0. The Federal Strategic Sourcing Initiative (FSSI) Understanding the Elements of Total Cost of Operations (TCO)

1. Workshop Objectives
Provide a brief overview of strategic sourcing and the Federal Strategic Sourcing Initiative (FSSI)
Provide a comprehensive definition of Total Cost of Operations (TCO)
Explain the key elements of TCO
Clarify the difference between cost elements and cost drivers
Present illustrative examples of acquisition decisions based on TCO analysis
Share the benefits that can be achieved by incorporating TCO analysis into the procurement process

2. Total Cost of Ownership
Prelude
What is TCO?
Total Cost of Ownership
The total cost of owning and operating an asset over its expected period of use, i.e., lifecycle cost.
Also includes costs to acquire and dispose of the asset
Total Cost of Operations
Similar to Total Cost of Ownership, but recognizes that certain assets might be leased or provided as part of a contracted operation.
Provides a useful cost framework to evaluate:
Policy options
Business process alternatives
Investment alternatives, e.g., in-house vs contract; own vs lease
Acquisition alternatives, e.g., vendor vs vendor; contracting options

3. Federal Strategic Sourcing Initiative (FSSI)
The Federal Strategic Sourcing Initiative is an OMB-initiated program that was established in November of 2005
2005 OMB Mandate
An OMB memo issued May 2005 required agencies to identify no fewer than three commodities to be purchased through strategic sourcing by October 2005 (excluding software purchased through SmartBUY). The memo stated that:
Agencies needed to leverage spending to the maximum extent possible
Sound business decisions needed to drive spending
Federal Strategic Sourcing Initiative (FSSI)
In November of 2005, as a direct result of the OMB mandate, FSSI was established with a mission to improve the federal government acquisition value chain, increase socio-economic participation and ultimately lower total cost of operations and/or ownership for strategic sourcing vehicles
FSSI is governed by OFPP and the Strategic Sourcing Working Group under the Chief Acquisition Officer’s Council
More than 60 Federal agencies, boards and commissions actively participate in the FSSI
Use of FSSI vehicles is non-mandatory, but agencies are encouraged to look at FSSI solutions first
Currently, three FSSI vehicles exist with GSA serving as the Executive Agent:
Express and Ground Domestic Delivery Services – GSA Schedule 48 BPA
Office Supplies – GSA Schedule 75 BPAs
Wireless Telecommunications Expense Management (TEM) Services – IDIQ, multiple award contract

4. Strategic sourcing is a process that strives to optimize an organization’s supply base while reducing Total Cost of Operations and improving mission delivery
Strategic sourcing is the collaborative and structured process of critically analyzing an organization’s spending and using this information to make business decisions about acquiring commodities and services more effectively and efficiently
A group of senior Federal executives participating in the 2006 Public Sector Strategic Sourcing Roundtable defined strategic sourcing in the federal government as:
A Systematic Process for analyzing and developing optimal strategies for buying goods and services
A Data Driven Process that relies on fact-based analysis for decision making rather than “hunches”
A Holistic Process that addresses customer needs, market conditions, organizational goals and objectives, and other environmental factors
Based on Market Intelligence and takes into account small business capabilities
Inclusive of Customer Requirements
A Cross-Functional Approach that incorporates the perspectives and expertise of acquisition specialists as well as end users
About Supporting an Organization’s Mission through procured goods and services
About Developing Organization-wide Strategies

