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CHAPTER 6
TOTAL COST OF OWNERSHIP (TCO)
each non-conformance and assign a cost to it, the calculation of a standardised
SPI becomes relatively easy. The SPI calculation for a specific period is a
straightforward formula:
SPI = (Cost of material + Non-conformance Costs)/(Cost of material)
Assume a supplier delivers R280 000 worth of parts to a company in the 1
st
quarter of a year. The supplier also commits three infractions in that quarter,
i.e., a late delivery, missing documentation, and some defective units. In its
cost accounting system the buying company assigns R13 500 in total non-
conformance charges for these infractions. The usual warnings apply regarding
whether the data are reliable. The supplier’s SPI for the 2
nd
quarter is 1.05, or
((R280 000 + R13 500)/R280 000).
How does one interpret this figure? The SPI of 1.05 means the total cost of
doing business with this supplier is 5% higher than the unit price. If the unit
price of a supplier’s good is R127.24, then the estimated total cost of that
item is really R133.60 (R127.24 x 1.05). Because the SPI is a standardised
metric, and this is one of its virtues, it allows comparisons between suppliers. A
supplier with a higher SPI has a higher total cost than one with a lower SPI. It is
important to compare suppliers within the same commodity to ensure ‘apples to
apples’ comparisons. Along with total landed cost models, SPI calculations are
essential for managing the supply chain from a cost perspective. An efficient
and accurate way to identify infractions and their charges is essential when
using an SPI model.
6.3.3 LIFE-CYCLE COST MODELS
Life-cycle cost models are most often used when evaluating capital decisions
that cover an extended time period, such as equipment and facilities. Buyers at
an energy company, for example, cannot propose the purchase of any pumps or
compressors unless they attach a life-cycle cost model that shows the decision
will result in the lowest total cost.
Life-cycle models are similar to net present value models used in finance. Most
of them are used (or should be used) to evaluate capital decisions rather than
the purchase of everyday components and services. The other cost models
described in this chapter are more applicable for goods or services that are
purchased repeatedly.
Life-cycle costs apply whether equipment is sourced domestically or
internationally. Companies should compare the assumptions made during the
development of life-cycle estimates with actual data as they become available.
This will help identify the validity of the life-cycle model while providing insights
regarding how to improve the process.