Academic journal article International Journal of Purchasing and Materials Management

Total Cost of Ownership: Elements and Implementation

Academic journal article International Journal of Purchasing and Materials Management

Total Cost of Ownership: Elements and Implementation

Article excerpt

INTRODUCTION

For years, purchasing departments in many companies have talked about purchasing based on "total cost" rather than just price. Unfortunately, few companies have the information or the reporting systems readily available to them to support such a goal. "Total cost of ownership" (TCO) is a phrase used to describe "all costs associated with the acquisition, use, and maintenance" of a good or service.|1~

Like the total cost concept in logistics, the total cost of ownership examines the cost associated with purchased goods and services throughout the entire supply chain. Thus, TCO considers costs all the way from idea inception, as in working with a supplier to develop a new or improved part, through warranty claims associated with that part once the final product is in use by the customer.

This article provides background information about key TCO concepts. It defines TCO and, based on case studies of nine firms that use TCO approaches, it discusses the benefits of using the TCO approach. To facilitate the understanding of TCO concepts, a framework is developed that divides purchasing related costs into pretransaction, transaction, and posttransaction elements. In addition, the article describes two general approaches for implementing the TCO concept, discussing both the benefits and disadvantages of each approach.

TOTAL COST OF OWNERSHIP IS DIFFERENT FROM MOST APPROACHES

TCO differs in two important ways from most models that attempt to look at the "cost" of doing business with a supplier. First, TCO considers a broader spectrum of acquisition costs than do most cost of ownership systems. Second, TCO attempts to look at life cycle costs, which consider costs associated with using a given item from a given supplier during the entire life of the item, including costs incurred once the item is in use.

For example, for capital equipment, postpurchase costs involve everything form maintenance, repairs, downtime, and obsolescence through to the ultimate disposal of the asset. For a component or material, total cost includes failure costs of the item once in use, such as warranty claim costs, lost goodwill, replacement, and similar costs. TCO issues associated with both of these types of purchases are expanded in the following sections.

TCO BENEFITS

TCO is a relatively complex method for developing an understanding of the true cost of a purchase. Yet, the firms studied in this research all believe that the benefits of TCO outweigh the major barrier to TCO implementation and execution--namely, the lack of readily available data to support TCO operation.

Major TCO benefits cited by the firms studied are shown in Table I. For convenience in discussing these benefits, they are grouped into five categories: benefits associated with (1) performance measurement, (2) decision making, (3) communication, (4) insight/understanding, and (5) the support of continuous improvement efforts. Although a benefit may fit into more than one category, for ease of discussion each benefit is considered in light of its most important role.

The "performance measurement" category of benefits includes those that improve the quantitative measurement of supplier performance. It includes such issues as the following: TCO is a good way to evaluate suppliers; TCO provides a quantitative method for measuring the results of supplier performance improvement/quality improvement efforts; and TCO provides an excellent tool for benchmarking. In benchmarking, TCO data can be used to compare suppliers, or to track changes in a supplier's cost performance over time.

TCO also supports improved decision making. TCO forces the quantification of tradeoffs in terms of dollars. It also provides a good basis for supplier selection decisions, because it provides complete cost data on the important cost issues. Thus, TCO creates more informed decision making, in a structured, systematic way. …

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