep operations humming along.

And this is how the leprechaun’s trick works.

Because it’s hard to quantify soft costs in a Service TCO, those little people can persuade you to buy on pennies at the contract’s signing, and get you paying in dollars over the term of the contract.

Your best strategy against leprechauns is to create a calculator for Service TCO.

Yes, it’ll take effort as you’ll be making “good enough” estimates on soft costs rather than holding out for “perfect and exact.” Specifically, you’ll have to identify:

  • Common service failures by service line
  • Impacted activities/areas per failure
  • Scaling factor per failure to adjust for size/extent
  • Soft cost increments per failure for the scaling factor

To get ideas for the structure of your Service TCO calculator, take a look at TCO calculators from other industries, such as:

Once you’ve made your own Service TCO calculator, your buyers can use it to:

  1. Accurately assess supplier prices during service RFP evaluations – where you may consider paying a higher purchase price for more service when it equals a lower TCO, and/or,
  2. Fine-tune supplier penalties for SLA-based, fee-at-risk contracts.

Conclusion

Little people in green suits can trick B2B buyers with the lure of a lowest purchase price for services.

Don’t be fooled. Assess service purchases on their TCO, which you can do once you’ve created your own Service TCO calculator. Better buys are out there.

IMAGES: Leprechaun by Sonny Abesamis, A Spot of Magic by JD HancockMoon Rise behind the San Gorgonio Pass Wind Farm by Chuck Coker, Scrabble by Abigail Silvester

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