Total cost of ownership models: an exploratory study

Transcription

1 pag.: 1 van 17 Total cost of ownership models: an exploratory study Bron: The Journal of Supply Chain Management, summer 2002 Auteur(s): B.G. Ferrin & R.E. Plank Summary This research examines organizational purchasing models focusing on the use of total cost of ownership (TCO) to value purchase opportunities. The research presents evidence that leadingedge companies actually use such models. This exploratory study provides, for the first time, data on the nature, and use, of the cost drivers on which organizations base their TCO computations. The study suggests a generic model of total cost of ownership is not appropriate. However, the findings of this research suggest a TCO model based on a core set of cost drivers, along with an auxiliary set of cost drivers, is appropriate. The core cost drivers would be present in all, or most, TCO computations. Purchasing managers could use different, specific cost drivers from the auxiliary set to tailor the TCO computation for a particular purchase situation. The authors also suggest that a value-bases, multi-firm, or supply chain, TCO computation model is needed. Such a TCO model should be similar to a single-firm TCO model. Introduction The concepts of total cost (Cavinato 1991, 1992), life cycle costing (Jackson and Ostrom 1980), product life cycle costs (Shields and Young 1991), and total cost of ownership (Ellram and Siferd 1993, 1998; Ellram 1993, 1994, 1995) are all related. These concepts all suggest that supply managers adopt a long-term perspective, not a short-term, initial-price perspective, for the accurate valuation of buying situations. Three ideas support all of these procurement valuation constructs. First, cost must be examined from a long-term perspective and should include elements other than initial purchase price. Second, supply managers must consider the impact of other business functions on the valuation of a specific purchase. Finally, to value a purchase situation accurately, a supply manager must understand, and measure, the cost impact of all the activities associated with the purchase. Ellram and Siferd (1993), in quoting the importance of considering cost beyond initial purchase price, suggested purchasing management books dating from 1928 have expressed this notion. Further, Cavinato (1992) suggested that firms in the 1940s first implemented interfunctional total cost analysis as they sought to understand the cost influence of one logistics function on another, transportation and inventory, for example. Ellram and Siferd (1993) proposed the concept of total cost of ownership (TCO) as an integrating concept. They defined TCO from the perspective of the flow of activities related to the purchase of a good or service and the costs associated with those activities. The purpose of this article is to report on a study that examines the nature of total cost of ownership. While still an exploratory study, in the sense that no hypotheses are tested, this research presents purchasing managers updated perceptions of the nature of total cost of ownership and its usage in practice. Further, the research examines the issue of the nature of TCO models and whether it is feasible to have a single TCO model for a firm or whether multiple TCO models are required for specific firms. The research generated, and categorized, a wide range of TCO cost drivers that supply managers currently use in TCO evaluations.

2 pag.: 2 van 17 The article begins with a literature review of total cost of ownership and related constructs. The study procedure is described, findings are reported in detail, and their significance for practicing supply managers is discussed. Finally, the limitations of the study are outlined. Literature review As shown above, the total cost concept is not new. However, as Milligan (1999) noted, accurate total cost measurement is elusive, because most organizations either don t understand the calculations or don t have, or won t share, the data necessary for such calculations. Meckbach (1998) reported that although information technology managers are aware that the annual cost of administering a (personal computer) can exceed its purchase price... total cost of ownership (TCO) is not a major factor in purchasing decisions... Meckbach s source attributed this to the fact that TCO is hard to measure and, to date: TCO estimates (for personal computers) often fail to account for factors such as user productivity, business benefits, and user satisfaction. Avery (1999) provided a different, more philosophical reason for the emphasis on price in supply management: she suggested that many companies concentrate on direct costs, mostly purchase price, because they feel indirect costs will decline as direct costs decline. However, Avery noted some organizations have successfully reduced total costs using project teams focused specifically on total overall cost reductions, including indirect costs. In other words, she suggested that indirect costs will not fall by themselves, or because of reduced direct costs, but because of management s focus on controlling indirect costs. Academic research defines several cost concepts incorporating both direct and indirect costs, including total cost (Cavinato 1991), total cost of ownership (Ellram 1993), product life cycle costs (Shields and Young 1991), or life cycle costing (Jackson and Ostrom 1980). However, whatever the name given the total overall cost concept, all of this research stresses the need for management to concentrate on reducing indirect costs by design. Ellram (1995) was very explicit: she stated clearly that effective implementation of total cost of ownership modeling depends heavily on the use of activity-based costing methodologies. Porter (1993) made basically the same argument, explicitly suggesting the need to focus on cost drivers and activity-based management systems. Tyndall (1988) also provided examples of total cost measurement, concentrating on logistics cost management in the distribution chain. Bennett (1996) offered a similar case study model using activity-based management concepts to measure and reduce overall costs. Finally, according to Ersten (1998), a market exists for TCO software systems. Ersten noted that several firms serve this market with software and systems for either purchasing or other corporate functions, such as information technology. Ellram (1993, 1994, 1995) and Ellram and Siferd (1993, 1998) conducted the primary research examining TCO. Their work defined the components of TCO in two ways. Ellram and Siferd (1993) suggested six categories: quality, management, delivery, service, communications, and price. However, this categorization examines only those purchasing activities that contribute directly to total cost of ownership (TCO). Ellram and Siferd did look at both formal activities and support activities, also suggesting some cost drivers for these activities.

