What do a Volvo,

Wine Barrels, and a

Vacuum have in common?

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Purchase 1998 Volvo V70, T-5 (Sweden) Discount Sales tax (90-day rule) Delivery to Port Hueneme (6-weeks) Train/taxi to Port Hueneme Luxury tax (10% over 36K)

$ 39,000 (6,500) 0 0 60 0

European license/Insurance for 3 monthsAirfare (Continental miles)Total Cost to take delivery in Göteborg/PH

555 0$ 33,115

Purchase 1998 Volvo V70, T-5 (SD, CA) Discount Sales tax (7.25%) Luxury tax (10% over 36K)

$ 39,000 (2,500) 2,646 50

European insurance for three monthsAirfare (Continental miles)Total Cost to take delivery in San DiegoRent equivalent Volvo (Europe)

0 0$ 39,196$ 6,000$ 45,196

$ 6,081/$12,081 difference and a GREAT trip!

“Exhausted” white oak red wine barrels from Temecula wineryIssues:• Choose and transport barrels• Number of barrels in one trip (no min.)• Storage capacity at PRDH/BMI• Fuel & 17’ box truck (rent)Total Direct Cost

$ 40 each ½ workday (2 people) 30 30$ 150$ 1,350 ($45/barrel)

“Exhausted” white oak red wine barrels from Napa wineryIssues:• Inspect and arrange purchase• Number of barrels in one trip (min.)• Travel expenses• Storage capacity at PRDH/BMI• Fuel & tractor semi-trailer (outsource)Total Direct Cost

$ 22 each 3 workdays (2 people) 70$ 300 30$ 1,050$ 2,890 ($41/barrel)

Other ‘soft/indirect’ considerations:• Wages of employees and lost productivity

• Head designer is billable at $90/hr.• Inability to choose barrels at Napa (lower yield?)• Barrel cost is 20% of direct costs of a chair• (FYI... Cost of new barrel is $1,000)• Lack of storage capacity, as well as personnel to breakdown and

kit barrels, but...• Establish relationship(s) for sustainable sources of supply• Build new business relationships for marketing barrel furniture• Enjoy road trip...• Other considerations ???

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21 pounds~ $230

17 pounds~ $150 4

All of the decisions involve the application of (or lack thereof...)

TCO(Total Cost of Ownership)

Total Ownership Cost – TOC Total Cost – TC

Total Cost of OperationLife-cycle Cost (TCO over time)

All-in-Cost Relevant Cost of Ownership - RCO

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And now for some academic stuff...

What is TCO?

TCO is a Philosophy, Methodology, and Tool for analyzing all the relevant quantitative and qualitative costs of an acquisition, project, investment, or relationship in order to make a decision...

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TCO as a philosophy…

TCO looks beyond the purchase price of a part, subassembly, asset, investment, project, and/or service…

TCO seeks to include all relevant information that will affect the outcome…

TCO considers qualitative considerations, as well as quantitative…

TCO seeks to understand short and long-term costs and benefits (life cycle cost)…

TCO explores customer and/or supplier relationships to determine their value to the organization…

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TCO as a Methodology1

A TCO analysis attempts to determine the type of buy, then applies certain processes and analytical tools to support the decision process. In general, TCO considers quantitative and qualitative

Acquisition Costs

Ownership Costs

Post Ownership Costs

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TCO as a Methodology4

Classification of Decisions:

Low Impact – low-cost commodity items(e.g., copier paper)

Leverage – large purchases of items in competitive markets(e.g., disk drives)

Strategic Item – large purchases from important suppliers (e.g., commercial airline jet engines)

Critical Projects – large dollar volume infrequent purchase(e.g., production facilities using various technologies/processes)

1 Adapted from Supply Chain Management, Fawcett/Ellram/Ogden, Ch8 10

TCO as a Methodology4

Apply TCO to appropriate buy1

1 Adapted from Supply Chain Management, Fawcett/Ellram/Ogden, Ch8

Don’t waste a lot of time here

e.g., commodity items, supplier A v. B, domestic v. offshore

e.g., alternative SC configurations, LCD v. Plasma, Important supplier relationships

e.g., infrequent purchases, custom software,

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TCO as a Methodology4

Many qualitative considerations can actually be quantified by careful analysis

There is a TCO issue in performing a TCO analysis. The cost/benefit relationship needs to be analyzed before committing the time and resources

Garbage in, garbage out – care must be taken when determining what and how to measure

Management’s concern is the effect of the TCO object/decision on the bottom line!