5. The benefits of strategic sourcing and drivers of TCO are numerous and go far beyond simple reductions in unit costs
Primary Benefits of Strategic Sourcing
Reduction in Cost Per Unit
Change in Consumption/ Volume
Change in Consumption/ Volume
Improved Operating Efficiency
Improved Focus on Socio-economic Goals
Pricing Improvements
Lower unit price
Volume rebates
Payment term discounts
Supply Chain Savings
Cost of capital
Warehousing costs
Shipping costs
Reduced Lifecycle Costs
Maintenance costs
Operating costs
Disposition costs
Demand Management
Eliminate demand
Reduce consumption
Encourage substitution
Change product mix
Specification Review
Eliminate “gold-plating”
Simplify specifications
Alternative products
Reduced Procurement-Related Operating Expense
Socio-economic Goals
Structured analysis of small/disadvantaged business opportunities
PO Processing
Accounts Payable
Receipt/Warehousing
Standardized procurement process
Other operating efficiencies
Performance Monitoring
Structured metrics and periodic review of contractor performance
Note: There are many benefits resulting from an understanding and application of the concept of TCO to an acquisition. These benefits are very similar to the benefits derived from the strategic sourcing process. One element of the strategic sourcing process that does not result from conducting a TCO analysis, is the improved focus on socio-economic goals and the increased participation of small and disadvantaged business as primes because vendor selection is not part of the TCO analysis.
Reduced Non-Procurement Related Operating Expense
DRIVERS OF TCO

6. What is Total Cost of Operations?

7. WHAT IS TOTAL COST OF OPERATIONS?
One of the primary goals of strategic sourcing is the reduction of Total Cost of Operations
WHAT IS TOTAL COST OF OPERATIONS?
Total Cost of Operations (TCO) is a comprehensive, full cost accounting estimate designed to help consumers and commodity managers assess costs
TCO consists of costs incurred throughout the life cycle of a service or commodity, including acquisition, deployment, operation, support and retirement
TCO identifies costs which are made up of two major components - direct and indirect:
Direct costs traditionally are made up of labor and capital costs
Indirect costs are more of the “soft” costs associated with an acquisition and tend to be more difficult to measure and rationalize
Understanding TCO broadens our baseline understanding of spend and identifies sourcing opportunities beyond purchase price

8. TOTAL COST OF OPERATIONS (TCO) ELEMENTS (Conceptual Example)
TCO of a commodity goes beyond purchase price, it also includes acquisition costs, lifecycle costs, end of life costs and other
ILLUSTRATION
TOTAL COST OF OPERATIONS (TCO) ELEMENTS (Conceptual Example)
Note: Important to highlight on this slide how there are many different elements that should be considered with the acquisition of a commodity and all of these elements build upon one another, resulting in the Total Cost of Operations.
For some commodities, cost elements beyond purchase price may be significant, at times equaling or exceeding initial purchase cost over the commodity lifecycle

9. TOTAL COST OF OPERATIONS (TCO) ELEMENTS (Conceptual Example)
Different commodities can vary significantly in their composition of TCO elements
ILLUSTRATION
NOTES
TOTAL COST OF OPERATIONS (TCO) ELEMENTS (Conceptual Example)
Many buyers will focus on achieving a competitive purchase price and will overlook opportunities to improve other cost elements
For some commodities, purchase price is not the largest cost element
Therefore, it is important to consider all cost elements, including (but not limited to):
Internal procurement, contract management and billing/invoicing processes
Internal management of the commodity
Operational costs (cost of use, spare parts, maintenance, etc.)
Disposal costs
Note: The TCO build up for each commodity will be different, based upon the operations and maintenance required or if there are large end of life/disposal costs, etc. but because each commodity is different in its composition, it is important to assess each commodity independently and after the composition of a commodity has been identified, it will be easier to identify which elements are important to have competitive pricing in

10. Key Elements of Total Cost Analysis: Understanding Cost Elements vs
Key Elements of Total Cost Analysis: Understanding Cost Elements vs. Cost Drivers

11. Understanding the total cost of a commodity involves the identification of cost elements and cost drivers
COST ELEMENTS VS COST DRIVERS
What are they?
Examples
COST ELEMENTS
Components of total cost of operations (TCO) – “buckets” of cost that can be quantified
Transportation costs
Purchasing administration costs
Inventory costs
Supplier certification costs
COST DRIVERS
Factors or activities that can be changed and have an impact on the magnitude of the cost element
Distance shipped
Number of suppliers
Number of purchase orders
Number of different SKUs
For the second bullet in the take away box, an example of a situation where this would be applicable would be for clerical services – with clerical services it is important to understand that 75-80% of the cost structure of this procurement will go to the salary of the individual. Because of this, defining the requirement is that much more important because the opportunity to impact total cost is limit to the make up of the remaining 25-20% of cost.
Cost drivers can at times be significant sources of savings for some commodities
Drivers of cost within suppliers’ operations can be very important for commodities where unit price is still likely to be the largest component of our total cost

