The concept of the Total Cost of Ownership (TCO) is not new and for many not a bit exciting. But, it is a critical part of the acquisition process and has been successfully used for the analysis of Information Technology and government procured products for many years. It is a mainstay of the Federal Acquisition Regulations (FAR). Yet, the concept of the Total Cost of Ownership hasn’t been universally adopted by middle market manufacturing and distribution companies as part of their standard Supply Chain Management Solutions.
Middle market companies don’t typically have sophisticated procurement systems and in most cases don’t have the systems and metrics to develop a Total Cost of Ownership model. Purchase price, shipping and delivery dates are what most buyers are interested in. They might pay attention to a vendor that is particularly bad, but don’t have the ability to define and measure the nuances of cost. This failure to do so can consume significant amounts of operating profit over the lifecycle of a product or a component. In some cases, purchase price can be as little as 20% of the Total Cost of Ownership.
Utilizing the Total Cost of Ownership model requires a process that once defined isn’t difficult to maintain. Take a look at Group50’s generic model below. It consists of 5 primary buckets of cost and their corresponding cost factors.
This generic TCO model summarizes the cost elements that are associated with acquiring goods and it needs to be customized for each company and its products. No company will require all of the identified elements and some of them may be moved into other buckets. Cost elements are controlled by different groups in the supply chain such as vendors, logistics companies, government regulations and the customer. The TCO model should be used for products, systems, components, plant and equipment, technology, software, vehicles, etc. When properly developed for a business, there will typically be three versions of the TCO model:
- One for the product the company sells
- One for the company’s purchases of raw materials, components and finished goods
- One for capital equipment
I have seen many sales closed because of a well laid out TCO model which convinced a customer that the product being acquired had the least total cost. Although purchasing agents will badger you on price, they do understand total cost and typically won’t go against total cost on important procurement decisions. You just need to present it!
The typical steps associated with creating a TCO model and business process are as follows:
- Identify the goals and objectives of the implementation. Understand the key elements of cost as shown in our model
- Identify the cost drivers and who controls or influences them
- Assess how important each cost element is and only focus on the ones that make up the majority of the total cost.
- Create measurement systems to acquire costs for each element selected
- Utilize a checklist of the elements of Total Cost to aid in decision making. (A simple checklist based spreadsheet works nicely).
- Make your decision based on the Total Cost of Ownership and not on price.
If you think this is too much work, I encourage you to think again. At Group50 Corporate Strategy Execution Consulting, we believe that “what gets measured gets managed”. Implementing a Total Cost of Ownership model and creating a focus on driving it down to its lowest level will not only increase profitability and sales, but it will cause everyone in the organization to focus on reducing cost, improving business processes. Lowering working capital and finding better vendors. TCO does a great job at identifying hidden costs and delivers a 1-2 punch when coupled with a Continuous Process Improvement Services.
Group50 Business Management Consulting Firm consultants fully understand the elements of cost in a company and how they impact COGS and profitability. As part of Group50’s Company Physical®, we have a Total Cost of Ownership workshop that you can see here. You can find out more about our Business Process Consulting Services by calling (909) 949-9083, sending an inquiry to firstname.lastname@example.org or you can request more information.
About the author:
Jim Gitney is the CEO of Group50® Consulting and specializes in the development and implementation of manufacturing and supply chain strategies and Continuous Improvement. Jim and the Group50 team are all former executives with well-known manufacturing and distribution companies who understand what it takes to put together a robust Total Cost of Ownership Model. Group50 has designed a series of strategic assessments, workshops and strategic execution tools that refocus companies and their critical business processes on cash flow, working capital and profitability. You can reach us at (909) 949-9083 or send a note to email@example.com.
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