Total cost of ownership1
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Total cost of ownership (TCO) considers all direct and indirect costs associated with purchasing, owning, and disposing of a good or service from a supplier. TCO includes acquisition costs, ownership costs like maintenance and downtime, and post-ownership costs like warranty repairs or environmental impact. Calculating TCO allows managers to make informed supplier selection and negotiation decisions based on the total lifetime costs rather than just the purchase price. TCO analysis provides benefits like improved performance measurement, decision making, communication, insight, and support for continuous improvement efforts. However, cultural resistance to change, lack of education and resources can present barriers to implementing a TCO approach.
Total cost of ownership1
- 2. Total cost of ownership is a philosophy for really understanding all supply chain related costs of doing business with a particular supplier for a particular good or service (Lisa Ellam, May 1999) Price vs Cost • Managers often use interchangeably • Price – Money coming in • Cost – Money going out • Profit – is the difference.
- 3. TCO is a Management Oriented Approach - TCO is most often used for the supplier selection decision - It could also be used to evaluate a supplier's performance - to enhance the value delivered to the buying organization - the assessment of the purchasing department itself and supporting negotiations with suppliers and volume allocation among suppliers.
- 4. • The four elements of cost: Quality, Service, Delivery, and Price (QSDP) TCO = Quality + Service + Delivery + Price EFFECTIVE NEGOTIATION: • Each element of QSDP has an impact on the TCO • The importance of each element varies with the product or service being purchased • The relative weight of each element depends upon our assessment of the TCO impact on business. • The identity and weight of each element is an ongoing part of the continuous negotiation process.
- 5. Three Components of Total Cost • Acquisition Costs • Ownerships Costs • Post-Ownership Costs
- 6. • Acquisition costs • Post-ownership costs – Purchase price – Environmental costs – Planning costs – Warranty costs – Quality costs – Product liability costs – Taxes – Customer dissatisfaction – Financing costs costs • Ownership costs – Downtime costs – Risk costs – Cycle time costs – Conversion costs – Non-value added costs – Supply chain costs
- 7. TCO Analysis NPV analysis is frequently incorporated into TCO analyses NPV analyzes present values of the initial expenditure along with the likely future revenue and expenditure streams NPV greater than zero suggests accepting the investment NPV less than 0 suggests rejecting the investment NPV = 0 is the point of indifference
- 8. BENEFITS OF TOTAL COST OF OWNERSHIP • PERFORMANCE MEASUREMENT – Good framework to evaluate suppliers. – Concrete way to measure results of quality improvement efforts. – Excellent tool for benchmarking. • DECISION MAKING – Forces purchasing to quantify tradeoffs. – Good bias for making supplier selection decisions. – More informed decision making. – Creates a structured problem solving environment. • COMMUNICATION – Excellent communication vehicle between firm and suppliers. – Way to get other functions involved in purchasing decisions.
- 9. • INSIGHT/UNDERSTANDING – Provides excellent data for trend analysis on costs, comparing supplier performance and negotiations. – Provides critical data for target pricing. – Requires purchasing to develop an awareness of the most significant non-price factors that contribute to TCO. – Long-term orientation by focusing on "big picture.“ • SUPPORTS CONTINUOUS IMPROVEMENT – Identifies where suppliers should focus improvement efforts- drives suppliers to work on "right thing." – Helps identify cost savings opportunities. – Forces firm to look at internal issues, how their own requirements/specifications may actually increase costs. – Encourages professional growth in purchasing personnel by broadening their perspective.
- 10. BARRIERS TO TCO • CULTURAL ISSUES – Cost is not important to "users." – Difficult to move away from a "price" orientation. – Resistance to change. • EDUCATION/TRAINING ISSUES – Image of inflexibility of TCO approach. – Need tools/training. – Too theoretical. – Frustration of trying to quantify "soft" issues. – Lack of user expertise/confidence. – Define the scope of TCO modelling. – Identifying all relevant costs and benefits.
- 11. • RESOURCE ISSUES – Lack of readily accessible data to support efforts/lack of systems. – Labour intensive to develop and support.