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Chapter 13 Total Cost of Ownership 13-2

Total Cost of Ownership 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) 13-3

Key Concepts Three Components of Total Cost »Acquisition Costs »Ownerships Costs »Post-Ownership Costs Purchase Price: But One Component of Cost 13-4

Key Concepts TCO, Net Present Value Analysis (NPV), and Estimated Costs The Importance of Total Cost of Ownership in Supply Management »Service Providers »Retail »Manufacturing 13-5

Three Components of Total Cost Acquisition Costs Ownerships Costs Post-Ownership Costs 13-6

TCO Components Acquisition costs »Purchase price »Planning costs »Quality costs »Taxes »Financing costs Ownership costs »Downtime costs »Risk costs »Cycle time costs »Conversion costs »Non-value added costs »Supply chain costs Post-ownership costs »Environmental costs »Warranty costs »Product liability costs »Customer dissatisfaction costs 13-7

Acquisition Costs Purchase Price Planning Costs Quality Costs Taxes »Customs Duties and Tariffs »Regional Trade Agreements »Income-Base Shifting Financing Costs 13-8

Ownership Costs Downtime Costs Risk Costs Cycle Time Costs Conversion Costs Non-Value Added Costs Supply Chain Costs 13-9

Ownership Costs Supply Chain Costs »Forecasting »Administration »Transportation »Inventory »Manufacturing »Customer service »Supplier selection/relationships »Global sourcing 13-10

Post - Ownership Costs Environmental Costs Warranty Costs Product Liability Costs Customer Dissatisfaction Costs 13-11

TCO, Net Present Value Analysis (NPV), and Estimated Costs 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 The present value of a sum of future cash flows discounted by a required rate of return »NPV greater than zero suggests accepting the investment »NPV less than 0 suggests rejecting the investment »NPV = 0 is the point of indifference 13-12

Tangential Reprographics Example 13-13

TCO Formula n TCO = A + P.V.  (T i + O i + M i – S n ) i = 1 A = delivered acquisition cost P.V. = net present value T i = training costs in year i O i = operating costs in year i M i = maintenance costs in year i S n = salvage value in year n 13-14

PVA Incorporated into a TCO Analysis Acquisition Cost = $120,000 PV Cash Outflows, yrs = 23,279 PV of overhaul in yr 3 = 5,208 PV of salvage value in year 6 = (2,512) TCO = $145,

PVA Formulas PV Annuity = CF [ 1/r – 1/r(1+r) t ] »CF = periodic cash inflow or outflow (must be the same each period) »r = discount rate per period (annual rate divided by the number of periods in one year) »t = total number of periods PV = FV / (1 + r) t »FV = future value of single cash inflow or outflow »r = discount rate per period (annual rate divided by the number of periods in one year) »t = total number of periods 13-16

Importance of TCO in Supply Management Service Providers Retail Manufacturing Supply Chains/Supply Networks 13-17

Service and Retail Providers Understanding what drives the cost of overhead expenditures is crucial to any service business Revenue must cover the direct costs, material and labor, and overhead in order to generate a profit »TCO analysis of recurring material costs are often overlooked and can yield great savings »TCO analysis of the labor base can reap lower per person costs, greater benefits, and improved morale »TCO analysis of equipment purchases may help reduce the expenditures for maintenance and parts over the lives of the investments 13-18

Manufacturing Manufacturers are concerned with all of the same TCO issues as service and retail firms, with some added issues Issues that are particularly important in cost analysis for manufacturers are: »Direct materials »Manufacturing overhead Emphasis should be placed on the variance between “should cost” and actual cost. »This should not be confused with price variance 13-19

Activity Based Costing A major problem in TCO analysis of manufacturers is accurate allocation of manufacturing overhead Many manufacturers have used activity-based costing to help improve cost allocation Activity-based costing (ABC) is a technique for accumulating cost for a given cost object that represents the total and true economic resources required or consumed by the object 13-20

Supply Chain/Supply Networks TCO analysis may include the study of: »Manufacturability »Infrastructure »Outsource decision »Analysis of suppliers beyond tier one »Structure of foreign and domestic tariffs/duties/taxes »Costs of delivery »Foreign regulations »Foreign political/economic stability »Foreign exchange risk »Language/communicati on requirements »Volatility of end- customer demand »Inventory carrying costs »Inventory risk »Quality costs 13-21

Concluding Remarks TCO is an analytical tool and a philosophy Accurate estimation of total costs requires a cross-functional approach Supply management is a critical member of such a cross-functional approach TCO is also applicable in one’s private life enabling better decision-making 13-22