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com/d/course/1000005766/transcript/
Preparing the Analysis for Total Cost of
Ownership (TCO)
Slide 1: Preparing the Analysis for Total Cost of Ownership
(TCO)
Slide 2: Course Overview
The goal of total cost of ownership (TCO) analysis is to develop an understanding of your true
costs of doing business so these costs can be understood as well as managed and non-value-
added costs can be reduced or eliminated. TCO does not actually require precise calculation of
all costs but instead looks at major cost issues and costs relevant to the decision at hand.
Supply managers play a critical role in any TCO analysis because they are often the people
most familiar with the many hidden costs associated with purchasing and outsourcing in their
day-to-day jobs. In addition, since purchasing professionals interact with many functional areas
within the organization, they have many opportunities for receiving feedback and gaining
insight into hidden costs.
In this course, you will explore the concept of TCO and determine how to understand and
manage hidden costs to reduce overall company expenses and enhance company value.
Slide 3: Course Objectives
After completing this course, you should be able to:
Explain the TCO concept.
Perform the prepare for analysis phase of TCO.
Build a project team based on TCO.
Slide 4: Lesson 1: Total Cost of Ownership Overview
Slide 5: Lesson Introduction
Total cost of ownership (TCO) is an analytical process for understanding all relevant supply
chain-related costs of doing business with a supplier for goods and services. TCO can be very
beneficial in improving decision making by helping you to select options that have the best
overall cost impact on the organization.
After completing this lesson, you should be able to:
Explain an overview of TCO.
Recognize TCO as it is applied to business.
Recognize when to use TCO.
Evaluate the details of TCO.
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Compare TCO to other cost management approaches.
Assess the TCO process.
Slide 6: Total Cost of Ownership
The TCO approach combines the value you want—that is, the features and functions you are
seeking—with an understanding of the true cost of what is being purchased. It does not
necessarily advocate buying whatever is cheapest. Rather, TCO encourages you to clearly
specify what you are looking for and then determine the best overall value that meets your
needs.
TCO is a process for knowing all the important supply chain-related costs of doing business
with a supplier for services and goods. TCO can improve decision making by helping managers
select options that have the best overall cost impact on the organization rather than just
providing a lower purchase price. In its broadest sense, TCO looks at the big picture by
considering many costs beyond price.
Slide 7: Total Cost of Ownership in Business
Understanding the true cost of doing business with a supplier, of making an outsourcing
decision, or of implementing a process is critical in determining whether your organization is
making the best decisions. There are many costs not accounted for in the purchase price that
can change a very good purchase price into a very bad deal overall. To make the best decision,
you need to identify and analyze these hidden costs.
When purchasing an item or service, hidden costs may include administrative costs, usage and
disposal costs, and elements of the purchase price itself. For example, hidden costs in
offshoring include longer lead times, supplier distance, and unforeseen costs. Longer lead
times can result due to a supplier being thousands of miles away, which increases the average
lead time and possibly the variation in that lead time. This can drive up inventory holding costs
and safety stock requirements.
Distant suppliers, especially when located in different cultures, require more administrative
effort to maintain relationships, and the transactions are more complex due to international
documentation regulations, as well as currency exchange. Accounting for that type of overhead
is part of TCO.
In addition, many other related unforeseen costs exist that do not occur with domestic
purchases, including import duties, taxes, employing customs house brokers and freight
forwarders, insurance coverage, and so on.
Slide 8: Total Cost of Ownership Use
A TCO analysis focuses on key hidden costs that may be overlooked in a price-oriented
analysis.
A supplier’s price generally includes the costs of a wide range of activities and components,
such as the cost of labor to perform the job and the cost of utilizing its building, utilities, and
supplies. If in doubt, always ask what is included in the price.
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What the supplier’s price will not include are incremental costs that your organization will incur
to do business with a supplier, such as the cost of travel to visit the supplier. If the supplier’s
employees require specific skills or knowledge to support your operations, such as using your
software, you may have to pay for their training cost and wages.
Slide 9: Total Cost of Ownership Use (Cont.)
You also need to ensure that the service you receive meets all your standards and provides the
value your customers expect. For example, a supplier of call center services based overseas
must meet the required selection criteria for how it will perform the service, how long customers
will have to wait on hold, the number of contacts required for problem resolution, and so on.
