Total Cost of Ownership

• Let's Get Started

  • Read: Course Overview and Objectives

    -

    Successful Procurement Professionals

    The most successful procurement professionals develop strong Total Cost of Ownership behaviors. These professionals systematically take a Total Cost of Ownership approach into account in their procurement decisions, use analytics and spreadsheet models to analyze suppliers, advise cross-functional teams on supplier selection, design decisions, and timing considerations based on TCO analysis, and search to identify innovative solutions to optimize Total Cost of Ownership. 

    To do this you need to get to know the suppliers along with their strengths and weaknesses. You need to have an eye to supplier performance improvement ensuring that both your company and the supplier work to improve service and costs according to set targets. When issues are identified, you work collaboratively with the supplier to see that they are resolved quickly and to the satisfaction of your client.

    This course is designed to help you learn to do that. By the end of this course, you should be able to:

    • Identify and measure Total Cost of Ownership (TCO) components and their impact on TCO value
    • Identify TCO components relevant to a class of products or services
    • Understand basic financial principals involved in calculating TCO components

    Let's get started!

  • Watch: Meet the Author

    -

    Our course author is Rob Handfield PhD, Bank of America Distinguished Professor of Supply Chain Management at North Carolina State University. He's worked closely with a number of successful businesses to address all kinds of procurement issues. Watch the video to hear more about his background on these important topics.

  • Post: Your Profile

    -

    The benefits of learning in a community include the relationships you develop with other members and the wisdom you gain from one other. Please take a few minutes to update your profile, which will allow other members to better understand who is in the cohort

  • Watch: The Social Learning Experience

    -

    A 2015 study^[1] found that 70 to 90 percent of all workplace learning happens informally — from knowledge sharing and mentorship among project team members to casual break-room chats. The study further found that 87 percent of survey respondents said social knowledge sharing among team members is “essential”

    This and other research  confirm that success of workplace learning rests on these essential principles:

    • Learning is fundamentally social
    • Knowledge is integrated within communities
    • Learning is active
    • The depth of your learning depends on the depth of your engagement 

    Your learning journey on this CORP/U platform is centered on social learning, the process of learning through peer and expert social interaction. CORP/U learning journeys integrate learning with work. They provide knowledge, tools and methods that you can apply immediately. Courses feature short, 30-minute daily sessions so that people don’t have to stop what they’re doing to learn something new. You learn and apply as you go.

    Watch this short video to learn more about how you can get the most from your social learning experience. 

    [1] Social Learning and the Future of Work.

  • Post: Meet Your Cohort

    -

    It’s time to find out what you and your colleagues have in common.

     Pick one of the following that had a significant or memorable impact on your life:

    • An interesting trip
    • A powerful movie
    • A meaningful work experience
    • An act of charity
    • A parenting moment
    • Any other life changing event

     Tell your colleagues why the experience was powerful and why you think it had an impact on you?

Selecting and Managing Total Cost of Ownership Projects

• Understanding the TCO Process

  • Watch: The Importance of Doing Cost Analysis

    -

    Let's listen as our expert faculty, Rob Handfield, sets the stage for the different topics that we will tackle in the course. He describes the importance of cost analysis and how it fits into the variety of issues that we face as we procure products and services for our business.

  • Watch: Introduction to the TCO Framework

    -

    There’s obviously a price associated with every material, product or service an organization purchases. The same is true of every product or service the organization produces and sells. Price, however, is only a percentage of what any item actually costs. 

    The Total Cost of Ownership framework helps us consider many other factors that add cost to items or materials we purchase or produce, especially as we consider the entire lifecycles of those items. 

    Listen as Rob Handfield describes the purpose of the Total Cost of Ownership framework and tools.

  • Read: What is Meant by TCO Costs?

    -

    Let's go back and touch on some of the definitions that Rob Handfield used in the prior video, starting with the definition of Total Cost of Ownership or TCO as we will refer to it throughout the course.

    Total Cost of Ownership (TCO) Definition

    The present value of all costs associated with a material, service, or capital equipment that are incurred over it's expected life. (1). 