3 pag.: 3 van 17 Ellram (1993) suggested a transaction-sequence cost component structure, involving pre-transaction cost components, transaction cost components, and post transaction cost components. This typology is more general and considers direct and indirect costs. Pre-transaction cost components include costs related to activities such as identifying a need and investigating a source. Transaction cost components include price, delivery, tariffs, inspection, etc. Post-transaction cost components include cost categories such as field quality problems and cost of repair parts. According to Tibben-Lembke (1998), posttransaction costs include reverse logistics. However, there is limited empirical research on the use of total cost of ownership modeling in supply management. Ellram and Siferd (1993) provided some empirical evidence: 18 percent of their sample of 103 purchasing personnel reported the use of a formal TCO system, whereas 25 percent reported no TCO use, with the remaining 58 percent reporting an informal approach to TCO. Ellram s 1994 research extended the definition of TCO models. She noted two basic models: the standard model, generally in writing and repetitively applied to a variety of purchasing situations; and the unique model, developed for a specific item or purchase situation. Ellram used a small set of in-depth interviews to collect data. She found evidence of both types of models and provided examples. She noted that effective use of TCO is difficult and found no standard implementation procedure. Ellram and Siferd (1998) also conducted case-based research focusing on 11 companies in 10 industries. They found TCO helped in supplier selection, communication, ongoing supplier management, continuous improvement initiatives, and creating organizational understanding of indirect costs. In addition, Ellram and Siferd reported most firms that use TCO modeling focus on important buying activities. However, they found each firm seems to have its own definition for an important buying activity. Ellram and Siferd reported several reasons more firms don t use TCO. Their list includes complexity of TCO measurement, organizational culture, and arguments regarding the relevance and proper use of TCO data. The research by Ellram and Ellram and Siferd suggests TCO is a little used concept. However, their findings suggest that when firms use TCO modeling, it may be through either formal or informal mechanisms. Further, Ellram and Siferd s research suggests significant barriers to the use of TCO modeling, including the nature of a firm s costing system and data reporting. Other authors have also examined total cost of ownership or related concepts. Cavinato (1991, 1992) used the total cost concept to examine cost structures across the supply chain. He examined such cost indicators as labor rate, process effectiveness, capital cost, tax rates, and depredation. Cavinato suggested comparing supply chain entities based on these cost indicators can provide a basis for assigning specific supply chain processes. He argued that firms can reduce their total supply chain costs by assigning specific supply chain processes to those firms in the supply chain whose cost structures are optimally configured to support the assigned processes.

