What do a
Volvo,
Wine Barrels,
and a
Vacuum
have in common?
1
Purchase 1998 Volvo V70, T-5 (Sweden)
Discount
Sales tax (90-day rule)
Delivery to Port Hueneme (6-weeks)
Train/taxi to Port Hueneme
Luxury tax (10% over 36K)
$ 39,000
(6,500)
0
0
60
0
European license/Insurance for 3 months
555
Airfare (Continental miles)
0
Total Cost to take delivery in Göteborg/PH $ 33,115
Purchase 1998 Volvo V70, T-5 (SD, CA)
Discount
Sales tax (7.25%)
Luxury tax (10% over 36K)
$ 39,000
(2,500)
2,646
50
European insurance for three months
Airfare (Continental miles)
Total Cost to take delivery in San Diego
Rent equivalent Volvo (Europe)
0
0
$ 39,196
$ 6,000
$ 45,196
2
“Exhausted” white oak red wine barrels
from Temecula winery
$
40 each
Issues:
• Choose
and transportconsiderations:
barrels
½ workday (2 people)
Other ‘soft/indirect’
• Number
of of
barrels
in oneand
trip lost
(no productivity
min.)
30
• Wages
employees
• Storage
at PRDH/BMI
• capacity
Head designer
is billable at $90/hr. 30
• Fuel
& 17’ box
(rent)
$ 150
• Inability
to truck
choose
barrels at Napa (lower
yield?)
Total• Direct
$ 1,350 ($45/barrel)
BarrelCost
cost is 20% of direct costs of a chair
• (FYI... white
Cost ofoak
new
barrel
$1,000)
“Exhausted”
red
wineisbarrels
Lackwinery
of storage capacity, as well as personnel
breakdown and
from• Napa
$
22 to
each
Issues: kit barrels, but...
• Establish
relationship(s)
for sustainable sources
of supply
• Inspect
and arrange
purchase
3 workdays
(2 people)
•
Build
new
business
relationships
for
marketing
barrel
furniture
• Number of barrels in one trip (min.)
70
• Enjoy
road trip...
• Travel
expenses
$ 300
•
Other
considerations
???
• Storage capacity at PRDH/BMI
30
• Fuel & tractor semi-trailer (outsource)
Total Direct Cost
$ 1,050
$ 2,890 ($41/barrel)
3
21 pounds
~ $230
17 pounds
~ $150
4
All of the decisions involve the
application of (or lack thereof...)
TCO
(Total Cost of Ownership)
Total Ownership Cost – TOC
Total Cost – TC
Total Cost of Operation
Life-cycle Cost (TCO over time)
All-in-Cost
Relevant Cost of Ownership - RCO
5
And now for some academic stuff...
6
What is TCO?
TCO is a Philosophy, Methodology, and Tool for
analyzing all the relevant quantitative and
qualitative costs of an acquisition, project,
investment, or relationship in order to make a
decision...
7
TCO as a philosophy…
 TCO looks beyond the purchase price of a part,
subassembly, asset, investment, project, and/or service…
 TCO seeks to include all relevant information that will affect
the outcome…
 TCO considers qualitative considerations, as well as
quantitative…
 TCO seeks to understand short and long-term costs and
benefits (life cycle cost)…
 TCO explores customer and/or supplier relationships to
determine their value to the organization…
8
TCO as a Methodology
1
 A TCO analysis attempts to determine the type of
buy, then applies certain processes and analytical
tools to support the decision process. In general,
TCO considers quantitative and qualitative
 Acquisition Costs
 Ownership Costs
 Post Ownership Costs
9
TCO as a Methodology
4
Classification of Decisions:
Low Impact – low-cost commodity items
(e.g., copier paper)
Leverage – large purchases of items in competitive markets
(e.g., disk drives)
Strategic Item – large purchases from important suppliers
(e.g., commercial airline jet engines)
Critical Projects – large dollar volume infrequent purchase
(e.g., production facilities using various
technologies/processes)
1
Adapted from Supply Chain Management, Fawcett/Ellram/Ogden, Ch8
10
TCO as a Methodology
4
Apply TCO to appropriate buy1
e.g., commodity items,
supplier A v. B,
domestic v. offshore
e.g., alternative SC
configurations,
LCD v. Plasma,
Important supplier
relationships
Don’t waste a lot of time here
e.g., infrequent
purchases,
custom software,
1
Adapted from Supply Chain Management, Fawcett/Ellram/Ogden, Ch8
11
TCO as a Methodology
4
 Many qualitative considerations can actually be quantified by
careful analysis
 There is a TCO issue in performing a TCO analysis. The cost/benefit
relationship needs to be analyzed before committing the time and
resources
 Garbage in, garbage out – care must be taken when determining
what and how to measure
 Management’s concern is the effect of the TCO object/decision on
the bottom line!
 TCO takes the emphasis off generic cost reduction initiatives to
support the strategic contributions of supply management
