Underestimating Total Costs Can Undermine Competitiveness

By SHRM Online staff Nov 14, 2014
Midsize companies tend to underestimate the true cost of managing their workforce, according to the 2014 Total Cost of Ownership Study that ADP Research Institute released Nov. 4, 2014.

The true “total cost of ownership” (TCO) consists of five human capital management (HCM) expenses: payroll, employee benefits administration, talent management, human resources administration, and time and labor management.

“TCO can be used to guide decisions regarding IT investments, projects, operations, performance and funding,” according to the Institute of Education Sciences.

A white paper from manufacturing and engineering firm ITT Corp. noted that TCO analysis “provides the critical foundation for making sound decisions” on staffing, vendor selection, inventory requirements and lease versus buy decisions.

“[It] can be used for decision making in almost any industry or business—including manufacturing, computer systems, transportation, buildings, real estate, and medical and laboratory equipment,” the authors of the paper wrote.

On average, in the past year, slightly more than one in three midsize businesses (those with 50 to 999 employees) have performed a formal cost analysis on any one of the five HCM areas to get their TCO number. Only one-fifth of those businesses have done it across all five areas, according to the ADP study.

The study’s findings are from an online Harris Poll conducted from July 29, 2014, through Aug. 13, 2014, with 1,004 U.S. senior personnel, both executives and managers who were working full- or part-time at a midsize company or self-employed with a midsize company.

It found:

  • 58 percent of respondents were familiar with the concept of TCO.
  • 66 percent thought their company spends the right amount on TCO.
  • 22 percent formally analyzed TCO accurately in the past 12 months.
However, while nearly 60 percent of respondents indicated that they were familiar with the concept of TCO, and two-thirds said it was important, nearly three-fourths were not able to correctly calculate it. That’s because, ADP concluded, only slightly more than one-fourth of managers consider all factors when estimating TCO and they are not as educated on this topic as they should be. Managers should be aware of what constitutes HCM TCO, the best practices for managing it, and the financial risks associated with not completely understanding it.

ADP noted in its report that there are at least “a dozen or more credible sources” that companies surveyed for the report have sought out for help in analyzing their HCM TCO costs. These include accountants, HR/payroll vendors, banks, HR/benefits consultants, lawyers and financial advisors.

Companies that miscalculate important metrics such as TCO risk losing a competitive advantage, according to ADP.

“HCM should be a corporate strategy. For this strategy to be effective, it requires that key stakeholders have good information. In order to have good information, companies need a high degree of knowledge, measurement tools, and complete and accurate analyses,” ADP wrote in its report.

Additionally, it is important to integrate HCM tasks onto a common platform in order to optimally manage each one, ADP urged in its report. Less than half of the respondents to the survey indicated that they thought it was essential to integrate some or all of their HCM functions into one system. Fifty-nine percent reported they had integrated two or more of the five HCM functions into one system, with payroll topping the list of functions that were most likely to have been integrated with other HCM functions, followed by time and labor management (49 percent).

More than Salaries and Benefits
“Focusing only on salaries and benefits can be misleading and can lead to making poor strategic and tactical business decisions,” ADP states in its report. The report cited a 2014 NelsonHall study that found North American firms that implement a human capital management strategy are able to reduce their TCO by 26 percent.

“Understanding your all-in TCO allows businesses to obtain a realistic picture of what they spend on their employees and what it takes to manage them,” said Anish Rajparia, president of major account services at ADP, in a news release.​

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