4 pag.: 4 van 17 Jackson and Ostrom (1980) did an early empirical study of life cycle costing. In the early 1960s, the Deportment of Defense developed life cycle costing to improve its procurement processes (Shields and Young 1991). Jackson and Ostrom indicated 25 percent of their 107 respondents used life cycle costing. This is similar to ElIram and Siferd s 1993 finding that 18 percent of their sample used formal systems for measuring total cost of ownership. The similarity in these results from two projects conducted 13 years apart suggests the field of supply management has made little progress in addressing the impact of indirect costs on sourcing decisions. Degraeve and Roodhooft (1999b) provided a case study illustration of the application of total cost of ownership to supplier selection. They divided purchasing activities into three hierarchical levels. A firm performs supplier level activities, e.g., a quality audit, only if it uses a specific supplier. A firm performs ordering-level activities, e.g., receiving, invoicing, transportation, each time it places an order. A firm performs unit-level activities, e.g., a production shutdown due to defects in purchased materials, based on the attributes of the specific items received in a specific order. Using this activity hierarchy, Degraeve and Roodhooft developed a mathematical programming optimization model to select suppliers based on total cost of ownership minimization. To test the model, they applied it to supplier selection decisions for heating elements and ball bearings faced by a large multinational Belgian steel producer with annual purchases of over $1.5 billion. Degraeve and Roodhooft reported expected cost savings of 8 percent for heating elements and more than 10 percent for ball bearings. Geiger (1999) discussed the challenges of selecting appropriate cost drivers for cost management systems. He defined a cost driver as...another measure that is used to proportionally distribute the cost of activities to cost objects. Geiger stated in any situation, typically there are many possible choices of cost drivers. Each potential cost driver may differ from others in how it distributes (or assigns) costs; the cost measurements it requires; the cost to make the measurements; and how it will effect managers behavioral response to the cost management system. Geiger explained cost driver selection can generate powerful managerial responses to reduce drivers because they appear to be causing the cost on which the firm evaluates managers. In other words, effective selection of cost drivers can focus management attention on the process attributes that create cost. Geiger also reported effective cost drivers must be measurable, with reasonable measurement costs. In summary, the TCO concept, and the very similar concept of life cycle costing, has been discussed, and examined empirically, in the literature, but with limited scope. The scholarly literature on total cost of ownership consists mostly of case study and anecdotal data. In particular, little empirical research has been done on the cost drivers organizations use for TCO modeling. Cavinato (1991, 1992) suggested a supply chain, or value chain, approach to total cost of ownership measurement; currently, little research exists on this approach. The purpose of this research is to provide empirical data on this complex topic. Although the investigation focuses on individual films, not supply chains, the study devotes some attention to supply chain implications. Some data on TCO usage were collected. However, the main focus of the study was to examine the complexity of TCO modeling. The research design focused on three issues; whether standard models are feasible or specialized models are required, development of more specific information on cost drivers, and development of an improved taxonomy for cost drivers.

5 pag.: 5 van 17 The study A questionnaire was developed to examine supply managers perspectives on total cost of ownership; a single-wave mail survey was used to elicit responses. The questionnaire was mailed to members of the Institute for Supply Management (ISM) (formerly the National Association of Purchasing Management (NAPM)). The data collection instrument included questions on the valuation logic supply managers use to assess specific purchases and on the use of total cost of ownership as a value mechanism. One hundred forty-six respondents, of the 990 who received the survey, returned the questionnaire, representing a 15 percent response rate. Of these respondents, 122, or 84 percent, reported manufacturing as their primary business. The remainder of the respondents represent a variety of service businesses and government agencies. Forty-two percent of the sample reported total annual revenue between $ 35 million and $ 10 billion. Forty-five percent of the sample reported annual purchase volume between $ 10 million and $ 250 million. Sixty percent of the sample reported total employment in their firm or division between 100 and 5,000. Forty-nine percent of the sample reported total purchasing employment between two and 10. Table I provides the demographics of the sample. Clearly, the sample of respondents is concentrated on medium-sized, manufacturing organizations with limited purchasing management staffing. Also, the response rate of 15 percent is moderate at best. Non-response bias was ascertained using a procedure suggested by Armstrong and Overton (1977). Using the variables total employment and total revenue, there were no statistically significant differences between first and fourthquartile respondent means. This suggests limited or very low non-response bias. Table I: respondent demographics A. Purchase volume Purchase volume Respondent frequency Percentage of respondents Under $ 1 million $ 1 million to $ 9.99 million $ 10 million to $ million $ 50 million to $ million $ 250 million to $ million $ 1 billion and over TOTAL 126 (18 missing) Purchase employment Number purchasing employees Respondent frequency Percentage of respondents Over TOTAL 143 (3 missing) 100.0

6 pag.: 6 van 17 Total revenue Company revenue Respondent frequency Percentage of respondents Under $ 5 million $ 5 million to $ million $ 100 million to $ million $ 1 billion to $ 9.99 billion $ 10 billion and over TOTAL 95 (51 missing) Total employment Company revenue Respondent frequency Percentage of respondents Under to ,000 to 4, ,000 to 9, ,000 to 24, ,000 and over TOTAL 145 (1 missing) Data collection instrument The questionnaire asked respondents to answer a number of open-and closed-ended questions. The survey form defined TCO as follows: We take a total overall cost, or total cost of ownership, approach (sometimes referred to as value in use) to valuing the purchase. In other words, we examine all the direct and indirect costs over the life of the product/service. This operational definition of total cost of ownership was used in the questionnaire to provide, for measurement purposes, a fundamental and explicit way for respondents to think about TCO without introducing all the technical nuances presented in the literature. The term value in use was included since it has been used in the marketing literature and there is a possibility this terminology would be familiar to some of the sample. The questionnaire first asked respondents to report the percentage of their firm s expenditures on purchased goods and services based on what the respondent considers a total cost of ownership valuation model. In addition, the survey asked respondents to check off the categories of goods and services their firm purchases for which there are examples of TCO valuation. In its second section, the questionnaire asked respondents to evaluate their firm s or division s overall efforts concerning TCO purchasing. In answering this question, respondents used a one (very poor) to five (excellent) scale. The survey asked respondents to use this same scale to assess their firm s or division s success in identifying key TCO cost drivers. The questionnaire asked respondents to think about one or more purchase situations with which they were familiar that use TCO. Based on their recollection, respondents listed or described the key cost drivers used. This was an open-ended question; respondents used their own words to describe one or more cost drivers their firm uses in a TCO model.