12
TCO as a Tool
 TCO and Direct Materials, Direct Labor, and Overhead
 TCO and Services
 TCO and Inventory
 TCO and Capital Equipment
 TCO and NPV (net present value) Analysis
 TCO and International Sourcing
 TCO and the Logistics process
 TCO and Qualitative Considerations
 TCO and MRO, Production/Operations, Services
 TCO and Supply Chain Optimization
13
TCO as a Tool
Inventory
 Non-Delivery
 Poor Quality
 Transportation and Packaging
 Carrying
 Working Capital !
 Insurance
 Property Taxes
 Floor Space
 Obsolescence/spoilage
 Administration
 ??????
14
TCO as a Tool
Quantitative & Qualitative
KATV Inc.
Differential analysis
ATV Engine
Supplier 1 m inus
Supplier 2
Total Cost Analysis (annual)
Supplier 1
Description
formula
Total engine cost
Cash discount
n/30
discount available
Largest discount
Tooling Cost
Transportation cost (22,000 lb. LTL)
Ordering cost
Carrying cost
Quality cost
Delivery rating
Back Order (50% )
Lost sales (50% )
6,000,000 x 0.10 x 30/360
6,000,000 x (0.10 x (10/360) +0.02)
Performance Metrics
Quality
Technology
Plant & Processes
Environmental
Financial
Responsiveness (inc. Delivery)
Business
50,000.00
136,666.67
amount
5,976,000.00
12,000 x $498
5,976,000 x 0.10 x 30/360
5,976,000 x (0.10 x (10/360) +0.01)
24,000.00
49,800.00
76,360.00
given
125 x 12,000 x 22 x $1.20/2000
12,000/1,000 x $125
1,000/2 x $500 x 0.20
6,000,000 x 0.02
-136,666.67
22,000.00
19,800.00
1,500.00
50,000.00
120,000.00
given
100 x 12,000 x 22 x $1.20/2000
12,000/1,000 x $125
1,000/2 x $498 x 0.20
5,976,000 x 0.03
-76,360.00
20,000.00
15,840.00
1,500.00
49,800.00
179,280.00
(60,306.67)
2,000.00
3,960.00
0.00
200.00
(59,280.00)
12,000 x 0.01 x 0.50 x $15
12,000 x 0.01 x 0.50 x $4,500 x 0.18
900.00
48,600.00
12,000 x 0.02 x 0.50 x $15
12,000 x 0.02 x 0.50 x $4,500 x 0.18
1,800.00
97,200.00
(900.00)
(48,600.00)
6,126,133.33
`
6,265,060.00
138,926.67
Weight
0.25
0.20
0.18
0.16
0.11
0.05
0.05
1.00
Difference, in favor of…
formula
6,000,000.00
12,000 x $500
Total Cost
Difference, in favor of…
Supplier 2
amount
Supplier 1
Rating
93
85
87
86
86
91
88
Final Value
Supplier 1
Weight
23.25
17.00
15.66
13.76
9.46
4.55
4.40
0.25
0.20
0.18
0.16
0.11
0.05
0.05
88.08
1.00
2.37
Principles of Supply Chain Management 3e (Wisner. et al.)
Supplier 2
Rating
88
94
82
98
91
89
95
(138,926.67)
Final Value
22.00
18.80
14.76
15.68
10.01
4.45
4.75
1.25
(1.80)
0.90
(1.92)
(0.55)
0.10
(0.35)
90.45
Supplier 2
2.37
15
TCO as a Tool
Quantitative
TCO-NPV Analysis
Machine A
Interest rate plus risk premium
Years
8.25%
0
1
2
3
4
5
Machine A
Machine B
Present Value Present Value
CASH OUTFLOWS
Purchase price
(612,000)
Installation and site preparation
(9,000)
Sales tax
Setup and testing
(6,000)
Expected repair and maint.
maintenance costs
Expected operating costs
0
Income tax on net revenues
0
0
(612,000) (510,000)
(9,000)
(9,000)
0
(38,542)
(6,000)
(2,000)
0
(4,500)
0
(6,625)
(7,500)
(6,400)
(6,800)
(15,148)
(14,029)
(5,800)
(5,675)
(5,320)
(22,095)
(24,943)
(27,289) (31,358) (33,007) (32,259) (30,666)
(122,115) (103,314)
CASH INFLOWS
Expected increase in revenue
generated by production
Expected salvage value
0 142,325 165,000 180,000 175,000 167,000
0
0
0
0
Expected depreciation Tax
shield benefit
0
20,790
20,790
20,790
0 102,000
20,790
20,790
653,985
560,758
68,622
77,367
82,464
69,826
18,713
6,124
9.28%
(627,000) 131,326 147,807 154,483 151,456 247,004
18,713
8.62%
6,124
16
TCO as a Tool
Quantitative
Buy (US)
Buy (China)
60,000
Per unit Annual cost
$30.00 $1,800,000
$0.75
$45,000
$0.10
$6,000
$0.25
$15,000
Unit cost
Packing cost
Tooling
Freight
Wiring Harness
Savings
$1.67 or ≈ 5.4%
Is it worth the added risk?
TOTAL COST
$31.10
$1,866,000
60,000
Unit cost
Packing cost
Inland transport
Freight forward fee
Ocean transport
Marine Insurance
US. Port Handling
Customs Duty
Customs broker fees
US Transport
Warehouse Cost
Cost of capital
Cost of hedging
Administrative time
Travel
Tooling
TOTAL COST
Purchasing and Supply Chain Management 4e (Monczka, et al.)
Per unit Annual cost
$19.50 $1,170,000
$2.00
$120,000
$0.12
$7,200
$0.02
$1,200
$2.40
$144,000
$0.11
$6,600
$0.72
$43,200
$0.98
$58,500
$0.03
$1,800
$1.86
$111,600
$0.50
$30,000
$0.71
$42,353
$0.08
$4,800
$0.02
$1,200
$0.33
$20,000
$0.05
$3,000
$29.43
$1,765,453
17
TCO as a Tool
Supplier risks/considerations:
Overseas business Risks:





























