Total Cost Analysis
By Brandon Ostler
Agenda
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Total Cost Analysis defined
Nuts and Bolts
Brainstorming Exercise
Benefits of Total Cost Analysis
How it works
Real world example
Exercise
Summary
Readings List
What is Total Cost Analysis?
• Total cost analysis (total cost of ownership) is the
sum of the costs related to the acquisition and use
of materials, products, or services.
The Nuts and Bolts
• Three main components
– Acquisition costs
– Ownership costs
– Post-ownership costs
Common Acquisition Costs
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Purchase Price
Planning Costs
Taxes
Financing Costs
Common Ownership Costs
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Downtime Costs
Risk Costs
Conversion Costs
Non-Value-Added Costs
Common Post-Ownership Costs
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Environmental Costs
Warranty Costs
Product Liability Costs
Customer Dissatisfaction Costs
The Big Picture
Acquisition Costs
Ownership Costs
Asset
Cost
Asset Life Cycle
Post-Ownership Costs
Quick Practice
Determine if the following are acquisition,
ownership, or post-ownership costs:
1. Tariffs
2. Recalled products
3. Lost Sales
4. Frequently moving Work-in-process
inventory
5. Contract Determination
Brainstorming Exercise
• Why would your organization want to
conduct a Total Cost Analysis?
Who Benefits?
• Your firm
– Service Providers
– Retailers
– Manufacturers
• The end customer
How It Works
1. Find each component cost
2. Sum the cost of the three components
3. When purchasing, compare total cost from
potential suppliers
4. If for a process, look for ways to reduce
total cost
Real World Example
• ABC, a retail store, is deciding whether they
should implement a new billing system or
upgrade their current system.
• Both systems are expected to last 3 years
and both will need to be un-installed at the
end of the third year.
• What should they do?
Real World Example
New Billing System
Acquisition Costs
Year 0
Year 1
$4,688
Year 2
$412
Year 3
$0
Total
$0
$5,100
Hardware
$1,067
$1,067
Initial Software
$2,000
$2,000
Initial Training
$823
$823
Transition Costs
$798
$412
$0
$1,713
$1,842
$1,379
$4,934
$1,000
$1,000
$500
$2,500
Subsequent Training
$214
$213
$149
$576
Maintenance
$101
$220
$330
$651
Operations
$398
$409
$400
$1,207
$0
$0
$1,500
$1,500
$1,500
$1,500
$2,879
$11,534
Ownership Costs
Subsequent Upgrades
Post-Ownership Costs
$0
$1,210
Un-install system
Total Annual Costs
$4,688
$2,125
$1,842
Real World Example
Upgrade Current System
Acquisition Costs
Hardware Upgrades
Year 0
Year 1
$200
Year 2
$0
$200
Year 3
$100
Total
$0
$100
$300
$300
Initial Software
$0
Initial Training
$0
Transition Costs
$0
Ownership Costs
$0
Subsequent Upgrades
Subsequent Training
Maintenance
Operations
Post-Ownership Costs
$0
$2,152
$2,792
$3,130
$8,074
$100
$100
$150
$350
$42
$45
$38
$125
$532
$1,078
$1,567
$3,177
$1,478
$1,569
$1,375
$4,422
$0
$0
$1,367
$1,367
$1,367
$1,367
$4,497
$9,741
Un-install system
Total Annual Costs
$200
$2,152
$2,892
Real World Example
New billing system total cost: $11,534,000
Upgrade current system total cost: $9,741,000
ABC should upgrade their current billing
system as they will incur the lowest total
cost.
Exercise
Total Cost Analysis for
Product XYZ
Supplier A
Supplier B
Price Tag
$300
$150
After-sale allowances
$50
$75
Contract Negotiations
$400
$550
Operations
$25
$75
Inventory Carrying Cost
$50
$100
Customer Service
$25
$50
Which supplier has the lowest total cost?
Which supplier has the highest cost of
post-ownership?
Exercise Answer
Acquisition Cost
Supplier A
Supplier B
$700
$700
Price Tag
$300
$150
Contract Negotiations
$400
$550
Ownership Cost
$75
$175
Operations
$25
$75
Inv. Carrying Cost
$50
$100
Post-Ownership Cost
$75
$125
After-sale allowances
$50
$75
Customer Service
$25
$50
TOTAL COST
$850
$1,000
Summary
• Total Cost Analysis:
– Three main cost components
– Can bring out the “hidden” costs.
– Spotlight the potential cost problems before
they become problems
– Can be used to find cost savings
Readings List
• Steven M Bragg. Cost Reduction Analysis: Tools and Strategies.
• Wouters, M. et al. The Adoption Of Total Cost Of Ownership
For Sourcing Decisions--A Structural Equations Analysis.
• Degraeve, D. et al. The use of total cost of ownership for
strategic procurement: a company-wide management
information system.
• Lisa M. Ellram. Total Cost Of Ownership; An Analysis
Approach For Purchasing.
• David Burt, et al. Supply Management. Eighth edition. pp 303320.