12. Hardware includes the actual price paid for the product
When identifying the various cost elements of TCO, it is also important to consider the percentage of TCO that is comprised of each the costs elements
For a common piece of office equipment - a network printer – there are multiple TCO components that should be considered when conducting an acquisition. What percentage of the total cost do each of these components make up?
NETWORK PRINTER COST COMPONENTS
TCO
Element
Description
Estimated % of TCO
Purchase Price & Acquisition Process Costs - Device
Hardware includes the actual price paid for the product
Lifecycle Costs -Operations and Maintenance Costs
Operations and Maintenance costs include maintenance, repair, help desk, asset management, upgrades, licensing, etc.
Lifecycle Costs-Consumables
Consumables (e.g. paper, ink, toner, cartridge) are a significant part of the office imaging cost
5%*
50%*
Note: Key take away is that the purchase price is such a small percentage of the overall cost of the printer, and also in the note it mentions that while End of Lifecycle costs are included in a TCO analysis, these percentages were not defined in the article and therefore have not been included in this break out.
45%*
Source: Prudential Equity Group Research, Oct 2006; Lexmark International; Censeo Analysis
* Percentages referenced above are based on an industry report from Lexmark International; this break out will not be true in all scenarios – End of Lifecycle Costs are also components that impact the TCO of a network printer, but the estimated percentage was not provided in the referenced industry report
The percentage break out of TCO components does not always align with initial assumptions and can impact the results of a total cost analysis

13. As demonstrated in the previous example, consumables, maintenance & IT support, and equipment costs are the key cost elements of desktop printers
RELEVANT TOTAL COST COMPONENTS
Purchase Price:
Hardware: Annual depreciation cost of printers
Acquisition Process Costs:
Acquisition: Estimated acquisition costs associated with requirements validation & contracting purchasing activity
Lifecycle Costs:
Operations & Maintenance:
IT Support: Cost estimate of in-house IT help desk support provided to local and network printers
User Support: Cost estimate of work effort associated with toner and paper replenishment performed by users
Property Mgmt: Estimated property management personnel costs associated with managing printers
Consumables:
Paper and toner costs
Power: Estimated power costs associated with devices
End of Life Costs:
Disposal: Cost of product disposal at end of life
Understanding internal costs related to purchasing and managing a commodity is important in identifying savings opportunities
DESKTOP PRINTER
TOTAL COST OF OPERATIONS BREAKDOWN
Note: The intent of this slide is to visually show the break out shown on the previous slide, and also to define other cost components that are not commonly thought of when considering an acquisition.
Purchase Price & Acquisition Process Costs - Device
Lifecycle Costs – Operations & Maintenance
Lifecycle Costs - Consumables
Total Cost of Operations
Source: Prudential Equity Group Research, Oct 2006; Lexmark International; Censeo Analysis
* Percentages referenced above are based on an industry report from Lexmark International; this break out will not be true in all scenarios – End of Lifecycle Costs are also components that impact the TCO of a network printer, but the estimated percentage was not provided in the referenced industry report

14. Key Elements of Total Cost Analysis: Conducting A Complete TCO Evaluation – In The Workplace

15. Based on the data above, Device C would be the best value
With most acquisitions, unit price is often the only cost component considered
NETWORK PRINTER COST COMPONENTS
Device A
Device B
Device C
Device
B&W Printer – medium size
Volume
100
Unit Price/Device Cost
$1,031.00
$783.75
$725.20
Note: When conducting an acquisition, the two main components that most people consider are volume and unit price, and in this example because the three examples are like-configurations, the purchase volume is the same (so no additional volume discounts), the logical for an acquisition professional would be the unit with the lowest per unit cost.
$725.20
Source: Censeo analysis
Based on the data above, Device C would be the best value

