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CHAPTER 6
TOTAL COST OF OWNERSHIP (TCO)
landed cost analysis could well reveal a different picture. The buyer would need
to consider all the hidden costs, including inventory carrying costs and increased
logistical handling, which erode unit price savings. Unless a total landed cost
model is developed it is not possible to know for certain that the correct decision
has been reached.
Total landed cost models should also be used when doing business with
international suppliers on an ongoing basis. After all, the factors that affect the
sourcing decision in the first place are dynamic and subject to change. Some
companies update their total landed cost models whenever cost factors, such
as transportation and exchange rates, change. Keeping these models current
is an ongoing challenge.
A potential issue with total landed cost models involves whether to include only
costs that the buyer incurs or whether to include all the costs incurred from the
point of origin to the point of destination. One school of thought argues that it
is best to include only those costs that are incurred directly by the buyer. If a
supplier maintains the title and risk of loss for a shipment until it reaches the
buyer’s dock door, why include the inventory carrying charge for the inventory?
Isn’t that the supplier’s concern? Another argument will say it makes sense to
have visibility to all supply chain costs - it’s hard to improve what is not measured.
And it is probably safe to conclude that the costs assumed by the supplier are
driving up the supplier’s unit price. A buying company can have parallel total
landed cost models.
One model could include the direct costs that the buyer is going to experience
firsthand. The second model, which will have a higher total landed cost model
than the first one, should include all the costs that are spread across the supply
chain. Spreadsheet software is ideal for developing total landed cost models.
6.3.2 SUPPLIER PERFORMANCE MODELS
One of the best known models used to capture the true cost of doing business
with a supplier on a continuous basis is the Supplier Performance Index (SPI).
While total landed cost models often consider total cost during the evaluation
phase of supplier selection, SPI measures costs incurred during a supplier’s
ongoing performance. SPI calculations are useful when tracking supplier
improvement over time, quantifying the severity of performance problems,
deciding which suppliers should leave the supply base, and establishing
minimum acceptable levels of supplier performance. This approach applies to
domestic and international suppliers.
The SPI is a total cost model that presents its output in the form of an index
or ratio. It assumes that any quality or other infraction committed by a supplier
during the course of business increases the total cost (and hence the total cost
performance ratio) of doing business with that supplier. This approach is more
applicable after supplier selection because it is populated with cost occurrences
that have happened rather than are expected to happen. If a company can track