7 pag.: 7 van 17 Following the open-ended question, the survey asked respondents two questions on cost drivers and TCO modeling. The first question asked if they thought specific TCO drivers vary from commodity to commodity using a one (no variation) to five (high variation) scale. The second question asked respondents whether if they were to design a TCO model for their purchasing responsibilities, they would create one model for multiple models. The questionnaire s next section focused on the issue of standard versus multiple TCO models. Specifically, the survey asked respondents to assess this statement: There is a core set of cost drivers that apply to every commodity or commodity category. If this statement is true, a company could have multiple TCO models for different commodities, but every TCO model would include some of the same cost drivers. Based on the TCO experiences of your firm or division, do you think this is an accurate description of the nature of cost drivers and TCO in your firm or division? So respondents could indicate their agreement with this statement, the question included a one (definitely yes) to five (definitely no) scale. The survey included a second item dealing with standard versus multiple TCO models. The instrument again, provided a one (definitely yes) to five (definitely no) scale for respondents to use to show their opinion with this statement: There are cost drivers (other than those in [the previous question]) that apply only to specific commodities or commodity categories. If this statement is true, a company could develop a modular TCO model in which, for different commodities or commodity categories, specific cost drivers could be connected or disconnected as required. Based on the TCO experiences of your firm or division, do you think this is an accurate description of the nature of cost drivers and TCO models in your firm? Finally, the questionnaire asked respondents to consider the involvement of other functions in the development and ongoing use of TCO. Respondents could, using a zero (no involvement) to five (heavy involvement) scale, indicate the involvement, in TCO modeling and cost management, of Purchasing, Design Engineering, Manufacturing, Marketing, Accounting, Information Technology, and Logistics. Results Thirteen of the survey s items required respondents to provide numerical answers or use a numerical scale. Table II provides summary statistics for these responses.

8 pag.: 8 van 17 Issue Percent of purchases made under TCO valuation Rate firm s overall efforts in TCO purchasing Rate firm s efforts at identifying key cost drivers Do the specific cost drivers your firm uses vary from commodity or commodity category? Is there a set of core cost drivers that apply to every commodity or commodity categories? Are there cost drivers that apply only to specific commodities or commodity categories? In your firm, is purchasing involved in the development and ongoing use to TCO? In your firm, is design engineering involved in the development and ongoing use of TCO? In your firm, is manufacturing involved in the development and ongoing use of TCO? In your firm, is marketing involved in the development and ongoing use of TCO? In your firm, is accounting involved in the development and ongoing use of TCO? In your firm, is information involved in the development and ongoing use of TCO? In your firm, is logistics involved in the development and ongoing use of TCO? Valid responses Table II : summary statistics for survey items Response range Mean range (%) σ of responses (%) to to to to to to to to to to to to to

