Integral Logistics Management — Operations Management and Supply Chain Management Within and Across Companies

2.1.3 Total Cost of Ownership in a Global Supply Chain

Intended learning outcomes: Explain the elements that make up the total cost of ownership. Disclose a method for analysis of the total cost of ownership (TCO).

Total cost of ownership (TCO) is a concept for analysis of acquisition costs; it is used for both make-or-buy decisions and for deciding between potential suppliers.

Total cost of ownership (TCO) of the supply delivery system is the sum of all the costs associated with every activity of the supply stream.

The main insight that TCO offers to the supply chain manager is the under­standing that the acquisition cost can be a small portion of the total cost of ownership (cf. [APIC16]). The crux of the concept is that decisions should be made not only based on the purchase price of a procured good but also based on consideration of all costs associated with acquiring the good ([Ellr93]). In addition to the purchase price of a good, the TCO is made up of a number of different cost elements, as shown in Figure For clarity, the costs are shown subdivided in four categories:

Fig.         Elements that make up the total cost of ownership.

  • Transport and logistics costs(category I) include the cost elements packaging, transport, temporary storage, duties and taxes, and insurance.
  • Landed costs generally denotes the sum of the purchase price and the transport and logistics costs.
  • Transaction costs (category II) comprise company-internal expenditures for organization of the buyer-supplier relationship. They include costs for the processes of searching, initiation, negotiation, drawing up contracts, adaptation, and control.
  • Depreciation, amortization, and capital costs (category III) comprise, for one, the cost elements investments and obsolescence and, for another, the costs for tied-up capital owing to transport times, payment arrangements, and safety stocks.
  • Total monetary costsis the sum of the landed costs, the transaction costs, and the depreciation and capital costs.
  • Risk costs (category IV) comprise risks concerning the company’s objectives in the target areas quality, costs, delivery, flexibility, and reputation.

Figure shows the relative importance of the cost elements based on a survey of 178 Swiss companies conducted in 2010, mainly in the machine, electrical, and metal industries.

Fig.         Importance of the cost elements.

The subdivision and examination of the costs in the four categories show that the companies participating in the survey rated all transaction costs and the cost elements transport, capital tied up in safety stock, and risk of insufficient quality as high. Quantitative assessments result in total additional costs for the four categories mentioned in Figure on average of 24.6% of the pur­chase price of the good when procuring from low-wage countries ([Brem10]).

Figure shows the method developed by [Brem10] for company-specific analysis of TCO.

Fig.         Method for analysis of TCO.Prof.

Here are examples of calculation functions.

1.) Cost element “freight costs”:

  • Cost category I, transport and logistics costs
  • Belongs to variable costs, calculated per piece
  • p1: amount, p2: exchange rate
  • Calculation function: f1 = p1* p2

2.) Cost element “traveling expenses”:

  • Cost category II, transaction costs
  • Belongs to fixed costs, calculated per PQ; that is, the estimated project quantity of goods to produce/procure
  • p1: number of persons; p2: costs for residence; p3: flight expenses
  • Calculation function: f2 = p1 * (p2 + p3) / PQ

In the model, generic cost types comprise those cost elements that have the same number and types of parameters and calculation functions. The calculation function determines the assignment to one of the monetary assessment dimensions (variable costs, fixed costs, and risk costs). Using a simple procedure, specific cost elements are derived from the generic cost elements and put together in an overall individual TCO model. In addition to the monetary view, the method is extended to also include non-monetary assessment criteria in the assessment dimensions delivery lead time, personnel costs, macroeconomic criteria, and qualitative criteria. The combination of monetary and nonmonetary assessment criteria produces an extensive and transparent database, based on which complex procurement decisions can be made. The method thoroughly incorporates the special demands of global procurement with regard to longer delivery lead times, dynamic factors, and supply chain risks as well as their implications for the profitability of procurement projects.

Course section 2.1: Subsections and their intended learning outcomes

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