You should not consider a good or service that has a good TCO analysis if it does not meet all
your criteria in terms of value.
Performing a TCO analysis is a good idea whenever you are considering a significant project
that has many hidden costs, as with offshoring. In addition, performing a TCO analysis is
important when a decision has long-term implications that are difficult to reverse, as is the case
with many outsourcing and offshoring decisions.
Slide 10: Total Cost of Ownership Comparison
Introduction
How does the TCO approach compare to other cost management approaches such as price or
cost?
Price
Price is the amount that the supplier charges for a good or service. Price is one element of
TCO and is often the largest single element, but it is still only one factor. Viewing cost from a
supplier’s perspective focuses on how much it costs the supplier to produce and deliver a
product or service to the customer, including raw materials, labor, overhead, packing,
transportation, and more.
Understanding such costs is useful in a sophisticated TCO analysis and relevant when the
supplier is working with the buying organization to reduce TCO. Many buyers now can be
found helping their suppliers understand their own cost structures. Such cooperation is growing
in practice with buyers reaping substantial returns for their efforts.
Cost
A cost is the value of money used to produce something and therefore is not available for use
anymore. From a buyer’s perspective, cost is the same as TCO. Rather than buying based on
price, the buyer should have a method to determine what a purchase really costs the entire
organization, including obvious issues such as product quality, transportation, import duties,
and on-time delivery, as well as more subtle issues such as supplier responsiveness and
technical support.
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In many industries, organizations have done all they can to lower the price. To make significant
cost improvements, they need to evaluate the costs of their own processes and supply chains.
Such evaluations are the future of competitive opportunity and a primary reason that TCO is
receiving increased visibility and concern among organizations.
Slide 11: The Total Cost of Ownership Process
Introduction
TCO involves understanding all the relevant major costs associated with a purchase—a
detailed activity that needs to be broken into usable and understandable elements. For that
reason, preparing a TCO analysis can be viewed as a five-phase process: prepare for analysis,
map the process, identify relevant costs, gather data, and perform analysis.
Prepare for Analysis
In the preparation phase, the goal is to determine whether the purchase, process, or
outsourcing situation is a high potential project for analysis. You will need to perform a quick
review of whether there are significant, hidden costs that you may be able to affect. If the
project seems viable, then you will need to identify who will be on the analysis team.
Map the Process
Mapping the process involves gathering detailed information about how the item you are
purchasing is used and then drawing a picture of that process. This increases understanding
and highlights potential opportunities.
Identify Relevant Costs
Identifying relevant costs focuses on determining which costs are important and can be
influenced in the TCO project being analyzed.
Gather Data
Gathering data involves collating cost information based on history, external data, and
estimates.
Perform Analysis
The information gathered during the prepare for analysis, map the process, identify relevant
costs, and gather data phases allows you to perform the TCO analysis.
Slide 12: Check Your Understanding
Slide 13: Lesson Summary
TCO is an analytical process for understanding all relevant supply chain-related costs of doing
business with a supplier. Moreover, it can improve decision making by helping you select
options that have the best overall cost impact on the organization.
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In this lesson, you identified TCO as a useful tool that is most effective when appropriately
applied. You defined TCO, determined when it may be best applied, and discovered how it can
be broken into a five-phase process that starts with preparation and ends with performing the
actual analysis.
Slide 14: Lesson 2: Prepare for Analysis: Selecting a
Project
Slide 15: Lesson Introduction
In the prepare for analysis phase, it is critical to select a project that will result in large and
visible savings. The overall cost versus the potential savings and other benefits should always
be carefully considered.
After completing this lesson, you should be able to:
Explain the preparing for analysis phase.
Determine when to apply a TCO analysis.
Apply selection criteria.
Slide 16: Prepare for Analysis
The first phase of the TCO process is to prepare for analysis. The goal is to determine whether
the purchase, process, or outsourcing situation you are analyzing has a high potential payoff if
a TCO analysis is performed. If the savings or improvement opportunity appears significant,
you will then identify who will be on the analysis team. As a first step, perform a quick review to
determine if there are significant, hidden costs that you may be able to affect.
Slide 17: Prepare for Analysis (Cont.)