    Source: "Purchasing and Supply Management" Monczka et al

     

    TCO can be broken up into 3 categories: Pre-transaction Costs; Transaction Costs; and Post Transaction Costs. Below is the definition and some examples of each category of transaction costs.

    Pre-transaction Costs: Costs include all costs that occur prior to the transaction, such as research and travel expenses to research the supplier.

    Examples of Pre-transaction costs include things like Identifying, investigating and qualifying sources and products; R&D, engineering and design; and Developing a contract.

    Transaction Costs: Costs include all costs that occur to make an item usable and to transfer ownership to the buying organization.

    Examples of Transaction costs include Price; Delivery/Transportation; Tariffs/Duties/Currency/Tax; Billing/Payment; Inspection; Parts Return; and  Corrective Action.

    Post-Transaction Costs: Costs include all costs incurred by the buying organization after the ownership has been transferred.

    Examples of Post-Transaction costs include Scrap; Warranty; part failure; reputation; Service and Maintenance; Disposal/Salvage; and Inventory Holding Costs.

    ---

    Having reviewed the definitions and examples you can see that TCO truly takes into account all of the costs throughout the entire lifecycle of the product or service from deciding that the item is needed, to maintaining it in working order, to disposing of it safely at the end of its life. Understanding and using TCO is the only way to evaluate the full impact of acquiring and using something throughout its life on the profitability of the company.

  • Read: How Companies are Using TCO

    -

    Total Cost of Ownership can take many forms from company to company. Each analysis needs to be tailored to address the specific industry, its cost structures, and its risks. It's common for companies to use TCO in Procurement and in Operations in trying to improve profitability by reducing key elements of cost. It can also be used on the sales side of the business when considering how to bid for business. 

    To give you an example of thinking through all these costs, consider this article about the experiences of an executive with UPS as he considered bidding on the transportation of high-end electronics from China to the US.

     

  • Discuss: How Does TCO Apply to Your Organization?

    -

    You’ve heard a brief introduction to the concept of Total Cost of Ownership. 

    1. How might the TCO concept make an impact on your organization's procurement practices, especially to drive greater benefits in ongoing projects?
    2. What do you anticipate could be most challenging about conducting TCO analysis at your organization?

  • Case Analysis: Practice: Buying a Fleet of Automobiles

    -

    ---

    Let's get a little practice with the thought process around starting a TCO project. We mentioned that each project is different and so the stakeholders and kinds of costs considered are different. In this practice exercise, imagine that you are part of a team responsible for acquiring automobiles for the sales force. 

    The team started by making a list of the fleet’s TCO elements.  They broke the elements into Pre-Transaction, Transaction, and Post-Transaction costs that the company will incur throughout the fleet lifecycle. Did they forget anything?

    • Pre-Transaction - Search, Bid, Specify Cost, Contract Development
    • Transaction - Price, Rebates, Title, Tax, License Fee, Destination/Transportation Fee, Marketing Fee, Pick-up Cost
    • Post-Transaction - Insurance, Maintenance, Upkeep (Washing), Gas, Asset Tax (some states), Finance Charges (Cost of Capital), Accident Costs, Leasing Costs, Salvage

    You do not need to put specific dollars associated with each element, but using the radio buttons, try to identify relative costs such as High, Medium or Low.

    (When quiz is answered, answer along with sample $ value will pop up)                         

  • Watch: Debrief of Automobile Purchase Example

    -

    How did you do estimating whether the cost elements of the fleet of automobiles would be high or low. The graphic here gives a typical breakdown of these kinds of costs. Rob mentions in the debrief video below that many people forget about amortization. Did you remember that one?

    

• Managing a TCO Project

  • Watch: Considerations When Managing a TCO Project

    -

    Before digging in too deeply on the process that we recommend for a TCO project, Rob Handfield provides a brief overview of the process and talks us through things we need to consider as we get started on a project.

    • What kind of products or services lend themselves to this kind of process because they represent a good opportunity for cost savings?
    • How should we define, and possibly limit, the scope of the project?
    • Who should be on the project team?
    • How should we coordinate with all the stakeholders to make a final decision?

