What do a Volvo, Wine Barrels, and a Vacuum have in common? 1

2 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) European license/Insurance for 3 months Airfare (Continental miles) 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, European insurance for three months Airfare (Continental miles) Total Cost to take delivery in San Diego Rent equivalent Volvo (Europe) 0 $ 39,196 $ 6,000 $ 45,196 $ 6,081/$12,081 difference and a GREAT trip!

“Exhausted” white oak red wine barrels from Temecula winery Issues: Choose and transport barrels Number of barrels in one trip (no min.) Storage capacity at PRDH/BMI Fuel & 17’ box truck (rent) Total Direct Cost $ 40 each ½ workday (2 people) 30 $ 150 $ 1,350 ($45/barrel) “Exhausted” white oak red wine barrels from Napa winery Issues: Inspect and arrange purchase Number of barrels in one trip (min.) Travel expenses Storage capacity at PRDH/BMI Fuel & tractor semi-trailer (outsource) Total Direct Cost $ 22 each 3 workdays (2 people) 70 $ $ 1,050 $ 2,890 ($41/barrel) Other ‘soft/indirect’ considerations: Wages of employees and lost productivity Head designer is billable at $90/hr. Inability to choose barrels at Napa (lower yield?) Barrel cost is 20% of direct costs of a chair (FYI... Cost of new barrel is $1,000) Lack of storage capacity, as well as personnel to breakdown and kit barrels, but... Establish relationship(s) for sustainable sources of supply Build new business relationships for marketing barrel furniture Enjoy road trip... Other considerations ??? 3

21 pounds ~ $ 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

6 And now for some academic stuff...

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 buy 1 1 Adapted from Supply Chain Management, Fawcett/Ellram/Ogden, Ch8 Don’t waste a lot of time here e.g., commodity items, supplier A v. B, domestic v. offshore e.g., alternative SC configurations, LCD v. Plasma, Important supplier relationships e.g., infrequent purchases, custom software, 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 Handout #1 15 Principles of Supply Chain Management 3e (Wisner. et al.)

Handout #2 TCO as a Tool Quantitative 16 maint.

Handout #3 Purchasing and Supply Chain Management 4e (Monczka, et al.) Savings $1.67 or ≈ 5.4% Is it worth the added risk? Wiring Harness TCO as a Tool Quantitative 17

TCO as a Tool Supplier risks/considerations:  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  ? Overseas business Risks:  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  ? 18 Adapted from Purchasing and Supply Chain Management 4e (Monczka, et al.)

Handout #4 Purchasing and Supply Chain Management 3e (Monczka, et al.) Guava Puree TCO as a Tool Quantitative 19

Handout #5 TCO as a Tool Quantitative Slide provided by Rey Huerta, President of Enterprise Logistics Solutions Zero-Based Theoretical Analysis 20

Component Outsourcing Buying components Buyer  supplier(s)  internal customer(s) relationship Initiate PO and verify final receipt Less people dependent, fewer interfaces Trend to eliminate monitoring and inspections via supplier certification ??? Logistics Outsourcing Buying a service process Buyer  third party supplier(s) & third party supplier(s)  ultimate customer relationship 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

Handout #6 Example: for Option 3 Weighted Sum of “+” = = 43 Weighted Sum of “-” = = -23 Total Weighted Sum 20 TCO as a Tool Qualitative 22

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) So...what is TCO – really? 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 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

27 I wonder if a TCO mindset would have been beneficial in this situation ?