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CHAPTER 6
TOTAL COST OF OWNERSHIP (TCO)
SYNOPSIS
Procurement managers are integrally involved in making purchase decisions and,
when they do, they must ensure they understand the Total Cost of Ownership
(TCO), not just the purchase price. TCO is a calculation designed to help people
make more informed financial decisions when procuring products or services. It is
also one of the most important concepts in purchasing and supply management.
Rather than simply looking at the purchase price of an object, TCO adds to the
initial purchase price other costs expected to be incurred during the life of the
product, such as service, repair, and insurance. Various TCO models exist and
are used to determine the true cost of ownership of a product or service.
6.1 INTRODUCTION
This chapter will explore the concept of TCO, which is defined here as a
philosophy for developing an understanding of all relevant supply chain-related
costs of a particular transaction or process. In the supply chain, TCO often
focuses on the cost of doing business with a particular supplier for a particular
good or service. TCO considers total cost of acquisition use/administration,
maintenance and disposal of a given item or service. TCO modelling requires
determining all the costs related to the procurement of a given product or service
or group of products and services to allow for an accurate estimate of true costs,
for cost comparison purposes and as a critical tool for use in supplier negotiation.
6.2 TOTAL COST OF OWNERSHIP (TCO)
While the concept of total cost applies whether companies engage in domestic
or international buying, the added complexity that surrounds international
purchases also means greater opportunity to experience a wider set of total
cost elements. With so many cost variables to consider, the job of consolidating
this information into a useful package can be intimidating [1]. One study has
identified over a dozen total cost categories with over 125 separate cost elements
embedded throughout these categories [2].
TCO is a topic companies simply cannot ignore as they search for new sources
of supply. This section defines the concept of total cost, including reasons to
measure it. Next, three common types of total cost models are presented.
Following this, the cost elements that typically comprise a total cost model are
presented followed by a case example that shows the development of a total
landed cost model.
6.2.1 TOTAL COST
Total cost includes expected and unexpected elements that increase the unit cost
of a good, service, or piece of equipment. Total cost systems attempt to capture
these cost elements. The logic behind the development of total cost systems