9 pag.: 9 van 17 TCO Usage One hundred thirty-seven of the 146 respondents answered question 1, on the percentage of purchases made with total cost of ownership valuation. As shown by the standard deviation provided in Table II, there was wide variation in the responses to this item. Table III shows the range of responses to this item. Table III: percent of purchases under TCO Percent of purchases Number of responses % of responses <5% % - 20% % - 40% % - 60% % - 80% % - 100% TOTAL 137 (9 missing) Table III suggests most respondents firms do same TCO valuation. Further, these results indicate same firms extensively use TCO concepts in supply management. TCO light vs. heavy users Data on TCO usage were examined further to compare characteristics of respondents reporting minimal use of TCO to respondents reporting extensive use of TCO. A frequency analysis of responses to TCO usage was performed. Responses were divided approximately into equal thirds and categorized as high, medium, or law TCO. Forty-eight respondents reported less than 15 percent of purchases under TCO and were categorized as minimal users of TCO. Fifty respondents reported 15 to 49 percent of purchases under TCO and were categorized as moderate users of TCO. Fifty respondents reported more than 50 percent of their purchases under TCO and were categorized as extensive users of TCO. Nine surveys did not respond to the question on TCO usage. Using cross-tabulation and chi-square analysis, the three groups were examined by product type (capital goods, packaging, raw materials, services, subassemblies, MRO, manufactured parts, other). Statistically significant differences in products/services acquired under TCO valuation were identified across the three usage categories for three types of items: subassemblies (π 2 = 9.246, p # 0.01), manufactured parts (π 2 = , p # 0.000), and MRO items (π 2 = 9.732, p # 0.008). For all three of these items, respondents reporting low usage of TCO were much less apt to use TCO for the specified product type. For example, none of the low TCO users reported using TCO for valuation in the purchase of subassemblies, manufactured parts, and MRO items. However, 30 percent of the extensive TCO users reported using TCO valuation for the purchase of subassemblies, manufactured parts, and MRO, while 28 percent of moderate TCO users reported using TCO valuation for the purchase of subassemblies, manufactured parts, and MRO items. Conversely, 55 percent of respondents reporting minimal TCO usage reported using TCO valuation for the purchase of capital goods, while 57 percent of extensive users of TCO and 62 percent of moderate TCO users reported using TCO valuation for the purchase of capital goods. For the purchase of services, similar percentages of minimal, moderate, and extensive users of TCO all reported the use of TCO valuation.

10 pag.: 10 van 17 This finding suggests that in employing TCO valuation logic, purchasing managers are likely to first apply it to nonroutine purchases, such as capital goods. The use of TCO valuation logic for routine purchases such as MRO items, subassemblies, and manufactured parts comes, if at all, much later. Items or services purchased under TCO valuation A total of 116 respondents answered question 2 by indicating the types of items, including services, purchased under TCO valuation logic. Table IV shows the range of responses to this item. Many respondents indicated more than one category. The other category included such purchases as paper/forms, fleet, animal tissue, specialty manufactured products and chemicals, prototypes for R&D, finished goods (OEM), laboratory supplies and computer equipment and software. The demographic profile of the sample accounts for purchase categories such as capital goods, raw materials and manufactured parts reported most frequently as items purchased with TCO valuation. Table IV: Type of Products/Services Purchased under TCO Valuation Type of Good/Service Number of Responses % of Responses Capital goods Raw materials Subassemblies Manufactured parts Packaging Services MRO Other TOTAL 247 (18 missing) Respondents ratings of their firm s or division s efforts in TCO implementation One hundred fifteen of the 146 respondents gave their overall rating of their firm s or division s efforts in the area of TCO purchasing. As indicated in Table II, the standard deviation of responses to this item was low. Table V shows the range of responses to this item. Table V: respondents ratings of their firm s or division s overall efforts in TCO purchasing Respondent rating Number of responses % of responses Excellent Good Average Somewhat poor Very Poor TOTAL 115 (31 missing) These results suggest that while a few firms believe they are successful in applying TCO valuation to strategic sourcing, many firms believe they are struggling in their attempts to use TCO valuation logic in supply management, or at best doing an average job.

11 pag.: 11 van 17 TCO cost drivers As described above, the data collection instrument included three questions dealing with TCO cost drivers. One hundred fifteen respondents rated their firm s or division s identification of its key TCO cost drivers. Table VI provides the range of responses to this item. Table VI: how well did your firm or division identify its key to cost drivers? Respondent rating Number of responses % of responses Excellent Good Average Somewhat poor Very Poor TOTAL 115 (31 missing) These results suggest, given the challenging nature of TCO cost driver identification, firms are unsure of their ability to effectively identify the critical cost drivers for estimating total cost of ownership. This finding is consistent with results from similar questions raised in connection with activity-based costing (Cokins 1996; Innes and MitcheII 1998). One hundred fifteen respondents answered the survey s question on variation in the specific TCO cost drivers their firms use for TCO valuation of different commodities. As indicated in Table II, the standard deviation of responses to this item was somewhat large. Table VII gives the range of responses to this item. Table VII: do the specific TCO drivers your firm uses vary from commodity to commodity? Respondent rating Number of responses % of responses High variation Major variation Moderate variation Minor variation Slight variation No variation TOTAL 115 (31 missing) These results support existing conceptual research in total cost of ownership. The literature clearly suggests the need for different cost drivers to accurately estimate total cost of ownership for different commodities (Ellram 1994; Degraeve and Roodhooft 1999a). Cost driver categories The third TCO cost driver question was an open-ended question asking respondents to think about a TCO purchasing situation and identify and describe the key cost drivers. A total of 73 responses generated a list totaling 237 cost drivers, with individual respondents providing between one and six cost drivers.