Because they are commonly aggregated into an overhead account or mixed with some other
cost factors, hidden costs often cannot be readily determined. Moreover, these costs may be
scattered among costs of goods, direct labor, indirect labor, and inventory.
For example, in offshoring, many firms consider the price paid to the supplier plus the cost of
transportation. However, they do not account for the difference in administrative overhead,
including indirect labor; duties and taxes, which in some firms may be added to the cost of the
materials; the fees paid for the various services, again often aggregated into an overhead
account; and the holding cost for inventory.
While inventory shows up as a current asset on the balance sheet, the cost of carrying it may
be especially challenging to account for because it may include:
Rented warehouse space.
Interest paid on borrowed funds or the loss of investment opportunity.
Loss or damage in handling.
An obsolescence factor.
State taxes on inventory held.
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Slide 18: When to Apply TCO Analysis
A TCO analysis is not appropriate for all purchasing situations because it can be a complex
and time-consuming process. There should be some assurance that the potential benefits
outweigh the costs. Once you have identified a potential project, assess it for its overall
potential impact.
It is critical to have a successful first project to gain support for TCO analysis. When conducting
a pilot TCO project, showing a dramatic difference between TCO and the price will
demonstrate the benefits of the analysis.
Slide 19: When to Apply TCO Analysis (Cont.)
Some characteristics make a purchase well suited for TCO analysis and an ideal candidate for
pilot or early TCO projects. These characteristics include when:
The spend is a relatively large amount of money.
An item is purchased with some degree of regularity that provides historical data and
allows opportunities to gather current cost data.
The potential exists for one or more currently unrecognized transaction costs to be
individually significant.
The opportunity exists to have an impact on transaction costs through negotiation,
changing suppliers, or improving internal operations.
Purchasers or end users will cooperate in data gathering to learn more about the item’s
cost structure.
Significant costs beyond the purchase price over the life of the purchase exist, such as
for capital acquisitions or major one-time buys.
Slide 20: Apply the Selection Criteria
In general, it is important to select a project where you have options for the supply base. This
means that multiple sources exist to choose from that might have different costs to do business
with, but that there are also suppliers who are willing to collaborate on a development initiative.
Note, however, that the issue does need to be important enough that you are willing to invest in
supplier development.
Slide 21: Check Your Understanding
Slide 22: Lesson Summary
In this lesson, you explored the first phase of the TCO process: prepare for analysis. This
phase strives to determine whether the purchase, process, or outsourcing situation you are
examining has a high potential payoff if a TCO analysis is performed. You also determined in
what situations it is best to apply TCO to a given project. Not all projects are suitable for the
TCO process, so you must determine all relevant factors when initially deciding whether to
apply TCO to a project. Finally, you gauged how to apply the selection criteria for a given
project, or how to select a process for TCO that has a broad supply base.
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Slide 23: Lesson 3: Prepare for Analysis: Building a
Project Team
Slide 24: Lesson Introduction
In TCO, it is also important to gain support for the project and the process by using a cross-
functional team that will create a thorough and balanced analysis. Your efforts will be more
successful when multiple points of view from various TCO team members can be taken into
account. With a cross-functional team, not only can different individuals be making
contributions, but they also increasingly will buy into the process as well as the overall project
itself.
After completing this lesson, you should be able to:
Secure management support.
Form a team for analysis and recognize its benefits.
Define the team members form.
Slide 25: Secure Management Support
Prior to identifying relevant TCO team members, you need to ensure your senior management
supports the TCO project that you are proposing. If you are on a TCO team, this is important
for the following reasons:
Reduce the resistance that others may have to devoting people to the TCO team. You
will have a much easier time securing the appropriate members for your team.
Support for the expenses that the TCO team might incur. For example, members of your
team might need computing resources or travel expenses, both of which may be more
readily approved when management has buy-in.
Facilitates the acquisition and use of cost information that the TCO team might need
from other parts of the company. Management sponsorship may encourage other
members of your company who are not directly involved in the project to find ways to
help you with your team’s effort.
Slide 26: Secure Management Support (Cont.)
TCO is a powerful concept, but your team also has the role of educating management to
support TCO and understand the value that it can bring to the entire company. Sometimes
management needs to understand that it is not just about getting a lower price from a supplier.