    This graphic of the 5 Step TCO Process is good to have in front of us as reference during his talk. We'll come back to this model throughout the course.

    Total Cost of Ownership Process

    

  • Reflect: Considerations for Selecting a Project

    -

    In the previous video you heard that choosing the right kind of project is important. 

    Characteristics of a good candidate project:

    • High Potential: If you think there is a lot of opportunity for cost reduction; If we currently don't know much about a process but currently incurs significant spend; 
    • Manageable: Especially for a first project, bite off something that isn't too big, that can be accomplished within a few weeks or a month;
    • Scope: Ensure there is a clear and limited scope. 

    Think about the project that you are planning to do as part of this course. In the Reflection box below, consider the above criteria for a good project and test your project against them. 

    To guide your reflection, complete the following statements with your project in mind:

    1. This project should yield significant cost savings because:
    2. I suspect we’ll discover hidden costs when we analyze:
    3. I think we can keep this project to about a month in duration if we:
    4. To ensure we have a manageable scope, we’ll have to:

  • Watch: Elements of the TCO Lifecycle Costs and Engaging Key Stakeholders

    -

    A sound TCO project needs to consider all elements of the life of the product. We talked in an earlier lesson about Pre-transaction, Transaction, and Post-transaction costs to make up the Total Cost of Ownership. This model demonstrates how those costs may be broken down further for consideration of applicability to a particular project.

    For each category of costs, it's good to consider which of the "3A's" are appropriate for the cost. Will the costs be Actual, Approximations, or Assumptions? TCO analysis is not an absolute science and only after the fact are we able to understand how good the model was that drove decisions. Consider for example Supplier Performance: Until a considerable amount of product has been delivered and used, we will not really be able to understand whether there were any costs incurred as a result of supplier performance. Costs that are closer to the actual transaction are a bit easier to model.

    

     

    Part of Preparing for Analysis is engaging the right stakeholders in the discussion. These can be internal to the organization in the variety of relevant functions or external to the organization in terms of suppliers or other 3rd party organizations with insights into potential costs. As you watch the video, think about who is relevant to your project. 

  • Discuss: Your TCO Project

    -

    In order to begin to apply the concepts shared during this course, everyone should be prepared with an idea for a TCO project in their organization. Let's start by sharing ideas on a potential TCO project you are considering in your organization.

    In the discussion forum briefly describe the project you plan to do or support and the nature of the cost saving you hope to achieve. What do you anticipate will be the toughest part of your project? What advice or guidance would you like to hear from Rob Handfield or others in your cohort?

  • Watch: Total Cost of Ownership - Steps 1 & 2

    -

    Let's dig into the 5 steps of the process by starting with the first two;

    

    Preparing for Analysis: TCO projects must be carefully selected because it does not fit all purchasing situations. It can be a very complex and time-consuming process. The intent is to apply TCO for:

    • Major Sourcing Projects (High $$$)
    • Major Issues with Supplier Performance

    Some examples include things like Strategic Sourcing; Low-Cost Country Sourcing; Major (Re)Sourcing / Outsourcing; Make / Buy / Import decision.

    ---

     

    Mapping the Process: The goal is to develop a good understanding of all of the activities associated with the acquisition, use, and disposal of the material or service and identify stakeholders and required team members. Mapping will assist the team in understanding redundancy, inefficiency, or another potential for improvement. 

    Generating Process Maps:

    • Members of the TCO team should physically observe the process and interview people who participate in the process
    • Members draw, review and modify the process map and send to process participants for their review
    • Modification of map as needed
    • The team lead determines where the process begins and ends

    Remember to keep the scope manageable. Make sure it includes all major elements of the cost-generating activity. Also, consider the team’s ability to affect costs. You don't want to spend a lot of time working on costs that the team has no ability to impact.

    Here, Professor Handfield offers suggestions about the kind of project to consider and how to get started by getting the right people involved. 

  • Read: Process Map Examples

    -

    In the previous video, Rob Handfield described Mapping the Process (Step 2) and said that he would provide some examples. Here are several varieties of Process Maps. Note that they are all a little different. This pictorial process map shows facilities as well as information flows which is useful in thinking through all the handoffs where additional costs may be incurred. 