12 pag.: 12 van 17 In an attempt to categorize these cost drivers, content analysis was performed. Based on the 237 cost drivers respondents listed, the authors created 13 cost driver categories. The 13 categories are the authors best estimation of the relationships between the 237 cost drivers respondents identified. One can think of this categorization process as much like naming factors in an exploratory factor analysis. Duplicate elimination reduced to 135 the cost drivers the respondents named. Table VIII lists these 135 cost drivers, separated into 13 categories. Operations cost The authors categorized 12 cost drivers as Operations Cost drivers. In the Operations category, most respondents mentioned cost, speed, or both. Quality. The authors categorized 14 cost drivers as Quality cost drivers, which typically relate to the consequences of poor quality. At least one respondent mentioned a Quality cost driver, customer downtime, related directly to quality s impact on the customer and their operation. Customer-related Three cost drivers were categorized as Customer-related cost drivers, which refer to user satisfaction, customer perceptions, and customer specifications. Obviously, these need to be measured from the customers point of view and represent respondents from organizations with very customer-focused strategies. Logistics There are 17 Logistics category cost drivers, covering almost the entire logistical process, including freight (service quality, costs, rate stability), packaging, materials handling, warehousing, tariffs and duties, availability and logistics customer service. Technological advantage The authors categorized seven respondent-specified cost drivers as Technological advantage cost drivers. These seven cost drivers all involve the ability of technology to affect the buyer s cost structure. Some of the Technological advantage cost drivers relate to the supplier s ability to deal with changing technology. Initial price Four respondent-specified cost drivers were categorized as Initial price cost drivers. One respondent identified long-term price stability as a key TCO cost driver. In this context, long-term price stability probably refers to a supplier s ability to maintain an initial quoted price over a longer time period. Opportunity cost The authors put two respondent supplied cost drivers in an Opportunity cost category: the cost of money, for obvious reasons, and overhead. One can only assume a respondent reported overhead as a cost driver because of the limiting effect increasing overhead can have on resource availability for other activities. Supplier reliability and capability The authors put 11 respondent-reported cost drivers in a Supplier reliability and capability category. Such cost drivers obviously include attributes like trust, partnering costs, and teaming costs; however, respondents often reported factors such as familiarity, suppliers ability to grow, supplier service, R&D capability, and payment terms. Maintenance Twelve respondent-reported cost drivers were categorized as Maintenance cost drivers, related to the presentation of the assets required for operation.

13 pag.: 13 van 17 Inventory cost Inventory cost normally falls in the Logistics category. However, with five respondents all mentioning different inventory attributes, the authors established a separate category. Four of the inventory related cost drivers are routine, post-transaction inventory issues. Interestingly, one respondent reported as a cost driver a supplier s influence on the customer s ability to design or procure an item in a way that permits the buyer to meet inventory reduction objectives. Transaction cost The Transaction cost category of cost drivers relates to the costs involved in the actual procurement. As shown in Table III, respondents identified a broad range of transactionrelated costs as cost drivers for TCO valuation. The authors put six of the respondentsupplied cost drivers in a Transaction cost category. Life cycle Life cycle costs suggest a longer-term orientation in supply management. Many respondents suggested they used life cycle costing procedures to examine cost over time. Whatever terminology the respondent used - life of the product, cost savings over the life of the product, or life cycle stability - the issue is the same: computing costs over time. The authors categorized nine respondent-supplied cost drivers as Life cycle cost drivers. Miscellaneous Thirty-two of the 135 respondent specified cost drivers did not seem to fit any of the other 12 established categories. Therefore, the authors created a Miscellaneous category. These Miscellaneous cost drivers provide considerable support for the argument that there will be situations in which accurate TCO estimation will depend on the identification of unique cost drivers. For example, disposal costs are relevant only for items that require disposal. Further, environmental issues are less important in many procurement situations, but more important in others. Total Cost of Ownership models Multiple models needed As described above, the data collection instrument included three questions on developing models to estimate total cost of ownership. One hundred fourteen respondents answered the question on the need for multiple models to accurately assess TCO for a variety of commodities. Ninety-six respondents, or 65.8 percent of the sample, believed multiple models are necessary to accurately estimate total cost of ownership for a variety of commodities or commodity categories. A total of 12.3 percent of the sample agreed it s possible to derive a general TCO model that applies to all commodities or commodity categories. As expected, most of the cost drivers identified by respondents are quantifiable attributes. In fact, entire categories of cost drivers (see Table VIII) are given over to indirect costs associated with supplier relationships and performance. However, respondents identified a number of qualitative drivers of total cost of ownership. In the Technological advantage category of cost drivers, respondents identified as cost drivers such difficult-to-measure attributes as suitability for intended use, flexibility for new use, changing technology, long-term advantage and supplier ability to change technology. In the Supplier reliability and capability category of cost drivers, respondents identified as cost drivers such qualitative attributes as trust, supplier capabilities, supplier R&D capability, supplier ability to grow, supplier support, and familiarity with supplier.

