Monday, July 5, 2010

ICO, not TCO

One of the most overused sales metrics in technology is “TCO”, or total cost of ownership. For decades now, sales teams have been abusing financial principles in order to get their business customers to buy hardware or software products using this made up metric. There are countless TCO models flying around Silicon Valley, and their ability to move products has more to do with sales skill than financial reality.

But in investigating products that have lasted far longer than the hype accompanying their release, one thing I've found consistently is that they don't have a low TCO, but a low incremental cost of ownership, or what I'll just call ICO, because like Washington, Silicon Valley likes three letter acronyms.

So what is ICO exactly?

Now calculating TCO often involves beating up Excel, plugging data points into macros, and ensuring that in the process, spreadsheet inputs lose all connection to operating reality. Incremental cost of ownership is a highly technical calculation that looks something like this:

Total amount of money needed to purchase product + 0 = Incremental Cost of Ownership

In looking at products and protocols that have been successful over the years, one thing stands out. Not their TCO, but their ICO. From Cisco's 6500 series switches to Gigabit Ethernet, it is hard to find a widely deployed technology that does not have a reasonable incremental cost of ownership. It's important to note that this does not mean the products sell for low margins, Cisco's gross margins have been in the 60s and its net margins in the teens for years, it's hardly scraping by. The same is true for many of its competitors and suppliers. But in spite of all its industry strength, Cisco could do little to save technologies like ATM and RPR, which promised lower TCO though collapsing network layers, but required buying switches with very high incremental costs.

If it weren't for low incremental costs, there would not be much to say about data center networks. The reason linking up is so attractive in data centers instead of through traditional enterprise or carrier networks is because short-reach hardware components are exponentially cheaper. 40 Gig on a sub-20 meter InfiniBand port will only set you back $400, a quarter of the bandwidth on a 10 kilometer metro link will costs about 30 times as much per port. No clever model or PowerPoint will change this.

Just as IRR accompanies ROI in most well-thought out business cases, ICO should accompany any TCO presentation. Regardless of overall economic conditions, products that have promised future opex savings have typically lost out to those bringing high returns on invested capital today. By presenting both ICO and TCO, vendors would show customers that they are addressing the financial risks they deploying networking hardware, rather than just relying on promises of future opex savings.

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