As a business owner or member of the senior management team, you know that it's a good practice to evaluate multiple alternatives to a particular requirement or solution. If you are considering buying products or services from potential vendors, you probably get 2-3 quotes from different vendors, and evaluate them on the merits of their cost as well as the nature and quality of the services they can bring to the table.
But if you've done this a few times, you know that it's not always easy to compare "apples to apples", as different vendors provide different products and services and may charge you different amounts. Lining up the components of each vendor's offering on a comparable basis, including their cost, can be a challenge but is important to ensure you are making the best decision.
Total Cost of Ownership Defined
If you are planning to buy complex products or services over a multi-year period of time, it's important to be able to quantify the Total Cost of Ownership (TCO) of each of the potential solutions. That means understanding not only how much it will cost you to buy the initial base solution, but also what other costs you might have to incur to be able to utilize the solution, and how much it will cost you to own and operate it over time. TCO is a widely-accepted metric for evaluating software solutions that helps you understand all the ongoing and sometimes hidden costs of owning and operating them over their useful life.
Components of TCO for Accounting Software
Many people make the common mistake of thinking about the cost of their accounting software purely in terms of how much it initially costs to buy the perpetual software licenses. (For purposes of this article, I'm using the traditional model of purchasing perpetual software licenses for on-premises software that you would run on your own computer system. There are other models, such as Software-as-a-Service, but this is the most-commonly understood scenario.)
Some people understand there is an additional cost to configure, implement and deploy the software, charged by either the software vendor or their integration partner. Including this cost is obviously a more complete picture, but still doesn't come close to identifying the total cost of ownership. Here is a more complete list of the major components of the TCO of accounting software in a traditional on-premises model, including the aforementioned costs:
- Perpetual software licenses
- Implementation cost
- Computer hardware, including operating system
- Database management system, such as Microsoft SQL (in the case of systems more sophisticated than desktop software)
- Ongoing annual software vendor maintenance fee, usually 18-22%
- Computer hardware maintenance cost
- Cost to upgrade the software when new versions come out
- Cost of IT support personnel to support and maintain the hardware and software
Perpetual Software Licenses
In the traditional model of buying software to own and operate on your own servers, you typically buy perpetual licenses giving you the right to own and use the software as long as you want. The cost of accounting software licenses can be based on a number of factors, including:
- Version or edition of the software purchased
- Number and types of users
- Modules of the software purchased
- Number of locations or legal entities
Version or Edition of the Software Purchased
Some vendors have different versions or editions of the software that include different features or capabilities. Higher-level versions with more features cost more.
Number and Types of Users
User count is usually an important factor in determining the price of the software. Some vendors price different user types at different levels, such as read/write users vs. read-only users. Make sure you've identified all the different types of user access you will require. Some companies overlook the read-only users and end up paying more when all is said and done.
It is also important to understand the distinction between concurrent users and named users. Vendors who price based on a concurrent user model limit the total number of users who can be logged in to the system at any given time, even if the total number of named users is much higher. Vendors who price on a named user basis charge for each active user ID in the system, regardless of when or how often they log in. Neither model is better or worse; you just have to understand how your needs will affect the final price.
Modules of the Software Purchased
Some accounting software includes multiple modules, such as general ledger, purchasing, consolidations, etc. Most software includes a base module that contains the core features, as well as add-on modules which typically cost more to purchase. You'll need to have a good understanding of your functional requirements in all business processes supported by the software, so that you know which modules you might need to buy.
Number of Locations or Legal Entities
Some vendors will charge extra for the use of more than one legal entity or location in the system. You will need to determine if this is the case with your vendor and how many entities or locations you will need in order to determine the impact on cost.
For any accounting software that is more sophisticated than something like Quickbooks or Peachtree, you may wish to hire the software vendor or professional consulting partner to design and implement the system for you. A professional consultant can help you deal with gathering complex requirements and customizing the system to meet your needs. There have been many horror stories of accounting software implementations that failed miserably because the system was not properly configured or the end users were not adequately trained. Using a good implementation consultant can help avoid these types of issues. There will be a cost for these services, though, which you will need to understand. Some consultants will charge you on a time and materials basis, while others may give you a fixed fee quote to install the software.
You may believe you can save money by doing the implementation yourself, or wish to minimize the implementation cost by going for the cheapest price. Just remember, you get what you pay for, and this will be the system you are going to run your business on, so make sure it will meet your needs.
Computer Hardware, Including Operating System
If you purchase Quickbooks, you can probably run the system inexpensively on a local desktop computer or something similar. However, for more complex systems, you will need to buy a server that has an operating system that can run your accounting software. Servers are not cheap, and can cost anywhere from $2,000 to $5,000 for entry level up to $100,000 for Tier 1 installations.
If your software has complex infrastructure requirements, you will probably want to rely on the vendor or professional implementation consultant to help purchase and configure your server to ensure it at least meets the software vendor’s minimum requirements.