14 pag.: 14 van 17 Clearly, this suggests that effective implementation of TCO valuation requires procurement managers to look beyond transaction costs and operating costs in their efforts to identify appropriate cost drivers. In implementing TCO supply managers must be prepared to consider the behavioral aspects of supply chain process performance. Table VIII: categorization of identified total cost of ownership cost drivers Operations Cost Quality Logistics Technological Advantage Manufacturing Durability Freight Design Obsolescence Machine Efficiency Replacement Packaging Suitability for Intended Production to Field Failure Customer Service Use Schedule Customer Downtime Customer Downtime Flexibility for New Use Labor Savings Inspection Handling Technology Assembly Cost Cost of Quality Instability in Freight Changing Technology Operating Supplies Calibration Cost Rates Long-Term Advantage Long-Term Operating Rework Outbound Cost Supplier Ability to Costs Scrap Tariffs Change Technology Capacity Utilization Customer returns Lead-time Increase in Production Rejection cost On-time Delivery Supplier Reliability and Output Quality Improvement Supplier-Managed Capability Equipment Speed Unplanned Downtime Inventory Partnering Costs Cost in Use Out-of-Service Costs Time to Schedule Team Costs Line Speed Warehousing Trust Duties Supplier Capabilities Area of the Country Payment Terms Customer Must Order Supplier R&D Capability From Supplier ability to Grow Import Fees Supplier Support Entry and Harbor Service by Supplier Maintenance Fees Stocking at Supplier (Quantity Availability) Familiarity Maintenance Inventory Cost Life Cycle Initial Price Supplies Safety Stock Long-Term Usage Unit cost Training Design/Procurement Projected Life Cycle Initial Purchase Price Downtime for Inventory Reduction Life of Product Long-Term Price Stability Costs Storage Life Cycle Stability Initial Capital Expenditure Labor Perish ability Cost Savings over life of Repair Costs Turnover Product Customer-Related Parts Useful life User Satisfaction Spare Parts Transaction Cost Redesign Cost Customer Perceptions Long-Term Maintenance Administration of Post- Life Cycle Obsolescence Customer Specifications Costs Purchase Agreements Repair Frequency Ease of Transaction Opportunity Cost Preventive Maintenance Supplier Conversion Cost Cost of money Schedule (Cost to Change Overhead Supplier) Small Orders Procurement Transactional Activity Long-Term Saving Miscellaneous Salary, Benefits Installation Direct Labor Taxes Indirect Labor Ease of Operation total Installed Price Value Chain Product Use Noise Level Lease Rate Factors Warranty Depreciation Technical Support Flexibility of the Supplier Product Design Lease or Buy Validation/Registration Tooling and Fixtures Availability form a Supplier Cost Drivers Cost Environmental Issues Supplier (from Requisition to Overall Competition Disposal Cost Receipt) Service Costs Liability and Safety Disposal Value Indemnification Support Costs Currency Exchange Obsolescence Cost Utility Costs Rates

15 pag.: 15 van 17 Core drivers One hundred fourteen respondents answered the survey item on the existence of a core set of cost drivers that could be applied in every TCO model for any commodity or commodity category. Table IX provides the range of responses to this item. Table IX: Core set of drivers that apply to every commodity or commodity category Respondent opinion Number of responses % of responses Definitely yes Mostly yes Neither yes nor no Mostly no Definitely no TOTAL 114 (32 missing) These results suggest that respondents agree with the proposition that while supply managers need multiple TCO models to estimate accurately the total cost of ownership for a variety of commodities, they would use some cost drivers for most, or all, of the TCO models. Modular drivers One hundred twelve respondents answered the question on the existence of a set of cost drivers, other than the core drivers that apply to all commodities, that only apply to some specific commodities. Table X gives the range of responses to this item. Table X: Set of drivers relevant only to specific commodities or commodity category Respondent opinion Number of responses % of responses Definitely yes Mostly yes Neither yes nor no Mostly no Definitely no TOTAL 112 (34 missing) These findings suggest the validity of a modular structure for TCO models. In this modular structure, supply managers would use the core drivers for every TCO model for any commodity or commodity category. However, supply managers would also create a set of modular drivers for specific TCO models related to a commodity or commodity category. This set of modular drivers would consist of all the additional cost drivers necessary to tailor the core cost drivers to estimate accurately the total cost of ownership for any commodity or set of commodities.

