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A series of articles on the world of procurement from the Insider Procurement consultancy team.

Procurement consultancy - how to model total cost of ownership

Posted by Jeremy Bowley
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Procurement has, for a long time, acknowledged the need to look at reducing the total cost of ownership. We found this reference from 1995, but I am sure this is a topic that has been raging for decades.

Lisa M Ellram, (1995) "Total cost of ownership: an analysis approach for purchasing",International Journal of Physical Distribution & Logistics Management, Vol. 25 Issue: 8, pp.4-23

Put simply, using total cost of ownership (TCO) is a much more effective way to drive down business costs than simply focusing on price.

Surprisingly, however, not everyone agrees on how to model TCO for a business.

It is very common to define different models for each of the following areas of the business:

  • the items that are boughtBusinessman holding ball of money in hand
  • the goods that are sold
  • the capital equipment used

In each case, the a comprehensive total cost of ownership model should include some or all of the following costs:

  • shipping
  • installation, maintenance, warranty, upgrades, spares
  • training, operating
  • packaging, handling, storage
  • spoilage, waste processing, environmental, security
  • end of life processing, disposal
  • tariffs, duties, taxes, exchange rates, interest rates
  • licenses, audits and quality assurance inspections
  • risk, quality
  • ....and more.

Over the years, we have developed our own very comprehensive TCO models that short-cuts the thinking time for measuring real TCO.

In fact it's easy to produce TCO models for THINGS - for assets, stock items, non-stock items etc.

But, here at Insider Procurement, (using our disruptive procurement thinking) we find far greater savings by reviewing not simply the TCO at the physical object level....but looking more holistically at the process that object is involved in or its required function.

In short, we recommend focusing on reducing the TCO of business processes not just the physical components.

Let me explain:

If you reduce the total cost of ownership for a piece of equipment, you'll probably deserve a pat on the back (at least!). But what if you took a further step back and looked at the function of that piece of equipment and determined a better way?

That piece of cutting equipment that is rarely used, but now needs replacing?

Instead of investing in all the costs associated with replacing that item (risk assessments, training staff etc), would it be possible to get a service from elsewhere at a lower total cost?

  • Could the supplier of the raw material pre-cut the items for you?
  • Or is there a local company that could do this on an as-needed basis?
  • How would that service compare with the lifetime cost of the machine?

This isn't as simple as it looks, of course!

On the upside, consider things like:

  • What could you do with the extra space created by removing the machine from your business premises?
  • Could the service you buy actually improve quality and reduce wastage?

On the other hand, think hard about the potential negatives:

  • Are you introducing another risk and/or delay into the supply chain by outsourcing this part of the process? How could you mitigate that?
  • Is there some Intellectual Property (IP) in the items that are cut that you would not want to share outside your business?

Here at Insider Procurement - a UK-based procurement consultancy - we look at the TCO of the function that the asset performs, or the process it's involved in, not simply the TCO of the asset.

Food for thought?

Contact us for a free initial consultancy to identify the key areas for cost savings in your business.

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Topics: Best Practice, Procurement Consultancy