     

    

       

    For the less artistic, the simple boxes represent the steps or handoffs in a process or lifecycle. The addition of the role that performs the step or provides the information is also useful. People performing these roles can then be identified as those who can provide estimates or actual data about the costs associated with that part of the process.

     

     

    You can see that there are many different examples. The actual form is less important than ensuring that the project team understands the full lifecycle of the product or service so that costs from every significant place from which they occur can be estimated.

• Exploring Costs that Impact TCO

  • Watch: Total Cost of Ownership - Step 3

    -

    

    Identify Relevant Costs - Now that you have the process mapped from Pre-acquisition to Disposition, take a look at each step, and handoff and information flow. 

    • Identify anywhere in the full lifecycle where a cost might be incurred. 
    • Determine how each cost element is to be measured.
    • Engage credible stakeholders for access to the costs. 

    This is a critical step and it can be challenging to get the data. The cost metrics must be determined to quantify each of the cost elements identified in Step 2. For example, to quantify the costs of sourcing labor, the hourly rate of the individuals performing the sourcing activity and the amount of time they spend or will spend doing it will need to be known.

    In this video, Rob Handfield recommends some approaches to gathering data and ensuring that the right stakeholders are engaged to ultimately support the information used in the analysis.

  • Watch: Total Cost of Ownership - Steps 4 & 5

    -

     

    Gather data and quantify costs - This is the most difficult and time-consuming step. In this step, gather data for each of the metrics identified in Step 3 (Identify Relevant Costs) and quantify the respective costs. This requires information from various sources including interviews, surveys, the Accounts/Payable (A/P) system, and other internal databases. If information from internal databases is used, make sure to validate the numbers. Input errors can sometimes cause the numbers generated by these databases to be significantly inaccurate.

    Remember also to consider costs that are representative of supplier performance. These may be less obvious than other per-piece costs. Use subject matter experts to help identify an assumption or estimate for the costs of these kinds of issues.

    • PPM  vs Target
    • Delivery Performance
    • Supplier Capacity
    • Others 

    ---

    

     

    Perform the Analysis  - This step is where you will find it most helpful (and perhaps most challenging) to have a cross-functional team including Accounting and Finance participating in the project. This team will help ensure that the data you gathered makes sense when monetized in the analysis. The credibility of the people involved will lend credibility to the work completed.

     

    The team will be helpful in all of these activities:

    • Develop TCO Spreadsheet and Calculations
    • List Assumptions
    • Provide Sensitivity Analysis
    • Challenge Data Accuracy

    You can imagine that each TCO Spreadsheet and Calculations will be different depending upon the actual scenario. It is often helpful to develop a cost timeline. In other words, construct a matrix of costs identified by year for the length of the lifecycle as we did in the PC Purchase example. Place each cost element quantified in Step 4 in a row with the appropriate costs under the time period in which the cost would occur.

  • Watch: Case Study: Purchasing PCs

    -

    There's nothing like making some of these points by trying your hand at a simple analysis through a case. Apply the concepts we've talked about to this exercise. 

    Purchasing Desktop PCs

    You are considering the purchase of 1000 desktop PCs. The life cycle is 3 years and the cost of capital is 12%. 

    Given the information in the chart, determine the Total Cost of the contract over 3 years and the Present Value. 

    You will download an Excel spreadsheet in the next activity to help you perform your calculations.

    COST ELEMENTS	COST MEASURES
    Purchase Price Equipment Software Licenses	$500 $300
    Acquisition Costs Sourcing Administration	2 FTE @100K for 2 months 1 PO@ $150, 12 invoices/year @ $40 ea.
    Usage Costs Installation Equipment Support Warranty Lost Productivity	$200 per PC (move, install, network) $20 per month per PC $100 per PC for a3 year warranty Downtime 15 hours per PC per year @ $30 per hour
    End of Life Salvage Value	$50 per PC

  • Practice: Case Study - Analysis

    -

    The Excel File attached provides this format to help with your analysis including the Present Value of the TCO.

