TU-E2040 Management of external resources (3-5 cr) Total cost of ownership (TCO): principles, process, and methods Kari Tanskanen

Transcription

1 TU-E2040 Management of external resources (3-5 cr) Total cost of ownership (TCO): principles, process, and methods Kari Tanskanen

2 The concept of total cost Total cost (of ownership - TCO) is an estimate of all direct and indirect costs associated with a product/service along it s lifecycle Highlights the difference between purchase price and long-term cost TCO provides essential information for a number of purposes in the management of external resources, for example Development of category strategies Directing sourcing efforts Negotiating with suppliers Selecting suppliers Continuous improvement efforts Provides information of the future opportunities and threats

3 The process of TCO analysis 1 A) Mapping the elements of the total costs by using a suitable structure, for example Pretransaction elements, transaction elements, posttransaction elements (Ellram, 1993) Acquisition costs, ownership costs, post-ownership costs (Burt, 2003) 1 B) Identifying the cost drivers or the TCO elements What determines the costs? 1 C) Calculate or estimate the total costs by using the appropriate method 2 A) Modelling the suppliers product costs Materials, direct labor, R&D, administration etc. 2 B) Identifying the cost drivers of the suppliers s product costs 2 C) Understanding the pricing policy of the suppliers Survival pricing, campaign pricing etc. 2 D) Understand the drivers of suppliers pricing policy

4 An example of structuring the total cost (Ellram 1993) Pretransaction components Identifying need Investigating sources Qualifying sources Adding supplier to internal systems Educating Transaction components Price Order placement Transportation Tariffs Billing/payment Inspection Returns Follow-up Postransaction components Line failout Defective finished goods relected before sale Field failures Repair in the field Customer goodwill Cost of repair parts Cost of maintenance and repairs Source: Ellram, Lisa, Total cost of ownership: Elements and implementation, International Journal of Purchasing and Supply Management, Fall 1993; 29, 4.

5 Another example of structuring the total costs (Burt, 2003) Acquisition costs Sourcing cost Price Planning cost Quality cost Taxes, tariffs, duties Financing cost Ownership costs Downtime cost Risk cost Cycle time cost Conversion cost Non-value-added cost Supply network cost Post-Ownership costs Environmental cost Warranty cost Product liability cost Customer dissatisfaction cost Lost business Burt, Dobler, Starling World Class Supply Management McGraw-Hill Irwin 2003

6 Capture cost drivers not just elements Cost elements informs us what forms the total costs For example direct labor, materials, transportation Cost drivers informs us what determines the total costs For example worker productivity and wages drive labor costs, and geographical distance and transportation mode drive transportation costs

7 Methods of TCO analysis Euro-based approach Relies of gathering or allocating actual cost data for each of the relevant TCO elements When possible, use actual cost data from relevant sources When this is not possible or requires too much effort too not give up - rough estimates are often enough Value-based approach Combines cost data with other performance data that is difficult or impossible to calculate in Euros For example supplier s know-how, availability of technical support etc Scoring-based approach Based on a scorecard including TCO criteria and their weights Scores for each supplier are based on expert assessment A light version of TCO analysis

8 The process of TCO analysis 1 A) Mapping the elements of the total costs by using a suitable structure, for example Pretransaction elements, transaction elements, posttransactio elements (Ellram, 1993) Acquisition costs, ownership costs, post-ownership costs (Burt, 2003) 1 B) Identifying the cost drivers or the TCO elements What determines the costs? 1 C) Calculate or estimate the total costs by using the appropriate method 2 A) Modelling the suppliers product costs Materials, direct labor, R&D, administration etc. 2 B) Identifying the cost drivers of the suppliers s product costs 2 C) Understanding the pricing policy of the suppliers Survival pricing, campaign pricing etc. 2 D) Understand the drivers of suppliers pricing policy

9 Modelling the product costs, simply but insightfully Margin Development, administration, sales and marketing Logistics, in-within-out Fixed production cost Direct labor The components of the price? Relative/absolute size? Factors driving each component? Issues influencing each factor? Further drivers of these issues? Direct material

10 Understanding supplier s pricing policy is crucial Survival pricing Campaign pricing Marketshare pricing Theoretical optimization based on production scale advantages and price sensibility of markets Cost+ Formal competition, hidden price agreements among suppliers Exceptional seller s (first mover) position Pricing based on buyer s (depending, urgent, critical) situation Pricing based on buyer s ignorance...

11 What are the drivers of suppliers pricing? Market price level? Pricing strategy? Individual pricing decision? Your attractivity as a customer? Your strategic position? Your negotiation power? Competitive situation? Supplier s technology? Efficiency and effectivity of the supplier s processes? Steps of the supply chain? Efficiency of the second tier suppliers?...

12 Group Task & Discussion Discuss the following questions in groups of 2-4 students: You are acquiring copy machines for your organization 1. What are the total cost elements and their drivers? 2. When evaluating total cost implications, should you also think the organisation, which will use it? 3. What else should you consider when making the decision?