Many business leaders intuitively understand the qualitative benefits of applications outsourcing-benefits that include easier maintenance, improved performance, and greater focus on core competencies. Financial executives, however, must rely on more than just intuition. The CFO and his or her team deal in hard facts and numbers-measuring, adjusting, projecting, and reporting the performance of the company with spreadsheets, shareholder reports, and SEC filings. The efforts of financial executives to quantify the potential risks and rewards of IT decisions-including decisions about whether to outsource applications management-has helped drive rapid and widespread adoption of relatively new metrics such as total cost of ownership (TCO) and return on investment (ROI).

Unfortunately, there is no universally accepted approach for calculating TCO of enterprise applications, or even for using this data within the organization. What does it really cost to manage an application in-house? Which factors must be considered when estimating the costs of outsourcing? And how should these values be compared? Each consultant, application vendor, and outsourcing provider seems to have a different answer to these questions. It's no surprise, then, that many businesses have become increasingly dubious about the value of TCO data.

This skepticism is regrettable. When used properly, TCO analysis is an important tool to help financial executives determine an effective applications management strategy. It can cut through the marketing hype to enable objective, apples-to-apples comparisons between multiple products or solutions. However, far too many companies do not use TCO appropriately. As a result, far too many companies make strategically vital business decisions based on data that is at best suspect-and at worst wildly inaccurate.

This document offers some guidelines to help you use TCO more strategically within your organization. It is not a primer on why this metric is important or which specific variables you should include in your calculations. Rather, the emphasis is on how you can make more effective use of TCO to support more informed business decisions. While this document focuses on applications outsourcing, the principles it outlines are broadly applicable to almost any TCO analysis.

How to use TCO strategically

The real power of TCO is as a tool for evaluating multiple possible scenarios, not as an absolute value for a single, specific case. In other words, TCO is a device for making measurements, not a measurement itself. It's the yardstick, not the distance; the thermometer, not the temperature.

There is no such thing as a single best or most accurate TCO measurement. Strategic TCO analysis relies upon open and configurable cost models with many variables that you can-and should-experiment with to obtain different results and compare different scenarios. This experimentation provides the objective data you need to quantitatively evaluate several alternatives and choose the one that fits your specific business needs.

It is this ability to predict and compare the relative impact of different courses of action that makes TCO so valuable in deciding whether-and how-to outsource your enterprise applications. That's why it has become increasingly common for both software vendors and outsourcing providers to "help" their customers with TCO calculations during the selection process.

Unfortunately, many of these analyses fail to take full advantage of TCO's strategic value. Instead of offering a tool for testing and understanding multiple business scenarios, a vendor may provide only a single set of best-case numbers. Even when a comparison is made, it is often a rudimentary one based upon "typical" or "industry average" outsourcing costs that are never fully explained. Many vendors are all too happy to provide the results of their proprietary TCO analysis, but reluctant to give customers access to-or even much knowledge about-the model used to calculate those results. These limited analyses can provide a useful starting point for further investigation, but they are no substitute for a comprehensive and focused approach tailored to the unique circumstances of your business.

Understanding "TCO Triangulation"

So what should a "comprehensive and focused approach" to TCO look like? Perhaps the best way to answer that question is to consider why businesses use TCO in the first place. What do they hope to gain from all the time and effort spent capturing, modeling, and projecting application ownership costs?

The answer, in a word, is direction. TCO analysis is like a GPS (global positioning system) for your business. Mapmakers, soldiers, scientists, and even automobiles use GPS technology to pinpoint geographic locations, plan travel routes, and calculate distances and travel times. Similarly, TCO analysis can help you steer your applications management strategy in the right direction and figure out what it will take to get there.

GPS technology relies on the principle of triangulation. By pinpointing signals from multiple satellites in space and tracking how those signals change, a GPS receiver can precisely determine its current location and calculate where it is headed. For accurate measurements, however, signals from at least three different satellites are required; a single data point, or even two, is not enough. The same fundamental concept holds true for TCO analysis. Without sufficient data and a solid understanding of what that data means, your business will never find its way out of the woods.

It's not enough to rely on a single provider's "best case" or mysteriously calculated industry averages. As described above, the real power of TCO is its ability to objectively compare multiple courses of action. A "TCO Triangulation" strategy must be based upon careful evaluation of at least three different cost scenarios:

Scenario One: Baseline in-house application costs. The first step is to use your company's in-house applications infrastructure and business processes as a baseline for evaluating alternatives. What will it cost you to continue supporting the applications you already have, or to install and manage new applications within your environment? Gather data about the hardware and software you are using, the staff required to maintain that infrastructure, user communities served by the application, and your current business objectives. Then feed that data into an open and configurable model that lets you calculate your baseline TCO.

This analysis often uncovers a number of items not previously identified as part of your application costs. In addition to broadening your focus to discover and include more known or easily measurable expenses, you can also incorporate industry standards and averages to estimate costs when hard data isn't readily available-as long as those estimates are clearly understood and freely adjustable.

Scenario Two: "Best of breed" in-house application costs. Next, estimate the ownership costs if your in-house solution was transformed to comply with industry best practices and recommended configurations. What would it cost to deliver best-of-breed quality, performance, and value for your employees, customers, and shareholders? It is essential that this estimate be based not on generic industry-wide averages, but on "best of breed" data that reflects your specific company size, user community, business processes, and other unique attributes.

This allows you to measure your current applications strategy-as well as any changes or upgrades you may already have planned-against the technologies and guidelines recommended by the application vendor (and that are generally available from outsourcing providers).

Scenario Three: Outsourced application costs. The third TCO metric used in triangulation is an estimate of application outsourcing costs for the specific functionality and service levels you need. Ensure that this estimate reflects your real-world business requirements by understanding exactly which items are included and excluded from the quote. Make sure there are no hidden costs, and that the vendor has done the appropriate due diligence in sizing and configuring the contract to meet your needs.

This triangulation strategy can help your company develop more meaningful and useful TCO figures. It enables you to objectively compare ownership costs of your in-house environment not only with the costs of an outsourced solution, but also with the costs of bringing your in-house solution up to best-of-breed industry standards. This allows you to take into account the "hidden" cost benefits of outsourcing such as reduced risk, less downtime, and greater availability-cost benefits that one- or two-point TCO measurements completely ignore.

What's more, because TCO triangulation is based upon open, configurable models - rather than upon attempting to arrive at a single, absolute value-it can be easily extended to include other data points for additional scenarios. This allows for even more accurate triangulation and virtually unlimited fine-tuning of business strategy. For example, your company may want to test the cost impact of implementing best practices only in certain areas instead of building a complete best-of-breed solution.

Final thoughts

Remember that TCO is not a fixed measurement or an absolute value, but rather a tool for testing multiple different scenarios. The more scenarios you test, the more strategically useful your results will be. Only by "triangulating" and comparing multiple scenarios can you develop an accurate and efficient "roadmap" to the results you need.

Finally, keep in mind that TCO is only the tip of the iceberg when it comes to evaluating the financial impact of different applications management strategies. In addition to the cost savings that show up in TCO analysis, outsourcing delivers numerous other fiscal benefits by enhancing productivity and improving business performance, including:

• Rapid and painless installation, migration, and upgrades, thus lowering deployment and management costs.

• Access to proven expertise and experience, reducing costs due to errors or rework.

• Better speed of response and change management, as well as 24/7 technical support, cutting the cost of downtime.

• A fixed-price service level agreement (SLA) that makes costs more predictable and manageable.