TCO takes the emphasis off generic cost reduction initiatives to

support the strategic contributions of supply management

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TCO as a ToolTCO and Direct Materials, Direct Labor, and Overhead

TCO and Services

TCO and Inventory

TCO and Capital Equipment

TCO and NPV (net present value) Analysis

TCO and International Sourcing

TCO and the Logistics process

TCO and Qualitative Considerations

TCO and MRO, Production/Operations, Services

TCO and Supply Chain Optimization

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TCO as a Tool

Inventory

Non-Delivery Poor Quality Transportation and Packaging Carrying Working Capital ! Insurance Property Taxes Floor Space Obsolescence/spoilage Administration ??????

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Differential analysis

Supplier 1 minus Supplier 2

Description formula amount formula amount

Total engine cost 12,000 x $500 6,000,000.00 12,000 x $498 5,976,000.00 24,000.00Cash discount

n/30 6,000,000 x 0.10 x 30/360 50,000.00 5,976,000 x 0.10 x 30/360 49,800.00discount available 6,000,000 x (0.10 x (10/360) +0.02) 136,666.67 5,976,000 x (0.10 x (10/360) +0.01) 76,360.00

Largest discount -136,666.67 -76,360.00 (60,306.67)Tooling Cost given 22,000.00 given 20,000.00 2,000.00Transportation cost (22,000 lb. LTL) 125 x 12,000 x 22 x $1.20/2000 19,800.00 100 x 12,000 x 22 x $1.20/2000 15,840.00 3,960.00Ordering cost 12,000/1,000 x $125 1,500.00 12,000/1,000 x $125 1,500.00 0.00Carrying cost 1,000/2 x $500 x 0.20 50,000.00 1,000/2 x $498 x 0.20 49,800.00 200.00Quality cost 6,000,000 x 0.02 120,000.00 5,976,000 x 0.03 179,280.00 (59,280.00)Delivery rating

Back Order (50%) 12,000 x 0.01 x 0.50 x $15 900.00 12,000 x 0.02 x 0.50 x $15 1,800.00 (900.00)Lost sales (50%) 12,000 x 0.01 x 0.50 x $4,500 x 0.18 48,600.00 12,000 x 0.02 x 0.50 x $4,500 x 0.18 97,200.00 (48,600.00)

Total Cost 6,126,133.33 6,265,060.00

Difference, in favor of… ` Supplier 1 (138,926.67)

Performance Metrics Weight Rating Final Value Weight Rating Final Value

Quality 0.25 93 23.25 0.25 88 22.00 1.25 Technology 0.20 85 17.00 0.20 94 18.80 (1.80) Plant & Processes 0.18 87 15.66 0.18 82 14.76 0.90 Environmental 0.16 86 13.76 0.16 98 15.68 (1.92) Financial 0.11 86 9.46 0.11 91 10.01 (0.55) Responsiveness (inc. Delivery) 0.05 91 4.55 0.05 89 4.45 0.10 Business 0.05 88 4.40 0.05 95 4.75 (0.35)

1.00 88.08 1.00 90.45

Difference, in favor of… Supplier 2 2.372.37

Supplier 1 Supplier 2

138,926.67

KATV Inc.

Total Cost Analysis (annual)

ATV Engine

Supplier 1 Supplier 2

TCO as a ToolQuantitative & QualitativeHandout #

1

15Principles of Supply Chain Management 3e (Wisner. et al.)

Handout #2

Interest rate plus risk premium 8.25%Years 0 1 2 3 4 5 Machine A Machine B

Present Value Present Value

CASH OUTFLOWS

Purchase price (612,000) (612,000) (510,000)Installation and site preparation (9,000) (9,000) (9,000)Sales tax 0 (38,542)Setup and testing (6,000) (6,000) (2,000)

Expected repair and maintenance costs

0 0 0 (7,500) (6,400) (6,800) (15,148) (14,029)

Expected operating costs 0 (4,500) (6,625) (5,800) (5,675) (5,320) (22,095) (24,943)

Income tax on net revenues 0 (27,289) (31,358) (33,007) (32,259) (30,666) (122,115) (103,314)

CASH INFLOWS

Expected increase in revenue generated by production

0 142,325 165,000 180,000 175,000 167,000 653,985 560,758

Expected salvage value 0 0 0 0 0 102,000 68,622 77,367

Expected depreciation Tax shield benefit

0 20,790 20,790 20,790 20,790 20,790 82,464 69,826

18,713 6,1249.28% 8.62%

(627,000) 131,326 147,807 154,483 151,456 247,004 18,713 6,124

TCO-NPV Analysis

Machine A

TCO as a ToolQuantitative

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maint.

