Chapter 3 TOTAL COST OF OWNERSHIP TCO DOSEN

Chapter 3 TOTAL COST OF OWNERSHIP (TCO) DOSEN : IR. HOETOMO LEMBITO, MBA, CSLP 1

Objektif Perkuliahan • Memahami konsep TCO • Memahami fungsi TCO dalam SCM • Memahami keterkaitan konsep TCO dengan aktivitas purchasing management 2 2 Hoetomo Lembito

Total Cost of Ownership • Total cost of ownership is a philosophy for really understanding all supply chain related costs of doing business with a particular supplier for a particular good or service (Lisa Ellam, May 1999) 3 3 Hoetomo Lembito

Key Concepts • Purchase Price: But One Component of Cost • The Importance of Total Cost of Ownership in Supply Management » Service Providers » Retail » Manufacturing 4 4 Hoetomo Lembito

Key Concepts • Three Components of Total Cost » Acquisition Costs » Ownerships Costs » Post-Ownership Costs • TCO, Net Present Value Analysis (NPV), and Estimated Costs • Supply Management Action 5 5 Hoetomo Lembito

Total Cost and WCSM • To achieve World Class Supply Management. SM, managers must shift their focus in procuring materials, services and equipment from price to total cost. 6 6 Hoetomo Lembito

Importance of TCO • Service Providers • Retail • Manufacturing • Supply Chains/Supply Networks 7 7 Hoetomo Lembito

Service and Retail Providers • Understanding what drives the cost of overhead expenditures is crucial to any service business • Revenue must cover the direct costs, material and labor, and overhead in order to generate a profit » TCO analysis of recurring material costs are often overlooked and can yield great savings » TCO analysis of the labor base can reap lower person costs, greater benefits, and improved morale » TCO analysis of equipment purchases may help reduce the expenditures for maintenance and parts over the lives of the investments 8 8 Hoetomo Lembito

Manufacturing • Manufacturers are concerned with all of the same TCO issues as service and retail firms, with some added issues • Issues that are particularly important in cost analysis for manufacturers are: » Direct materials » Manufacturing overhead • Emphasis should be placed on the variance between “should cost” and actual cost. » This should not be confused with price variance 9 Hoetomo Lembito 9

Activity Based Costing • A major problem in TCO analysis of manufacturers is accurate allocation of manufacturing overhead • Many manufacturers have used activity-based costing to help improve cost allocation • Activity-based costing (ABC) is a technique for accumulating cost for a given cost object that represents the total and true economic resources required or consumed by the object 10 10 Hoetomo Lembito

Supply Chain/ Supply Networks • TCO analysis may include the study of: » Manufacturability » Infrastructure » Outsource decision » Analysis of suppliers beyond tier one » Structure of foreign and domestic tariffs/duties/taxes » Costs of delivery » Foreign regulations » Foreign political/economic stability » Foreign exchange risk » Language/communicati on requirements » Volatility of endcustomer demand » Inventory carrying costs » Inventory risk » Quality costs 11 11 Hoetomo Lembito

Three Components of Total Cost • Acquisition Costs • Ownerships Costs • Post-Ownership Costs 12 12 Hoetomo Lembito

TCO Components • Acquisition costs » » » Purchase price Planning costs Quality costs Taxes Financing costs • Ownership costs » » » • Post-ownership costs » Environmental costs » Warranty costs » Product liability costs » Customer dissatisfaction costs Downtime costs Risk costs Cycle time costs Conversion costs Non-value added costs Supply chain costs 13 13 Hoetomo Lembito

Acquisition Costs • Purchase Price • Planning Costs • Quality Costs • Taxes » Customs Duties and Tariffs » Regional Trade Agreements » Income-Base Shifting • Financing Costs 14 14 Hoetomo Lembito

Ownership Costs • Downtime Costs • Risk Costs • Cycle Time Costs • Conversion Costs • Non-Value Added Costs 15 15 Hoetomo Lembito

Ownership Costs • Supply Chain Costs » Forecasting » Administration » Transportation » Inventory » Manufacturing » Customer service » Supplier selection/relationships » Global sourcing 16 16 Hoetomo Lembito

Post - Ownership Costs • Environmental Costs • Warranty Costs • Product Liability Costs • Customer Dissatisfaction Costs 17 17 Hoetomo Lembito

TCO, Net Present Value Analysis (NPV), and Estimated Costs • NPV analysis is frequently incorporated into TCO analyses • NPV analyzes present values of the initial expenditure along with the likely future revenue and expenditure streams • The present value of a sum of future cash flows discounted by a required rate of return » NPV greater than zero suggests accepting the investment » NPV less than 0 suggests rejecting the investment » NPV = 0 is the point of indifference 18 Hoetomo Lembito 18

Major Categories for the Components of TCO Total Cost of Ownership Pretransaction Components • Identifying need • Investigating sources • Qualifying sources • Adding supplier to internal systems • Educating: » Supplier ins firm’s operations » Firm in supplier’s operations Transaction Components • Price • Order placement/preparation • Delivery/transportation • Tariffs/duties • Billing/payment • Inspection • Return of parts • Follow-up and correction Posttransaction Components • Line fallout • Defective finished goods rejected before sale • Field failures • Repair/replacement in field • Customer goodwill/reputation of firm • Cost of repair parts • Cost of maintenance and repairs Source: Lisa Ellram, “Total Cost of Ownership: Elements and Implementation, ” International Journal of Purchasing and Materials Management, Winter 1993. 19 Hoetomo Lembito 19

Tangential Reprographics Example 20 20 Hoetomo Lembito

TCO Formula n TCO = A + P. V. (Ti + Oi + Mi – Sn) i=1 A = delivered acquisition cost P. V. = net present value Ti = training costs in year i Oi = operating costs in year i Mi = maintenance costs in year i Sn = salvage value in year n 21 21 Hoetomo Lembito

PVA Incorporated into a TCO Analysis Acquisition Cost = $120, 000 PV Cash Outflows, yrs 1 - 6 = 23, 279 PV of overhaul in yr 3 = 5, 208 PV of salvage value in year 6 = (2, 512) TCO = $145, 975 22 22 Hoetomo Lembito

PVA Formulas • PVAnnuity = CF [ 1/r – 1/r(1+r)t ] » CF = periodic cash inflow or outflow (must be the same each period) » r = discount rate period (annual rate divided by the number of periods in one year) » t = total number of periods • PV = FV / (1 + r)t » FV = future value of single cash inflow or outflow » r = discount rate period (annual rate divided by the number of periods in one year) » t = total number of periods 23 Hoetomo Lembito 23

Concluding Remarks • TCO is an analytical tool and a philosophy • Accurate estimation of total costs requires a cross-functional approach • Supply management is a critical member of such a cross-functional approach • TCO is also applicable in one’s private life enabling better decision-making 24 24 Hoetomo Lembito