16 pag.: 16 van 17 Functional involvement in Total Cost of Ownership valuation mechanisms As described above, the survey asked respondents to indicate the involvement of other functional areas in the development and ongoing use of total cost of ownership valuation in supply management. Table II provides the average response, on the zero (no involvement) to five (heavy involvement) scale, and the standard deviation of responses for each functional area. Table XI provides the range of responses to this item for each corporate function. However, since for each business function different numbers of respondents answered this question, the percentages are not directly comparable. Purchasing Table XI: involvement of different business functions in TCO valuation Manufacturing Logistics Marketing Accounting Information tech. Design engineering # % # % # % # % # % # % # % Heavy Major Moderate Minor Slight None TOTAL As expected, and with solid justification, respondents perceived purchasing managers as having a major role in TCO valuation. Respondents also indicated, again not surprisingly, that design engineering has an important role in TCO. However, nearly 63 percent of respondents indicated their perception that the contribution logistics managers make to TCO valuation is moderate, minor, slight or none. Further, 84 percent of respondents indicated that marketing makes only a moderate, minor, slight or no contribution to TCO valuation; 75 percent of respondents indicated accounting plays little role in TCO valuation; and nearly 72 percent of respondents indicated information technology managers play only a minor role in TCO valuation. Clearly, as firms attempt to make their supply chains market-responsive, marketing managers must assume a larger role in TCO valuation. Further, as firms pursue marketresponsive supply chains, boundary-spanning functions such as logistics and information technology must also make a significant contribution to TCO valuation, especially given the impact that supplier performance can have on the buying firm s costs in areas such as logistics, manufacturing, and information technology. Conclusions This research supports the notion that total cost of ownership valuation is a difficult process, but is likely to be worthwhile for firms that apply it well. The data, while not necessarily an outstanding sample of the population from which it was drawn, indicate firms are making significant efforts at TCO valuation. An important finding is the staggering number of cost drivers that companies can and do use when attempting to implement TCO. This research suggests that a standard TCO model will not exist, but that some cost drivers are more universal than others and win appear in many TCO valuation models. This is, however, consistent with the work of Ellram (1994) who found support for both standard and unique TCO models. It is suspected, as companies continue to refine their TCO models, these will evolve into various sets of models, some of which will be standardized, same slightly modified, and same unique.

17 pag.: 17 van 17 This research also suggests that a completely precise categorization scheme for TCO cost drivers is likely to be elusive. The three-category schema developed by Ellram (1994) is a good start. However, the large number of cost drivers identified by respondents, and the subjective nature of many of these cost drivers, suggests a more complex categorization taxonomy may be useful. Further case-based research is probably necessary as TCO valuation continues to grow. An examination of many cases will provide the reader with insight into how the process is developing over time and the nature of the cost drivers firms use in different situations. Limitations of the research As with any research, the limitations of this investigation must be considered. This is a cross-sectional study, based on a single respondent in each firm. Thus, the responses are based on the memories and perceptions of a single individual and may not represent all TCO purchasing activity in a given firm. The sample frame was drawn from the membership of ISM and may not represent the total population of purchasing professionals. For example, in this sample, only 12.8 percent of respondents are employed in firms with less than 101 employees; whereas the ISM 1999 Profile of Purchasing and Supply Management Professionals shows 20 percent of ISM membership is employed in firms of this size, and the 1992 Economic Census of the U.S. Department of Commerce shows 38.3 percent of the general economy is employed in firms of this size. Thus, a typical survey respondent is employed by a larger firm. The moderate response rate of 15 percent is another limitation of this research. This response rate is attributed to the difficulty of the questionnaire; that begs the question of non-response bias. While a procedure (Armstrong and Overton 1976) indicated limited potential non-response bias, that procedure is not above criticism. Therefore, confirmation of these findings on different samples is necessary before projecting these results to the general corporate population.