Handout #3

Purchasing and Supply Chain Management 4e (Monczka, et al.)

60,000 60,000

Per unit Annual cost Per unit Annual cost Unit cost $30.00 $1,800,000 Unit cost $19.50 $1,170,000Packing cost $0.75 $45,000 Packing cost $2.00 $120,000Tooling $0.10 $6,000 Inland transport $0.12 $7,200Freight $0.25 $15,000 Freight forward fee $0.02 $1,200

Ocean transport $2.40 $144,000Marine Insurance $0.11 $6,600US. Port Handling $0.72 $43,200Customs Duty $0.98 $58,500Customs broker fees $0.03 $1,800US Transport $1.86 $111,600Warehouse Cost $0.50 $30,000Cost of capital $0.71 $42,353Cost of hedging $0.08 $4,800Administrative time $0.02 $1,200Travel $0.33 $20,000Tooling $0.05 $3,000

TOTAL COST $31.10 $1,866,000 TOTAL COST $29.43 $1,765,453

Buy (US) Buy (China)

Savings$1.67 or ≈ 5.4%

Is it worth the added risk?

Wiring Harness

TCO as a ToolQuantitative

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TCO as a Tool

Supplier risks/considerations:

Design changes Supplier integration in new product

development On-going cost savings sharing agreements On-site technical support Alignment of corporate cultures Other joint improvement initiatives (e.g.,

R&D) Financial stability Means of production/process capability Supply chain integration/processes Lead time Labor skill set Quality and technology Early supplier involvement Price escalation Volume changes/capacity Cost sharing Delivery ?

Overseas business Risks:

Political stability Economic stability Relations between countries Exchange rate volatility Communication (language) Time zones Labor skill set Accessibility to technology/engineering Political corruption Travel Infrastructure (transportation,

communications, energy, water, waste, etc.) Local laws Customer/culture ?

18Adapted from Purchasing and Supply Chain Management 4e (Monczka, et al.)

Handout #4

Purchasing and Supply Chain Management 3e (Monczka, et al.)

Running

Description Cost/lb. Shipment Annual Subtotal Formula

Cost per pound Purchase price/pound 0.2900 11,600.00 139,200.00 Given Ocean freight 0.0575 2,300.00 27,600.00 $2,300/40,000 = $0.0575 Import duties 0.0435 1,740.00 20,880.00 $0.29 x 0.15 = $0.0435 A. Landed cost (price paid, ocean freight, import duties) 0.3910 15,640.00 187,680.00 0.3910

Dock to stock Ship to local warehouse/container 0.0063 250.00 3,000.00 $250/40,000 = $0.00625 Storage 0.0165 0.0014 55.00 660.00 $5.50 x 10 / 40,000 = $0.001375 Warehouse fee 0.0030 120.00 1,440.00 $6 x 20 / 40,000 = $0.003

subtotal 0.0106 425.00 5,100.00 0.4016

Interest on value of average inventory 0.0375 0.0360 1,440.00 17,280.00 $0.401625 x 240,000 x 0.18 / 480,000 = $0.036

B. Transportation & warehousing cost 0.0466 1,865.00 22,380.00 0.4376subtotal

Warehouse to production cost Freight 0.0038 150.00 1,800.00 0.4414 $150/40000 = $0.00375 Quality control 0.0010 40.00 480.00 0.4424 $2 x 20 / 40000 = $0.001 Purchasing and storing loss 2% 0.00916 0.0080 321.30 3,855.60 0.4504 40,000 x 0.02 x $0.401625 / 40,000 = $0.008 Factory yield 3% 0.01401 0.0120 481.95 5,783.40 0.4625 40,000 x 0.03 x $0.401625 / 40,000 = $0.01205 Spoilage/recall 0.0625 2,500.00 30,000.00 0.5250 $20,000 x 1.5 / 480,000 = $0.0625

C. Warehouse to production cost 0.0873 3,493.25 41,919.00 0.5250

Total cost of Guava Puree before SG&A 0.5250 20,998.25 251,979.00

SG&A 0.0787 3,149.74 37,796.85 $0.5250 x 0.15 = $0.07875

Total cost 0.6037 24,147.99 289,775.85 0.6037

Guava Puree

TCO as a ToolQuantitative

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Handout #5

TCO as a ToolQuantitative

Slide provided by Rey Huerta, President of Enterprise Logistics SolutionsZero-Based Theoretical Analysis

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Component Outsourcing Buying components Buyer supplier(s) internal

customer(s) relationship Initiate PO and verify final receipt Less people dependent, fewer

interfaces Trend to eliminate monitoring and

inspections via supplier certification ???