16. But to truly obtain best value, it is critical to evaluate all TCO cost components before completing an acquisition
NETWORK PRINTER COST COMPONENTS
Device A
Device B
Device C
Device
B&W Printer – medium size
Usage*
4,000 pg/month
Volume
100
Product Support
4-Yr Extended Warranty
4-Yr Onsite Warranty
4 Yrs Onsite Product Support
Purchase Price
$1, (34% of total cost)
$ (28% of total cost)
$ (19% of total cost)
Acquisition Process Costs
Procurement
$ (5% of total cost)
$ (4% of total cost)
Lifecycle Costs
Est. 4-Yr Consumables Cost
$1, (47% of total cost)
$1, (46% of total cost)
$2, (72% of total cost)
4-Yr Product Support Cost
$ (13% of total cost)
$ (19% of total cost)
$ (4% of total cost)
End of Life Costs
Disposal
$50.00 (2% of total cost)
$50.00 (1% of total cost)
Total 4-Yr Estimated TCO
$3,064.67
$2,604.45
$3,880.80
Note: Using the same printers from the previous slide, by conducting a true TCO analysis (considering lifecycle costs: product support, operations and maintenance, consumables) the best value solution will result in the selection of a different model (than when the analysis was simply based upon unit cost and volume). Depending on the price difference and total volume of the purchase, selecting the true “best value” solution can result in significant savings.
$2,804.45
* Usage estimates are based on avg # users per device (8), typical # of pages per user (500) resulting in the estimated total # of monthly pages (4,000). Projected Consumables Costs assume utilization of high-yield cartridges where available.
Source: Censeo analysis
A complete analysis of TCO indicates that Device B truly is the best value solution

17. Key Elements of Total Cost Analysis: Conducting A Complete TCO Evaluation – In Daily Life

18. TOTAL COST OF OPERATIONS (TCO) EVALUATION
The process of conducting a TCO analysis can be applied in everyday life
TOTAL COST OF OPERATIONS (TCO) EVALUATION
Example A
(Non hybrid)
Example B
(Hybrid)
Purchase price
Sticker Price: $22,151
Sticker Price: $23,650
Acquisition process and lifecycle costs*:
Depreciation
Taxes and Fees
Insurance Premiums
Fuel
Maintenance
Repairs
Interest on Financing
Stimulus - Auto Assistance Ownership Amendment
$9,981
$1,600
$10,216
$10,700
$3,050
$671
$3,840
$1,500
$10,549
$1,635
$5,600
$3,953
Purchase price after TCO analysis
Price: $40,058
(cost is 53 cents per mile to drive)**
Price: $35,658
(cost is 48 cents per mile to drive)**
When purchasing a car consumers often consider only one variable – sticker price – and based on the sticker price in the example to the right, Example A, the non-hybrid is the more economic choice
Note: The example provided above demonstrates how TCO is part of our everyday lives. Like the printer, even when making such a large investment as purchasing a car, most people still only consider the sticker/purchase price, but only after analyzing all TCO elements can one truly understand the total cost of owning and operating a vehicle. Many people are hesitant to consider the higher priced alternative, because it is difficult to move beyond the initial price and consider the total cost, but when purchasing an item that has a long lifecycle it is very important to invest the time to evaluate all costs.
*End of Life Costs are not included in this example
**Cost of ownership is assumed over a five year period and 15,000 miles a year
Source:
TCO analysis indicates that the cheaper car to buy is actually the more expensive car to own and operate

19. Estimated Daily Cost of Commuting But are these the only cost drivers?
When selecting a means of transportation, it is important to understand how different cost drivers can influence the TCO
Commuting to work is a daily activity for most individuals. In nearly all instances, there are a number of expenses incurred with a daily commute. These expenses will vary based on method of transportation, distance traveled, number of options available, etc. These expenses may also drive us to choose one method of transportation over another.
For this exercise, assume that there are only two commuting options available, to drive or to utilize public transportation. Based on the “out of pocket” expense incurred on a daily basis, let’s calculate the cost of a daily commute:
Estimated Daily Cost of Commuting
Based on an initial assessment, there are multiple cost components that should be considered for both methods of transportation
Method of Commuting
Cost Components
Estimated Cost (per day)
Total Estimated Commuting Cost (per day)
Drive
Parking
Gas
$10
$5 (each direction)
$20
Public Transportation
Fare
$3.50 (each direction) $5
$12
But are these the only cost drivers?

