Business is simple in concept: Sell products to generate revenue, use the revenue to cover costs, and consider the remainder profit. Nice!
Except that the middle portion of that equation can be trickier than it sounds. For ecommerce brands in particular, costs come from all sides. Physical goods come with costs for production, warehousing, and logistics, and the digital side is no different.
A truly best-in-class ecommerce shop might have a storefront, a customer account portal, a loyalty program, retention tools, subscription software, marketing tools—the list goes on. Each of those features or capabilities has its own purchase price, and they can add up fast, resulting in a high total cost of ownership (TCO) for a brand.
Brands around the industry are working hard to keep their TCO low and their resources free. Let’s dive into what TCO is and how to manage it.
Key takeaways
- Total cost of ownership accounts for both capital and operational expenditure to form a complete picture of costs.
- It can be measured at the organizational level or for individual pieces of tech. Both are valuable for guiding strategic and tactical decisions.
- While building software in-house is appealing for many brands, opting for third-party options often leads to better results at lower costs.
What is total cost of ownership?
Initial purchase price + maintenance costs
Total cost of ownership is just what it sounds like: the all-in cost of a particular piece of tech in a brand’s stack, or, more broadly, the total cost of all the tech in their stack. Both definitions are useful for assessing your business at different levels (more on that below).
Keep in mind that total cost of ownership really is total. Up-front acquisition or build costs, also known as capital expenditure, are just one factor to account for. TCO also includes ongoing maintenance costs, or operational expenditure, to help you see the big picture.
While the initial purchase price is typically flat and transparent, maintenance in particular can entail more costs than anticipated—keep a close eye on them over time to be sure they don’t outpace the benefits your tech provides.
Why it’s important to determine TCO—and mitigate it
Total cost of ownership is critical to understanding your business’s health and guiding purchasing decisions. Take a holistic approach to TCO analysis, considering it at multiple levels:
- The overall TCO of your entire platform or tech stack, to ensure that your tech investments are sustainable overall.
- And the TCO of individual products, to make sure each is delivering the expected value.
Overall platform TCO
Even if sales are growing, ballooning costs could undercut your gains. A high total cost of ownership will siphon resources away from growth-oriented ventures like product development or customer acquisition and toward simply keeping the lights on, ultimately capping your brand’s growth.
Product TCO
The total cost of ownership of each individual product in your tech stack is equally important, helping you evaluate their true value to your business. Even if the product delivers on a promise of increased sales or customer acquisition, those gains need to be weighed against the costs—not just the initial cost or ongoing costs, but the full TCO, evaluated over an appropriate timeframe. With all factors considered, a low-cost, medium-impact product could provide better value to your brand than a high-cost, high-impact product.
When TCO doesn’t tell the full story
But the opposite can also be true! In addition to capital and operational expenditure, a broad ownership analysis could even consider the opportunity cost of missing out on a more capable asset.
Sure, a low-cost, low-maintenance asset may look like a no-brainer that keeps your TCO low on paper. But what if a more capable alternative could broaden your market or accelerate your growth? Simple TCO calculations won’t reflect that. Try projecting what your TCO could be, compared to the potential benefits.
TCO analysis: Comparing to GMV
There’s no one ideal total cost of ownership that guarantees a healthy business. But remember, you want most of your resources going back into your business itself, not just into your platform.
With that in mind, comparing your TCO to your gross merchandise value (GMV) makes a helpful reference point. You want platform costs to reflect a relatively low portion of your revenue, with some sources recommending that the TCO of your ecommerce platform itself be as low as 1% of GMV. If the TCO of your platform and other foundational tools starts to stretch far past that, it may be time to reevaluate.
Build or buy: in-house vs. third-party
When a brand needs a new product or capability, they may realize that they have the option of building it in-house or paying for a ready-built version.
Both options have merit and can positively affect total cost of ownership under the right circumstances. But the choice isn’t as clear-cut as it may seem at first—a strong TCO analysis will help you make the right call.
In-house investment
For enterprise brands in particular, building a product in-house is appealing. An initial analysis might find that it would result in the ideal platform at a low TCO.
There are valid reasons for that. Every brand has unique goals and needs; a third-party solution built for a broad audience could easily have critical feature gaps with no recourse, whereas an in-house solution that a brand controls completely would be purpose-built for their platform.
Building in-house could also introduce cost savings too. A third-party product’s purchase price doesn’t reflect the product’s value alone—it includes a profit margin for the developer, not to mention additional costs like marketing that wouldn’t even apply to a homegrown tool.
Why risk overpaying for an inadequate product when you can build a complete one for a lower total cost?
The inflexibility dilemma
Unfortunately, building in-house is often more complex than it seems, and even more resource-intensive than that.
Starting from scratch drives expenses
For one, if a development team isn’t already in place, then building one is an enormous investment with a high initial cost and administrative burden. Long-term maintenance is similarly expensive. And that’s not to mention the overhead involved with managing the product and the team behind it.
Keeping pace with the industry
Eventually, the industry standards for a product may begin to change faster than an in-house team can keep up with. A product that met its original goals might start to lag behind the rest of the market, lacking features that customers have grown accustomed to.
With so many resources tied to the product, it becomes even harder for the brand to pivot to an alternative. What was once an asset is now an anchor, inflating TCO instead of controlling it.
Gaining value by buying third-party
Brands grappling with tech debt and outdated infrastructure—or simply hoping to avert them—may have better luck buying third-party.
External tools aid agility
Adopting external tools can make an organization nimbler almost immediately, offloading the development process and resource management to another, more specialized company. That leaves the brand free to focus on their products and customer experience—their real differentiators.
Specialization reduces operating costs
The same effect leads indirectly to lower costs, too. The product developer is similarly free to direct resources right back into their own product, resulting in more mature tech at lower cost.
Buying is more flexible than building
And the perceived flexibility provided by a custom-built in-house solution can eventually be outweighed by the very real flexibility of having options. Adapting an entrenched homegrown platform in response to changing needs can be slow and difficult, or even unfeasible on a tight timeline. Shifting from one ready-made product to a more capable alternative can be comparatively quick and easy, especially when the new provider already has infrastructure in place for migration.
For a pulse check on your business, start with total cost of ownership
Let’s be clear: total cost of ownership isn’t the be-all, end-all metric for a healthy business. It’s one KPI of many, and it’s best used in conjunction with others like GMV to form a comprehensive picture of your performance.
But TCO directly relates to your business’s sustainability, so if you’re going to put just one KPI in the spotlight, a TCO analysis is a great place to start for a gut check.
Take a look at your costs. Does it seem like lots of your revenue is going right back into your platform? It might be time to take a closer look at the returns that each piece of tech in your stack is delivering.
Look for areas where impact doesn’t seem to outweigh investment—you may find a good opportunity to pivot toward a tool that can deliver more results at a lower cost.
