Business Planning / TCO

Business Planning Using Total Cost of Ownership (TCO) Instead of Purchase Price Only

Traditional Purchase Price Modeling

Business case development for adoption of m2m has traditionally been done with an adaptation of traditional” bill-of-materials (BOM)(1) plus refinement cost” estimation employed in electronic component selection processes. As an example, a point of sale (POS)(2) terminal manufacturer developing an m2m connected variant of a product would take the BOM plus manufacturing costs of the pre-m2m terminal, and add to that the BOM of an m2m module, antenna, and other components necessary to complete the m2m enabled terminal with associated refinement costs.That would account for the total in variable costs for the business case. Then some non-recurring expense (NRE)(3) would be considered to cover certification expenses and engineering design costs associated to the m2m integration.

In the vast majority of cases a module supplier would be selected with the objective of minimizing these cost elements. OEMs have traditionally ignored elements pertaining to operating costs due to complexity of modeling these costs out. This failure has left the task of making things work economically to other players in the value chain, typically the vertical services provider. In the POS terminal example, the task of analyzing the total-cost-of-ownership (TCO) and making decisions would be carried out by the payment services provider.

Unfortunately for this group of companies, by the time they procure the m2m enabled POS terminal, their control over the business model going forward is already largely pre-defined by the cellular module inside. A number of constraints may already be imposed on the service provider which cannot be easily re-configured. For example, entering a new market previously unplanned, not served by cellular technology compatible with the particular POS terminal; or yet, an early end-of-life for the POS terminal caused by an upgrade required by the network operator which cannot be accommodated without a redesign of the terminal.

Whatever the issue, when you consider that, for most business cases, typical m2m device operating life range from 5 to 10 years and that physically touching a deployed m2m device for maintenance is costly if not impossible, it is clear that downstream costs can easily surmount the impact of acquisition costs. Most of the exceptions to this rule come from application areas involving very high price devices such as medical imaging systems, high-end copy and printing systems, and other low-volume – high-cost items.

Total Cost of Ownership Modeling

As the m2m value chain becomes more integrated and dynamic, players down and upstream from one another are likely to demand products and services that do not hinder each of their own ability to meet their business case requirements. They are likely to do this in a manner where risk is shared more evenly throughout the chain. But this is only possible when all players work from a complete view of the total lifecycle of the m2m product. These are some of the elements which deeply impact the m2m device business case viability on a TCO basis and which differ quite dramatically from the counterpart electronic component acquisition-price model.

One-stop-shop – Whenever it is possible to source more than one element in a value chain from a single source, gains can be reaped from the perspective of vendor management, customer support and price flexibility. This is particularly important in complex and/or long value chains and when the integrated product has a long service life, both of which are characteristics of m2m. Over the long term, price pressures squeeze value chains eliminating players with smaller value contribution. This process is known as consolidation and it is happening in m2m right now. At this juncture it should pay off to look at the players from whom you need to source products and services and mitigate risk of seeing some disappear by preempting the process and selecting one or a few which already occupy a broader section of the value chain. Go for the one-stop-shop model.

Long term availability – This is critical because m2m modules are not commodity products. An unplanned interruption in the supply of your selected module would almost invariably translate into a redesign of your m2m enabled device unless it was designed to take modules from two or more different vendors, which is typically not an economically viable strategy for most applications, and a practice less and less used in the market. An unplanned, early redesign of an m2m application could translate into business failure particularly for start-ups or tightly funded businesses. And an interruption in cellular module supply is not as unlike as it seems. Differently from traditional electronic components, cellular modules rely on base technologies that move at a much faster pace than that of most industrial and commercial devices.

This is due to the fact that this base technology is driven by the consumer cellular phone industry where the average device lifetime is taken to be in the 6 to 18 month range depending on the class of cell phone. There are a number of cellular module makers in the market that supply their products in line with immediate spot-market availability of cellular chipsets and when these are exhausted, so is the module. In a TCO evaluation you should require that your module vendor or that the module inside the device you are considering can show a guarantee of availability for the life of your device and/or business case. TCO also shows substantial net present value (NPV)(4) in selection of components for your device that are designed to bring technology enhancements to your device while maintaining backward compatibility in form factor and logical interfaces. Factors such as ownership of the intellectual property in key elements such as cellular protocol stacks can make it possible for new generations of modules to retain all of its predecessor’s attributes therefore eliminating the need for redesign and recertification of the application on your side.

