Part 1: A Closer
Look at TCO and
David Daffner, Vice President
In a previous blog article on procurement best practices, we briefly touched on Total Cost of Ownership (TCO) and best value. Now let’s take a closer look at these two important concepts and their impact on procurement and the supply chain. In part one, we’ll focus on Total Cost of Ownership.
Most people have made a significant purchase at some point in their lives, like a car or a home. Whether you knew it or not, you likely applied some aspect of TCO analysis when making that decision. For example, you may have first considered purchasing a used vehicle instead of a new one or renting before buying a home.
Cost is a primary concern in any purchase but TCO looks at the complete lifecycle of the purchase — taking every phase of ownership into consideration, not just the price tag. In fact, when purchasing equipment, it’s been said the initial cost represents less than 10 percent of the total cost over its lifetime
Three key components of TCO
The Purchasing & Procurement Center offers a simple definition of TCO: the difference between the purchase price and long-term cost. They also break down three key components:
- Acquisition costs — cost of equipment or property
- Operating costs — cost of utilities, labor and training
- Personnel cost — cost of administrative staff, equipment support and operators
Acquisition costs are often called short-term costs because they represent only the initial purchase price, not all of the long-term costs associated with the item. Those must be part of the analysis when considering alternatives in capital investments and projects, such as technology, buildings, manufacturing equipment and vehicles. TCO is a cost-benefit analysis, as defined by Julia Kagan on Investopedia, or a calculation designed to help people make more informed financial decisions.
Uncovering hidden costs
Perhaps the strongest benefit of applying the TCO concept is uncovering potential hidden costs. These are all the expenses associated with the purchase, operation and/or use of the item, including disposal if applicable. TCO often changes over time too, so it’s important to research areas such as:
- Financing — how accounting will treat deductions, capitalized expenses and depreciation
- Installation — deployment and potential reconfiguration needed
- Labor — training (negative) and greater efficiencies (positive)
- Operation — energy, fuel and service
- Repair and maintenance — estimated based on usage
- Environmental impact — waste disposal, clean up and pollution control
- Security — physical and electronic
One final thought about TCO: Keep in mind that after completing your analysis, the decision may be not to make the purchase at all. Be sure to fully consider the potential business benefits too, which leads us to the second part of this discussion where we examine getting the best value, which is much more than simply the lowest price.