Database Management System
Database management systems (DBMSs) are software systems that house the data used by the accounting system and manage the access to the data as it is being used and modified. Examples of well-known database management systems include Microsoft SQL or Oracle Database.
The accounting software vendor will specify which DBMS systems are acceptable for use with their software. These systems are not cheap, and cost anywhere from $5,000 to $10,000 for entry level up to $75,000 for Tier 1 installations. To be clear, this cost is on top of the cost of the server hardware and related operating system. This is an often overlooked component of cost that can come as a surprise when the final bill comes due.
Annual Software Vendor Maintenance Fee
Another often overlooked cost that is nevertheless part of the TCO of accounting software is the annual maintenance fee that must be paid to the software vendor. These annual fees must be paid in order to have rights to future software updates and upgrades (rights only – the upgrades themselves often cost extra), and support of the application by the software vendor. The industry standard for these annual fees is between 18% and 22% of the perpetual license cost. Contrary to what one might expect given the maturation of the software industry, these percentages are actually on the rise.
Many buyers don’t think about these costs when evaluating the cost of software, nor do the software vendors or resellers point it out. But if you are looking at the TCO of your software that includes a 20% annual maintenance fee, failing to include these costs means the software alone will actually cost you twice as much as you think over a 5-year period.
Computer Hardware Maintenance Cost
After you buy a server, there is periodic maintenance that has to be done in order to keep it running smoothly, ensuring that all security and operating system patches are up-to-date, hard drives are in good shape and not in danger of failing, backups are working successfully, and all other hardware components are operating correctly.
The cost of maintaining your server depends on your requirements as well as on the complexity of the hardware involved. A good rule of thumb is to budget between 20% and 30% of the initial server hardware cost for annual server hardware maintenance.
Software Upgrade Cost
As you continue to use your software and the vendor comes out with new release upgrades, you will want to periodically upgrade your version of the software. Most vendors come out with upgrades about every 24-36 months. You don’t need to upgrade immediately, or even every time a new release is available, but just be aware that you generally can’t fully avoid the costs of upgrading to each version by delaying your upgrade for a few releases and then skipping to the latest version. Generally, the bigger the delta between your version and the version you are upgrading to, the more complex and costly the upgrade is going to be.
The cost of upgrading your software depends on the type of software you use and the complexity of your environment. Upgrade costs for a package like Microsoft Dynamics GP, a typical “tier 2” application that many small and medium-sized companies graduate to after Quickbooks, are estimated to be between $5,000 and $15,000. The major drivers of this cost are the complexity and footprint of the software you have implemented (e.g., which modules are deployed, how many users, etc.) as well as the number of customizations you have written for your environment. Customizations to the software are not guaranteed by the vendor to survive any upgrades, so you may have to re-write those each time.
To determine the impact of upgrades on your TCO, you need to make an assumption about the frequency of the upgrades over time, as well as the estimated cost.
IT Support Cost
If you purchase any accounting system that is more complex than Quickbooks or Peachtree, you will probably need someone to provide IT support of the application and infrastructure. This support will include everything from basic end-user support for things like password resets and new user setup, to more complex support of the application in the form of database administration, application updates and security patches, and other support. The cost of this support once again depends on the software and its complexity. You can estimate this cost by determining how many IT personnel or full time equivalents will be needed and what their fully-loaded annual cost is, or getting a quote from a third-party IT support firm to do it.
So What is the Total Cost of Ownership of My Accounting Software?
Now that you have a good understanding of the many cost drivers of owning and operating accounting software, it is fairly straightforward to calculate your total cost of ownership. The TCO can vary significantly depending on the nature and complexity of your software, as well as your ongoing requirements for system availability, performance and reliability.
Having done a few TCO calculations for clients myself, I can tell you the pitfalls of failing to understand total cost can be expensive. Here are some data points to keep in mind:
- Purely looking at the initial cost of the perpetual licenses in year 1 grossly underestimates TCO. My calculations of total cost of ownership over a 5-year period have ranged from 5X the initial perpetual license cost to 16X, with an average of 9X. Only looking at the perpetual license cost can be extremely misleading, especially when comparing an on-premises solution to cloud-based or SaaS solutions where the TCO is rolled up into a single annual subscription fee.
- Even adding up the full costs in year 1 still grossly underestimates TCO. My 5-year TCO calculations have ranged from 2X the total year 1 costs to 3X, averaging 2.5X year 1 costs.
TCO may be less important when evaluating similar solutions. For example, two similar on-premises solutions may have comparable software maintenance, hardware and IT support costs over time. However, when comparing on-premises solutions to cloud-based or on-demand software solutions, TCO becomes critical in comparing the cost of the two. Stay tuned for follow-on articles about the total cost of ownership of on-premises accounting solutions vs. on-demand or SaaS-based solutions, as well as the TCO of the finance and accounting function.
If you would a free assessment of your finance and accounting function, including the TCO of your current or prospective accounting software, click the link below.