The True Cost of Software: Consideration for Vendor Selection

See also: high level software selection Q&A

Selecting a software vendor is a complex task that every business faces and nobody particularly likes. 

How did you decide to buy your last software? Was it peer reviews, brand recognition, or choosing the standard solution in your industry?

Does your business use software that the entire company dislikes? Perhaps it doesn’t do what you need, or you can’t convince your team to use it consistently (and so the ROI is severely impacted), or it just doesn’t work well. 

Between analyzing requirements, dodging calls from sales reps, and figuring out the budget, it’s easy to overlook important aspects of selection. Making a less-than-ideal choice can have long-term consequences impacting your bottom line over time.

The tricky part is no textbook answers can tell you if X vendor is better for you than Y vendor. Everybody’s company and context are different.

This series is a refresher diving into multiple aspects of successful software vendor selection.

And we’ll start with the price. 

Beyond the Initial Price Tag: Software Total Cost of Ownership (TCO)

It’s only natural to focus on the initial purchase or subscription fee when evaluating options. 

Sometimes, that’s not a bad approach - for example, when you want to obtain a single-purpose software like a conversion tool or a calculator. 

But for anything more complex, consider total cost of ownership instead of using the subscription fee for vendor comparison.

While it takes longer to calculate, TCO is a much more accurate metric as it considers the true cost of obtaining, switching to, using, and retiring the software.

Some costs are direct (fees, hardware, support), while others are indirect (like training and initial productivity losses), and a few may require estimations to quantify.

Why is TCO more accurate? Because the initial purchase fee often represents just a small percentage of the total associated cost when viewed over years of ownership. Picking the product with the cheapest license may end up costing more.

TCO helps you to compare apples to apples.

Software TCO Formula

TCO=Cost to Obtain Solution + Cost to Run +Cost to Retire.

What is included in each formula component depends on your specific use case.

For example:

Cost to obtain

Creating

• Cost to develop
• License cost
• Customization cost

Integrating

• Data migration.
• Training and onboarding
• Updating documentation and guides
• Adding integration with existing solutions

Installing

• Hardware, networking, domain fee
• Server fee

Cost to run

Support

• Support contract cost
• Vendor management
• Issue reporting, management, and resolution
• Downtime costs

Maintenance

• Installing updates (security, version)
• Disaster recovery preparedness

Operations

• Hosting cost
• Data transport, storage, and backup cost
• Monitoring

Anticipated cost increases

• License cost creep
• License model creep (for example, from flat fee to per seat)

Cost to retire

• Data management (export, archive, delete)
• Updating guides, documentation
• Cost to leave (for example, data transfer fee)
• Cost to retire integrations

Challenging the common cost truths

Total Cost of Ownership metric gives your organization the power to question commonly accepted assumptions - which may not be accurate for your context. 

Cost assumption: public cloud is more cost-efficient

The cloud wins when comparing the cost of buying a server and setting up on-premises hosting with purchasing a cloud subscription. 

But does the cost saving hold when viewed long term - in your case?

Here are just a few considerations:

• Cost creep. The cost will escalate as you add more data, users, and traffic. Some of the cost creep can be managed to prevent spending waste, but that, in itself, is an added cost - regardless of whether you use an internal team, service, or advisor for cost management.
• Integration performance challenges when connecting cloud services with existing on-premise systems. Solving these challenges often require additional investments.

There has been a noticeable trend of cloud repatriation (moving some data-intensive workflows from the cloud back on-premises), and cloud spending control remains the top priority of many organizations (see Flexera State of the Cloud report). 

While cloud solutions offer flexibility and can be cost-effective for many scenarios, creating a solid TCO metric for your specific case will help you decide if cloud is indeed a better option for your organization. 

Cost Assumption: Open-source software is always cheaper

No upfront license fee will reduce the acquisition cost portion of your TCO metric but may significantly raise it in other categories - unless your organization has the talent and bandwidth to manage open-source solutions and the cost is already covered elsewhere.

Otherwise, consider these realistic increases:

• Cost to obtain the necessary expertise to install, customize, support, and manage the solution.
• Cost of hardware.
• Cost of managing updates that may include breaking changes.

Cost Assumption: when using software as a service (SaaS), the subscription fee is what you pay

While it’s true that your TCO metric will not have any costs under hardware purchases, don’t forget to consider:

• Cost of data overages.
• Integration cost with other applications and systems (for example, API calls or plugins).
• Cost of leaving (if vendor charges for your data download).
• Backups and downtime. 

Cost assumption: market leader is the better investment

“Nobody got fired for buying IBM.” 

It’s natural to gravitate toward market leaders and justify paying a premium, expecting quality and reliability.

Which makes it easier to overspend. 

Consider these points in your TCO metrics:

• The true cost for features used. It’s easier to justify the premium for a large set of features. However, if your organization only uses 50% of what’s available, compare costs with smaller vendors that provide a subset of features critical for your business.
• Cost of support - understand the support tiers offered and which level is preferable for your organization.
• Cost of premature leaving due to cost increases, forced product migration (when the product you are using is being discontinued), or changing business needs.

Does calculating TCO feel like too much work?

Everybody is busy, and creating complex formulas may feel too time-consuming and unnecessary, considering their potential inaccuracy.

After all:

• Predicting future costs or usage patterns is hard, especially years in advance.
• It requires time and effort.
• It assumes budgets stretch across years and reduces the importance of cash flow, where distributing the higher cost across multiple years is preferable to paying less but once.

TCO is not a solve-everything metric. While predicting the future is impossible, trying to come up with estimates helps to consider other aspects of software acquisition that may have been overlooked, like unexpected costs or talent readiness. 

It doesn’t have to be perfect. Start small by creating a standard TCO template for your company, ask for help if needed, and use your analysis for vendor negotiation. 

TCO helps with making the right decision

Look beyond the initial price tag when selecting a vendor and question the common assumptions of what approach is the best practice or most cost-effective. Utilizing the TCO metric gives you a 360 view of the true software acquisition costs, helping you to make more informed decisions that align with your business’s long-term financial and operational goals.