20. In our assessment of the daily cost of commuting, it is important to remember that all costs may not be apparently obvious
In our calculations of the cost of a daily commute, have we considered all costs?
NOTES
Estimated Daily Cost of Commuting
Method of Transportation
Drive
Public Transportation
Parking
$10 $5
Fare $0
$3.50 (each direction)
Gas
$5 (each direction)
$3 (each direction)
Car Insurance
$5.68
$5.11
Depreciation of the car
$1.69
Maintenance and repair of the car
$5.50
$4.95
TOTAL
$32.87
$29.75
There are a number of additional cost drivers that were not immediately apparent in this example
These additional costs can have a significant impact on total cost, and only by assessing all drivers can one truly understand the total cost and make an informed decision between the two alternatives
Time is another cost element that was not considered. Time can be assessed as an opportunity cost.
Because of limited contracting resources within the government, time is a critical element in any acquisition and cost analysis
Cost Components
*Figures for “drive” method assumed for a 2009 Honda Civic over a five year period and 15,000 miles a year
Source:

21. Understanding the Benefits of TCO

22. Once we understand cost elements and drivers and identify specific actions we can take to impact total cost, savings estimates can be developed to support recommended changes
SAVINGS CALCULATION FRAMEWORK – TOTAL COSTS
Examples
Price
Volume Rebates
Payment term discounts
Cost of Capital
Warehousing Costs
Shipping costs
Maintenance costs
Operating, energy and other costs
Disposable costs
Elimination
Substitution
Change in mix
Cost of processing purchase orders
Cost of processing accounts payable
Cost of receipt/warehousing
Other Operating efficiencies
Reduced Prices
Reduction in Cost per Unit
Reduced Supply Chain Costs
Reduced Lifecycle Costs
Total Savings Related to Purchased Goods and Services
Change in Consumption/ Volume
There are multiple benefits which can result from understanding TCO
Reduced Procurement Related Operating Expense
Improved Operating Efficiency
Reduced Non-Procurement Operating Expense

23. Understanding TCO and how to apply the concept to acquisition decisions can result in significant savings opportunities, specifically unit cost reduction and planned changes in consumption and volume
NOTES
Unit price reductions can be achieved by:
Negotiating payment terms to gain pricing improvements and discounts
Optimize the supply chain
Reducing lifecycle costs through the management of maintenance costs, operating costs, and disposal costs
Planned changes in consumption and volume can be achieved through:
Demand management, eliminating demand and reducing consumption
Specification review, simplifying specifications and suggesting alternative products
The following slide provides an example of how unit price reductions and changes in consumption/volume can result in reduced lifecycle costs and efficiencies

24. ROOFING SCENARIOS 20-YEAR LIFETIME
In the example below, understanding the TCO elements of lifecycle costs and specification requirements can result in significant cost savings when making an acquisition decision
EXAMPLE
ROOFING SCENARIOS 20-YEAR LIFETIME
COST COMPARISON
($ per SF)
NOTES
Reduction in Cost per Unit and Lifecycle Costs:
Investing in higher quality materials, workmanship, and warranty coverage upfront will cost more in year one, but will provide the lowest “lifetime” TCO
Change in Consumption/Volume:
For major facility capital investments like HVAC equipment or roofing, clearly identifying and assessing specifications can result in cost savings by reducing consumption (and limiting replacements of parts or full structures)
Note: Similar to the car purchase, understanding TCO can lead to an informed purchase which can result in cost reduction and improvements in consumption and volume. In this roofing example, understanding TCO and the value of reduced lifecycle costs can result in significant savings. 1 2 3 4
Source: Censeo Analysis

25. TCO can also help evaluate the benefits of operational decisions such as changes in consumption/volume and improved operating efficiency
NOTES
Change in consumption/volume and improved operating efficiency can be achieved in a number of ways:
Through the implementation of an online ordering system to reduce paper and manual transactions and improve invoice processing and auditing
Business Process re-engineering
Note: One of the key benefits of understanding TCO, is improving operational efficiency, unfortunately many times this benefit is overlooked if the acquisition professional is not comfortable with the methodology of estimating operating costs
The following slides provide an example of how to calculate savings gained through improved operational efficiencies

