TOTAL COST OF OWNERSHIP (TCO) Chapter 3 TOTAL COST OF OWNERSHIP (TCO) DOSEN : IR. HOETOMO LEMBITO, MBA, CSLP

Objektif Perkuliahan Memahami konsep TCO Memahami fungsi TCO dalam SCM Memahami keterkaitan konsep TCO dengan aktivitas purchasing management

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) TCO

Key Concepts Purchase Price: But One Component of Cost The Importance of Total Cost of Ownership in Supply Management Service Providers Retail Manufacturing

Key Concepts Three Components of Total Cost Acquisition Costs Ownerships Costs Post-Ownership Costs TCO, Net Present Value Analysis (NPV), and Estimated Costs Supply Management Action

Total Cost and WCSM To achieve World Class Supply ManagementSM, managers must shift their focus in procuring materials, services and equipment from price to total cost.

Importance of TCO Service Providers Retail Manufacturing Supply Chains/Supply Networks

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

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

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

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/communication requirements Volatility of end-customer demand Inventory carrying costs Inventory risk Quality costs

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

TCO TCO Components Acquisition costs Ownership 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 TCO

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

Ownership Costs Downtime Costs Risk Costs Cycle Time Costs Conversion Costs Non-Value Added Costs

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

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

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

Major Categories for the Components of TCO Total Cost of Ownership Pretransaction Components Identifying need Investigating sources Qualifying sources Adding supplier to internal systems Educating: Supplier ins firm’s operations Firm in supplier’s operations Transaction Components Price Order placement/preparation Delivery/transportation Tariffs/duties Billing/payment Inspection Return of parts Follow-up and correction Posttransaction Components Line fallout Defective finished goods rejected before sale Field failures Repair/replacement in field Customer goodwill/reputation of firm Cost of repair parts Cost of maintenance and repairs Source: Lisa Ellram, “Total Cost of Ownership: Elements and Implementation,” International Journal of Purchasing and Materials Management, Winter 1993.

Tangential Reprographics Example

TCO = A + P.V.  (Ti + Oi + Mi – Sn) TCO Formula n TCO = A + P.V.  (Ti + Oi + Mi – Sn) i = 1 A = delivered acquisition cost P.V. = net present value Ti = training costs in year i Oi = operating costs in year i Mi = maintenance costs in year i Sn = salvage value in year n

PVA Incorporated into a TCO Analysis Acquisition Cost = $120,000 PV Cash Outflows, yrs 1 - 6 = 23,279 PV of overhaul in yr 3 = 5,208 PV of salvage value in year 6 = (2,512) TCO = $145,975

PVA Formulas PVAnnuity = CF [ 1/r – 1/r(1+r)t ] PV = FV / (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

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