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CHAPTER 6
TOTAL COST OF OWNERSHIP (TCO)
Two other types of measurement systems include categorical systems and
weighted-point systems. Categorical systems involve subjective check-offs for
various items. A user assigns ratings such as excellent, good, fair and poor to
selected performance categories. Categorical measurement is the lowest level
of measurement in terms of sophistication. Weighted-point systems, which
are widely used in supplier performance scorecards, use scales with defined
values. This approach weighs and quantifies scores across different performance
categories. Currently, the most common system used when making sourcing
decisions is a weighted-point approach. Neither categorical nor weighted-point
systems consider total cost, although a total cost metric instead of a price
measure could be included in a weighted-point system.
Cost-based systems offer advantages and disadvantages and systems can be
extremely challenging to develop and use. As they relate to supply management,
total cost models are applied within three major areas: total landed cost models;
supplier performance cost models; and life-cycle cost models. While at first
glance these may appear as three independent types of models, they can have
overlapping cost categories. A life-cycle cost model for capital equipment, for
example, should include the purchase price along with any charges incurred to
transport and install the equipment. Transportation costs will usually appear in
total landed cost models. The three models are discussed in more detail below
and a later section identifies the kinds of cost elements or categories that may
populate these models.
6.3.1 TOTAL LANDED COST MODELS
A total landed cost model is ideal when evaluating suppliers prior to making
purchase decisions. Landed cost is the sum of all costs associated with obtaining
a product, including acquisition planning; unit price; inbound cost of freight, duty
and taxes; inspection; and material handling for storage and retrieval [6]. Of
course, each of these cost categories will contain numerous sub-categories.
On seeing the word ‘landed’ it is reasonably safe to assume a reference to total
cost estimates or calculations that involve international shipments. Total landed
costs models are also used, however, when evaluating domestic shipments.
In this case some of the cost elements (such as tariffs) will not have costs
allocated to that element. Every company that is serious about controlling costs
should develop total landed cost models. Best practice companies require their
commodity teams or buyers to attach spreadsheets that show the total landed
cost whenever they propose a supply strategy or make a supplier selection
decision. Few supply managers would question the importance of these models
when making foreign sourcing decisions.
If a company were to develop only one type of total cost model in the international
arena, this should be it. Various costs incurred when sourcing internationally are
not present when sourcing domestically. For example: a company is evaluating
three suppliers, one in Germany, one in China, and one in the USA. Considering
price alone, the Chinese supplier may be an obvious choice, but a detailed total