Design changes
Supplier integration in new product
development
On-going cost savings sharing agreements
On-site technical support
Alignment of corporate cultures
Other joint improvement initiatives (e.g.,
R&D)
Financial stability
Means of production/process capability
Supply chain integration/processes
Lead time
Labor skill set
Quality and technology
Early supplier involvement
Price escalation
Volume changes/capacity
Cost sharing
Delivery
?



Political stability
Economic stability
Relations between countries
Exchange rate volatility
Communication (language)
Time zones
Labor skill set
Accessibility to technology/engineering
Political corruption
Travel
Infrastructure (transportation,
communications, energy, water, waste, etc.)
Local laws
Customer/culture
?
Adapted from Purchasing and Supply Chain Management 4e (Monczka, et al.)
18
TCO as a Tool
Quantitative
Description
Cost/lb.
Shipment
Annual
Running
Subtotal
Cost per pound
Purchase price/pound
Ocean freight
Import duties
A. Landed cost (price paid, ocean freight, import duties)
0.2900
0.0575
0.0435
0.3910
11,600.00
2,300.00
1,740.00
15,640.00
139,200.00
27,600.00
20,880.00
187,680.00
Dock to stock
Ship to local warehouse/container
Storage
0.0165
Warehouse fee
subtotal
0.0063
0.0014
0.0030
0.0106
250.00
55.00
120.00
425.00
3,000.00
660.00
1,440.00
5,100.00
0.0360
1,440.00
17,280.00
0.0466
1,865.00
22,380.00
0.4376
0.0038
0.0010
0.0080
0.0120
0.0625
150.00
40.00
321.30
481.95
2,500.00
1,800.00
480.00
3,855.60
5,783.40
30,000.00
0.4414
0.4424
0.4504
0.4625
0.5250
0.0873
3,493.25
41,919.00
0.5250
0.5250
20,998.25
251,979.00
0.0787
3,149.74
37,796.85
0.6037
24,147.99
289,775.85
Interest on value of average inventory
0.0375
B.
Transportation & warehousing cost
subtotal
Warehouse to production cost
Freight
Quality control
Purchasing and storing loss 2% 0.00916
Factory yield 3% 0.01401
Spoilage/recall
C.
Warehouse to production cost
Total cost of Guava Puree before SG&A
SG&A
Total cost
Formula
Given
$2,300/40,000 = $0.0575
$0.29 x 0.15 = $0.0435
0.3910
$250/40,000 = $0.00625
$5.50 x 10 / 40,000 = $0.001375
$6 x 20 / 40,000 = $0.003
0.4016
$0.401625 x 240,000 x 0.18 / 480,000 = $0.036
$150/40000 = $0.00375
$2 x 20 / 40000 = $0.001
40,000 x 0.02 x $0.401625 / 40,000 = $0.008
40,000 x 0.03 x $0.401625 / 40,000 = $0.01205
$20,000 x 1.5 / 480,000 = $0.0625
$0.5250 x 0.15 = $0.07875
0.6037
Purchasing and Supply Chain Management 3e (Monczka, et al.)
19
TCO as a Tool
Quantitative
Slide provided by Rey Huerta, President of Enterprise Logistics Solutions
Zero-Based Theoretical Analysis
20
Component Outsourcing
Logistics Outsourcing
 Buying components
 Buying a service process
 Buyer  supplier(s)  internal
customer(s) relationship
 Buyer  third party supplier(s) &
third party supplier(s)  ultimate
customer relationship
 Initiate PO and verify final receipt
 Less people dependent, fewer
interfaces
 Trend to eliminate monitoring and
inspections via supplier certification
 ???
 Monitor series of service transactions
 More people dependent, more
interfaces
 Continuous monitoring over time to
create visibility
 ???
Arnold Maltz & Lisa Ellram suggest this modification to the TCO
framework is necessary to account for the extra interface, quality
measurement, and customer satisfaction costs involved in using TCO
analysis in Logistics decision-making.
TCO + Logistics = TCR (total cost of the relationship)
21
TCO as a Tool
Qualitative
Pugh
Matrix
Supplier
Requirements/Attributes
5
0
-
-
-
Cost
8
0
-
-
-
Logistics
10
0
-
-
0
Development
10
0
0
0
0
Business
10
0
-
0
0
Technology
10
0
+
-
+
Physical environment
8
0
0
0
0
Human environment
4
0
+
+
+
4
0
0
0
0
Handling
9
0
+
+
+
Ride
5
0
0
0
0
Cornering
10
0
+
+
+
Acceleration
10
0
0
0
0
0
OR
Mate
Option 1 Option 2 Option 3
Quality
OR
Machine
Importance
Baseline
of Need
4
0
0
0
Communication
10
0
-
-
-
Physical persona (looks)
4
0
0
0
0
Spiritual persona (soul)
10
0
0
0
0
OR
10
0
+
0
0
?
10
0
0
+
+
Sum of positives "+"
0
5
4
5
Sum of sames "0"
19
9
10
11
Sum of negatives "-"
0
5
5
3
Weighted sum of positives
0
43
33
43
Weighted sum of negatives
0
-43
-43
-23
Total weighted sum
0
0
-10
20
151
22
So...what is TCO – really?
A Way of Thinking…
 Understand and concentrate on your core competencies
 Direct your focus from tactical to strategic
 Be proactive, not reactive
 Emphasize total cost, not just purchase price
 Understand the qualitative, less tangible issues in a procurement
 Measure, so you can manage
 Know the Voice of your Customer (VOC)
 Develop and align your key performance indicators (KPI’s) with VOC
 Gather data to gain knowledge
 Truth is not reality, truth is perception (Rey Huerta, President Enterprise Logistics Solutions)
23
Supply Management & TCO
(Adapted from Supply Chain Management, Fawcett/Ellram/Ogden, Ch8)
Candidates for TCO analysis