Logistics Outsourcing Buying a service process Buyer third party supplier(s) &

third party supplier(s) ultimate customer relationship

Monitor series of service transactions More people dependent, more

interfaces Continuous monitoring over time to

create visibility ???

Arnold Maltz & Lisa Ellram suggest this modification to the TCO framework is necessary to account for the extra interface, quality measurement, and customer satisfaction costs involved in using TCO analysis in Logistics decision-making.

TCO + Logistics = TCR (total cost of the relationship)21

Handout #6

Pugh Matrix

Requirements/AttributesImportance

of NeedBaseline Option 1 Option 2 Option 3

Quality 5 0 - - -

Cost 8 0 - - -

Supplier Logistics 10 0 - - 0

Development 10 0 0 0 0

Business 10 0 - 0 0

Technology 10 0 + - +

Physical environment 8 0 0 0 0

Human environment 4 0 + + +

OR 4 0 0 0 0

Handling 9 0 + + +

Machine Ride 5 0 0 0 0

Cornering 10 0 + + +

Acceleration 10 0 0 0 0

OR 4 0 0 0 0

Communication 10 0 - - -

Mate Physical persona (looks) 4 0 0 0 0

Spiritual persona (soul) 10 0 0 0 0

OR 10 0 + 0 0

? 10 0 0 + +

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Sum of positives "+" 0 5 4 5

Sum of sames "0" 19 9 10 11

Sum of negatives "-" 0 5 5 3

Weighted sum of positives 0 43 33 43

Weighted sum of negatives 0 -43 -43 -23

Total weighted sum 0 0 -10 20

Example: for O

ption 3

Weighted Sum of “+” = 10+4+9+10+10 = 43

Weighted Sum of “-” =

5+8+10 = -23

Total Weighted Sum

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TCO as a ToolQualitative

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A Way of Thinking… Understand and concentrate on your core competencies

Direct your focus from tactical to strategic

Be proactive, not reactive

Emphasize total cost, not just purchase price

Understand the qualitative, less tangible issues in a procurement

Measure, so you can manage

Know the Voice of your Customer (VOC)

Develop and align your key performance indicators (KPI’s) with VOC

Gather data to gain knowledge

Truth is not reality, truth is perception (Rey Huerta, President Enterprise Logistics Solutions)

So...what is TCO – really?

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Supply Management & TCO(Adapted from Supply Chain Management, Fawcett/Ellram/Ogden, Ch8)

Candidates for TCO analysis Large dollar spend items

Regular purchases requiring cost information

Procurements with significant unrecognized transaction costs

When purchasing can impact transactions costs, via negotiation, changing suppliers, and/or improving internal operations.

When there is a desire for cross-functional involvement in understanding item or service cost structure

Capital purchases

Value network optimization

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Supply Management & TCO(Adapted from Supply Chain Management, Fawcett/Ellram/Ogden, Ch8)

Reasons for TCO analysis Performance measurement Framework for cost analysis Benchmarking performance More informed decision making Communication of cost issues internally and with suppliers Encourages cross-functional interaction Support external teams with suppliers Better insight/understanding of cost drivers Build a business case Support an outsourcing analysis Support continuous improvement Helps identify cost savings opportunities Prioritize/focus your time on high potential opportunities

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Would all of these benefit from TCO analysis?

•Study for advance degree, continue working, or both•Buy a vehicle (new v. used, compact v. small SUV, …)•Lease v. buy•Rent v. own•Investment A v. B•Adjustable rate mortgage v. fixed rate•747-8 v. A-380•Vacation options (Egypt v. Japan?)•Drive v. Fly•Make v. Buy•Project A v. Project B.•Supplier A v. Supplier B, or both•Production Process A v. B v. C•Remain in a bad marriage v. divorce•Cloud based software v. computer resident•Obama v. Romney economic plans

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27I wonder if a TCO mindset would have been beneficial in this situation ?