TCO also has the potential to lower many other costs, such as lower inventory, less expensive
transportation, and better results in sourcing against specifications.
It is much easier for other areas of your company to provide support if they truly understand
what the team is attempting to achieve. This will likely raise expectations, which may likely
increase the pressure for the team to produce significant results within a reasonable time
frame. Be certain to give reasonable time line and potential result estimates of what the team
might achieve. A hurried project might not produce results as expected.
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Slide 27: Form a Team for Analysis
Once you identify a promising project for analysis, the next step is to identify who to involve in
the process. This will vary depending on the project, but it is important to have a cross-
functional mix of team members to consider all major viewpoints and objections.
When you are building the team, try to enlist those individuals who may have a vested interest
in the outcome. It is often a good idea to meet with prospective team members to be certain
that they understand what you are trying to accomplish, but also that they possess the right
teaming skills to help the project progress.
At a minimum, the team should include purchasing, operations, and finance representatives.
Finance involvement increases the level of credibility of the financial results. In addition,
finance can play an instrumental role in identifying available cost data and performing analysis.
If you have identified a technical item or service, there may be clear advantages to having an
engineering representative on the team. If you are focusing on an asset with a long useful life,
do not overlook a maintenance representative. Every TCO team may have its own unique
composition, but keep asking the questions: What is in it for TCO team members? How do they
benefit by being a part of the project themselves―that is, what do they have to gain from the
experience? Will it improve their job? Will their new experience on this team improve their
overall company performance?
Slide 28: Form a Team for Analysis (Cont.)
Once you have identified which company functions need to have representation, the question
becomes one of who may be the best representative of those respective team roles. You will
need to assess individual capabilities, including:
Who may have access to the information that you initially believe that the team needs to
have?
Who has past experience with TCO and can help the team overcome some of the
inherent obstacles?
Who may readily embrace TCO as a concept as opposed to who might position
themselves as opponents?
Who has demonstrated prior experience to effectively participate in a team-based effort?
Slide 29: The Team Members Form
The project’s initiator should complete a TCO team members form prior to the first meeting to
determine who should be on the analysis team. The form should be shared with the team at the
first meeting to:
Clarify expectations.
Clarify roles and responsibilities.
Adjust the team membership, as some members may decide to leave while others may
join.
The team members form should include:
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Team members’ names and the company areas that they represent.
Team members’ expectations and expertise.
How members’ involvement benefits the TCO team.
How members’ involvement benefits their jobs.
In practice, the team may be formed prior to, simultaneously, or after the TCO analysis
opportunity is identified. However, if the team forms prior to the selection of opportunities, it
might be necessary to reassess membership to ensure the right people are included to support
the selected project.
Slide 30: Check Your Understanding
Slide 31: Lesson Summary
In this lesson, you investigated how to prepare for analysis by building a strong project team.
You identified the importance of gaining management’s support for the TCO project, especially
when it comes to staffing the team, supporting its efforts, and achieving managements’
understanding of the benefits that TCO can provide.
Broad organizational support for the project can be achieved by forming a cross-functional
team that includes purchasing, operations, and finance representatives. In this lesson, you
were also exposed to a team members form, which demonstrated the strengths and
weaknesses of selecting the correct individuals to staff your project team. Having a project
team with the appropriate makeup can help build a thorough and balanced analysis, as well as
build support for both the project and the process. A good team forms the foundation for a
successful TCO project.
Slide 32: Course Summary
In this course, you explored the concept of TCO, and you determined how to understand and
manage hidden costs to reduce overall company expenses and enhance company value. TCO
can be very beneficial in improving decision making by helping you to select options that have
the best overall cost impact on the organization.
In addition, you were introduced to TCO analysis using a five-phase process: prepare for
analysis, map the process, identify relevant costs, gather data, and perform analysis. You were
provided with a detailed explanation of the first phase of the entire TCO Process—prepare for
analysis.
You also evaluated how to select a project, the importance of obtaining management support,
and how to select the correct team that will enhance the effectiveness of the project. You
discovered that a project can be selected by preparing for analysis, but also that project teams
can be appropriately constructed by the use of a screening tool known as a team members
form.
TCO analysis presents an opportunity for organizations to improve if they carefully choose the
right projects, engage the right people, and follow the five-phase approach.
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