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CHAPTER 6
TOTAL COST OF OWNERSHIP (TCO)
is that unit cost or price never equals total cost. Based on this proposition it
becomes important to understand the size of the gap between a unit price and
its corresponding total cost. It is also important to know, in some detail, what
makes up that gap.
Those involved in international purchasing are fully aware that variables, such
as long lead times and distance, carry additional costs and risks that are not
as relevant to domestic purchases. Supply managers are increasingly realising
that they need to quantify these cost elements, as abstract as some may be,
wherever possible. One expert has noted that the ‘soft costs’ that are rarely
included in off-shore cost models are starting to become painfully clear [3].
6.2.2 MEASURING TOTAL COST
Almost every purchasing measurement system includes price-related measures
rather than total cost measures. Price is by far the easiest of any metric to
identify across a supply chain. Without a total cost system, however, it is difficult
to make sourcing decisions that do not contain a fair amount of subjectivity. It
becomes next to impossible to select a higher price sourcing option (but a lower
total cost option) without a total cost system supporting that decision. Having a
‘gut feel’ that a higher price supplier will be the lower total cost supplier will not
work and companies must obtain total cost data to make objective decisions
based on total cost.
The reasons for measuring total cost are clear. A recent study by a leading trade
journal found that over 80% of companies that employed total cost analysis
reduced their total landed cost [3].
Total cost models help companies to:
• Identify the impact of different cost elements, including quality non-
conformances.
• Track in real terms cost improvements over time.
• Gain management’s attention regarding the areas where cost reduction efforts
will have their greatest payback.
• Target specific areas for improvement or elimination.
• Make fact-based rather than subjective supply chain decisions.
• Gain a better understanding of the supply chain.
Companies operate in a volatile world business market with price fluctuations that
are influenced by the world economy. Importers can and do experience product
and logistics cost increases. A survey by Archstone Consulting and the Supply
Chain Management Review reports that 35% of manufacturers experienced
a 25 to 50% increase in material and component costs from foreign suppliers
over a three year period. Over 50% of survey respondents reported up to a
25% increase in product costs. Similar increases were reported for logistics and
transportation costs [3]. Therefore, in uncertain times, the need to understand
every element of cost is great.