Large dollar spend items

Regular purchases requiring cost information

Procurements with significant unrecognized transaction
costs

When purchasing can impact transactions costs, via
negotiation, changing suppliers, and/or improving
internal operations.

When there is a desire for cross-functional involvement
in understanding item or service cost structure

Capital purchases

Value network optimization
24
Supply Management & TCO
(Adapted from Supply Chain Management, Fawcett/Ellram/Ogden, Ch8)
Reasons for TCO analysis













Performance measurement
Framework for cost analysis
Benchmarking performance
More informed decision making
Communication of cost issues internally and with suppliers
Encourages cross-functional interaction
Support external teams with suppliers
Better insight/understanding of cost drivers
Build a business case
Support an outsourcing analysis
Support continuous improvement
Helps identify cost savings opportunities
Prioritize/focus your time on high potential opportunities
25
Would all of these benefit from TCO
analysis?
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Study for advance degree, continue working, or both
Buy a vehicle (new v. used, compact v. small SUV, …)
Lease v. buy
Rent v. own
Investment A v. B
Adjustable rate mortgage v. fixed rate
747-8 v. A-380
Vacation options (Egypt v. Japan?)
Drive v. Fly
Make v. Buy
Project A v. Project B.
Supplier A v. Supplier B, or both
Production Process A v. B v. C
Remain in a bad marriage v. divorce
Cloud based software v. computer resident
Obama v. Romney economic plans
26
I wonder if a TCO mindset would have been beneficial in this situation ?
27