26. Reducing processing times improves operational efficiency
IMPROVED OPERATIONAL EFFICIENCY– PROCESSING TIME
Shipment of FedEx Packages
PREVIOUS SHIPPING STEPS
REVISED SHIPPING STEPS
Employee walks to copier room to obtain FedEx letter and requisition form
Employee walks back to their desk to complete the form
Employee secures requisition form to the letter with tape
Employee walks back to the copy room to place the outgoing letter in a designated place
At a designated time a mailroom employee walks the halls and picks up all out going FedEx packages and mail and returns all to the mailroom
In the mailroom the mailroom employee keys into a FedEx system the destination address
The mailroom employee records the tracking number on the requisition form
The form is returned to the original sender
The form is secured in a file cabinet
FedEx then picks up all outbound shipments
All time was studied and this took on average 14 minutes and 42 seconds to complete
Employee walks to copier room to obtain a FedEx letter
Employee returns to their desk and clicks on FedEx Online
After 3 clicks the label prints out on the employees printer
Employee walks back to the copy room to place the outgoing letter in a designated place
At a designated time a mailroom employee walks the halls and picks up all out going FedEx packages and mail and returns all to the mailroom
FedEx then picks up all outbound shipments
All time was studied and this took on average 1 minutes and 22 seconds to complete
Note: Improved operational efficiency resulted in a reduction of required process steps and saved the individual processing the order 13 min and 20 seconds.
Source: This example is provided courtesy of Federal Express Corporation

27. Reduced labor costs is an example of the savings that can be achieved through improved operational efficiency
SAVINGS CALCULATION
IMPROVED OPERATIONAL EFFICIENCY– PROCESSING TIME
Reduced Labor Costs Associated With Shipment of FedEx Packages
Savings Calculations
STEP 1: Divide the hourly labor rate of the individual conducting the procurement (based on GS level and pay grade) by 60 min in an hour to generate the estimated labor rate per minute.
STEP 2: Next, work with subject matter experts to estimate the current and future processing time of the given transaction and subtract the current time from the future processing time. Then, multiply the variance by the labor rate per minute identified in Step 1.
STEP 3: Identify the total number of transactions that are processed per year. Multiply this number by the labor cost savings per unit identified in Step 2.
These calculations result in the annual estimated labor rate savings achieved through improved processing time 1 2
Note: Reductions in labor costs resulting from improved operational efficiency can result in significant savings, in the example shown above the savings are over $400K, unfortunately many people overlook labor rate costs as a key component of total cost, but as demonstrated above, they are clearly a metric that should be addressed. 3
Source: This example is provided courtesy of Federal Express Corporation

28. STEPS TO CONDUCT A TCO EVALUATION
There are a number of key steps that should be completed as part of any acquisition to ensure a thorough TCO evaluation has been conducted and best value achieved
STEPS TO CONDUCT A TCO EVALUATION
Before beginning any acquisition, through market research or product analysis, identify the key cost elements that comprise the total cost of operations for this commodity – beyond just price
Identify the cost drivers for this commodity – which of these can we control/influence?
Once the cost elements and drivers have been identified, assess each of these components and assign an estimate percentage of total cost– if the assigned percentage is not significant (falls below 5%) eliminate it from your evaluation
Identify the appropriate timeline to measure the total cost of this acquisition
With a revised, prioritized list of TCO components, assess the true cost of the commodity
Compare and save!
Note: Most formal TCO analysis is conducted through well structured analytical models, but even a “quick and dirty, back of the envelop” TCO analysis can raise awareness in regards to cost elements and drivers that effect and will lead to an informed acquisition.

29. Points of Contact: GSA FAS - FSSI Program Management Office Michel Kareis, PMP FSSI Program Manager (703) FSSI website: FSSI address: Office of Federal Procurement Policy (OFPP) Jack Kelly (202)

30. Questions?