Scalability and growth – You want to be successful. But your business plan likely requires that you start slow and ramp up. It would be typical for your first generation device to be based on components that are compatible with low-volume manufacturing and logistics. But to be successful and achieve target returns on your investments developing your application and back office infrastructure, you must absolutely sure that you will be able to continue using them as your device sales grow. When you make a decision solely based on purchase price, you will find that you may need to reinvest in application development and support services to upgrade your device to match you sales growth ramp. In a TCO evaluation the ability to ramp and scale easily with no additional investments has an enormous net present value impact which far offsets disadvantages in purchase price of the module.

Expansion into other markets – Unlike a regular electronic component, a cellular module is very region-sensitive. Your business plan likely maps out where and when you will be deploying your devices. You will certainly be making sure that the module you select meets your business plan’s regional availability criteria. But because opportunities are unpredictable, you may find yourself needing to deploy your product in a market you did not originally have in your forecast. Alternatively you may find that the original plan to deploy in a certain region would be better accomplished if you could use another technology than the one you planned. A high net present value impact in a TCO evaluation is associated with this flexibility. Make sure your module provider can canvas as many technologies as possible without requiring that you redesign your device or your service.

Mitigate the risk of betting on any given cellular technology – Another major element bearing substantial net present value in a TCO evaluation is the ability to mitigate the risk of betting that your selection of a cellular technology will be the best and most viable for the entire life of your product. Selecting a module vendor that can buffer you from the cellular technology risk by providing you one or five years from now another variant of the same module form factor in a different, more suitable technology for your needs will immensely impact the resilience of your business plan.

Quality - A standard mobile phone plant where cellular modules are typically manufactured tolerates defects in the neighborhood of several hundreds to thousand parts per million (PPM). This is the industry benchmark and accepted quality level; however, this is NOT where your business plan requires you to be for viability and success. A solid supplier should be expected to adhere to a zero PPM goal and actually delivery quality around 10 PPM with field returns less than 50 PPM. This means that any cellular module going into your design must be manufactured to a different standard. When you start looking at how failures and defects in the field affect your business plan, you will quickly realize just how much TCO impact module quality has on your financial success.

Operating Costs – This is certainly the largest, most impactful element in integration of m2m. Different business plans are more or less sensitive to the cost of managing and running the device once deployed. As an example, an armored vehicle transporting high-value content in an urban environment has a lot higher tolerance to such costs than a connected residential meter. In a TCO evaluation, it is critical to have clear and full visibility of all cost elements that have any chance of becoming recurring in the life of your device. These have to be scrutinized, understood, and fully rationalized. It is quite common for the face-value of price-per-kilobyte(5) to be the sole deciding factor in an operating cost calculation. But in the vast majority of cases, the inaccuracies in this estimation model result in business plan failures. In the long operating life of an m2m connected device, things like seasonality of operation common in assets that are active for a few months out of the year; field service avoidance – when you can diagnose and fix a problem over the air instead of taking the cost of field service visit; and others need to be considered thoroughly. What you find in most cases when you take these factors into account is that the choice of a lower price/kilobyte provider might in fact be entirely the wrong one to make.

(1) BOM - bill of materials is the tem used to refer to the complete list of components necessary for the assembly of an electronic device. BOM cost generally refers to the total cost a company pays for the list of components to build the device
(2) POS - Acronym referring to the term point-of-sale. In this context: electronic devices associated to processing a retail transaction such as a credit card reader, a smart cash register, etc.
(3) NRE - is a term used in the context of business planning and finance to refer to one-time-expenses typically associated to R&D efforts necessary to bring a product to market.
(4) NPV - net present value is the business planning and finance term used to refer to the tangible value today in terms of money, of a financial impact which is forecast to affect a business plan over the course of time, typically several years.
(5) Price-per-kilobyte, or price/kilobyte refers to common charging practice by connectivity services provider where the user pays typically monthly an amount in direct proportion to data consumed, or a minimum subscription fee if no data was consumed for the period.