Lower Cost vs. Lower Price

Back in 2002 we bought a computer. Seven years later, that computer is approaching the end of its life - still, almost everyone will agree that 7 years for any piece of consumer electronics is pretty incredible. The longevity of the computer is a testament to the value of a simple consumer principle: don't go for the cheapest option, or for the product in the fanciest package, go for the most cost effective option. In business we call this the Lowest Total Cost of Ownership.

Here are the different components which together make up the total cost of ownership of any item:

Purchase Price - in many cases the purchase price is the highest component in the total cost of ownership equation, which is why many people are tempted to buy the item with the lowest price.

Maintenance Costs - when buying a car, many people consider the cost to maintain that car over its expected life time. How expensive is the regularly scheduled maintenance? How complicated is the car to maintain? What happens if something goes wrong? This is where issues such as reliability and serviceability come into play. The thing is, the exact same principle applies when buying a computer, a new refrigerator or pretty much any other item you can imagine.

Operating Costs - a car consumes gasoline, a computer runs on electricity, a pony consumes food and needs to be housed in a stable. The cost of operating an item frequently greatly outweighs the cost of buying it. For example, buying a hot tub may not be that expensive, but over time heating and cleaning costs can really add up. Operating costs are often a category in which smart consumers can generate the bulk of their savings.

Salvage Value - salvage value = resale value. Even when you no longer want a product, it may still retain some residual value. Used cars can be sold, but even if no one will buy your car, you may still be able to donate it for the value of a deduction, or sell it for scrap. Some items hold their value better than others. While consumer electronics are notorious for losing their value quickly, you are more likely to be able to sell a used iPod than you are to sell a used no-name MP3 player.

Replacement or Obsolescence Cost - this is where we saved big on our computer. When buying our computer we bought a near top-of-the-line machine, rather than a discount model. Yes, we could have purchased a computer for 30% less, maybe even more, but we would have needed to replace it within two or three years. By paying a bit more, we were able to get much more value out of the system.

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