    

    ---

    Given your analysis, how would you approach reducing the TCO for computers over the life of this contract? When considering this question, think about:

    • What costs were “important” and which were “insignificant”?  
    • What strategies can be used to lower the total cost of ownership? 
    • What assumptions might you want to challenge to reduce the TCO? 
    • Who would you consult within your company to be on the team?  
    • What other options exist to meet the requirement (think outside the box)?  

    Before checking the solution in the next activity, work through the analysis on your own for the best learning experience.

  • Read: Case Study Solution - Purchasing PCs

    -

    The Solution to the Computer Purchase TCO case study is attached in the document. Compare this solution to your solution.

  • Read: Present Value and Opportunity Cost

    -

    Present Value:

    Computing the present value allows decisions to be made based on present dollars. This is important because a dollar spent one year from now is not worth the same as a dollar spent now.

    The value of money spent any time in the future will depend on the organization’s cost of capital.  The cost of capital represents the value of money to an organization that could be spent in different ways, including depositing in a bank to derive interest, investing it in a new project, or other alternatives. 

    To calculate the present value:

    1. Obtain the organization’s cost of capital from its finance department, which is internally defined.
    2. Calculate the present value of each total in the cost timeline by using a present value table or a financial calculator.
    3. Add the present values for each time period to arrive at the total cost of ownership. 

    Opportunity Cost:

    An opportunity cost is defined as the cost of the next best alternative. Typical opportunity costs include lost sales, lost productivity, and downtime. When considering usage costs, make sure to identify opportunity costs, if any. The absence of these costs in an analysis could lead to an entirely different decision and, possibly, a wrong one.

• Preparing for Analysis: Selecting a TCO Project

  • Draft: Your TCO Project Proposal

    -

    During this week, you learned the importance of selecting a project where the potential for achieving cost savings is high. Earlier in this course, we asked you to share some initial ideas for a potential TCO Project that you had in mind for your organization. In preparation for the upcoming live event, use the personal reflection space below to go one step further by framing a draft proposal of your TCO Project. 

    Remember that the characteristics of a good candidate project include:

    • It Has High Potential for Cost Reduction: 
    • There is significant belief this cost category presents a lot of opportunity for cost reduction (taking out costs or reducing costs);
    • There is little known about the processes associated with this cost category but it currently incurs significant spend; 
    • Examples can include items that are considered for Strategic Sourcing; Low-Cost Country Sourcing; Major (Re)Sourcing / Outsourcing; a Make / Buy / Import decision
    • It is Manageable: Choose a project that can be accomplished within a few weeks or a month;
    • Scope: Ensure there is a clear and limited scope. 

    TCO Project Proposal Prompts:

    1. Using these characteristics as a gauge, write two sentences to describe your proposed project.

    2. Who are the Key Stakeholders that would be involved?

    3. Write two sentences to describe why this project should yield a cost savings.

    4. Make a rough guess or estimate of the savings you hope to find through this project.

    5. List factors that give you confidence that the project can be completed in 6 weeks or less.

    6. Identify elements of your project that are IN SCOPE or OUT OF SCOPE at this time.

    After answering the prompts above, jot down any questions you may have in preparation for the upcoming Live Event. This is an opportunity to ask questions and discuss how to apply key concepts from the course with the other members of your cohort.

  • Discuss: Ask the Course Author

    -

    Based on what you've learned during this week, do you have a question that you would like to ask the course author in preparation for the upcoming Live Event? 

    It may be helpful to review your reflections and discussion posts. The easiest way to do so is to click on the backpack icon above. There, you'll find links to your reflections, notes and discussions. This review will not only refresh your memory on some commitments you have made to yourself, but it may also trigger a question.

    In the box below, please post your question. Be sure to return to this forum to see if you can learn from what others have posted as well. 

• Capstone: Live Event

  • Attend: Live Event

    -

    The Live Event Capstone is designed to give you a chance to discuss the topics covered during the week with an expert and your cohort. To get the most from this event, you should have completed the reading and discussion activities.

    Please make an effort not only to join this live interactive session, but also to actively participate in the conversation. Take advantage of the opportunity to engage your fellow leaders in the context of the topics discussed during this module and their application to your work.