procurement and TCO

Procurement and TCO

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When buying new equipment, the price tag only tells you part of the story. Energy costs, maintenance, and repair fees are often several times higher than the initial price! But often these are left unconsidered and hold nasty surprises further down the line. Calculating the Total Cost of Ownership is an important step when planning new investments.

What is Total Cost of Ownership (TCO)

There is an anecdote amongst sailors about sailboats that says: "The only good times are when you buy it, and when you sell it". This seems to indicate that the ownership itself is enjoyable, but may have some drawbacks too. Calculating all potential costs a new purchase may tag along include not only the initial price, but its operation, maintenance, downtime, output, and longevity – all of these factor into the Total Cost of Ownership and are always dependent on the specific purchase made.

The importance of TCO

The general idea is, that whenever there is a purchase, you need to consider more than the costs or the investment at the moment of the transaction. Ownership and usage of a particular piece of equipment, a product or a service has a cost too. These costs can vary considerably between the choices that are available.

When evaluating alternatives when it comes to making a purchasing decision, buyers should look not just at an item's short-term price, the so-called purchase price. But, buyers should also look at its long-term price, or rather its Total Cost of Ownership (TCO). The item with the lower total cost of ownership is the better value on the long term.

How is TCO calculated?

Originally the term TCO was taken into consideration when companies and individuals were looking to buy assets or make investments in capital projects. The final purchase decision was based on the calculation of adding Capital Expenditures (CAPEX) on a major purchase, that will be used in the future, with Operating Expenditures (expenses, OPEX), that represent day-to-day usage costs.

TCO and the supply chain

Looking at TCO through a supply chain lens has broadened its meaning. In supply chain management, the total cost of ownership 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 is often a very small portion of the total cost of ownership.

Want to know more? Experience TCO!

Seeing is believing. It helps to simply experiment and experience what the effects on TCO are, when purchases are made.

In the business simulations that Inchainge offers, participants are department managers and together they form the management of a virtual company. Part of running the business is dealing with suppliers to buy components, or pieces of equipment. Services can be sourced from logistics service providers or banks. Various department heads make important decisions in these matters.

For example, if purchasing is able to negotiate a low component price, it may very well be, that the price break received goes at the expense of buying large trade units. As an consequence, that will need more storage space, and thus increases costs elsewhere. Meaning, TCO may have gone up.

Part of this type of training is that participants receive almost instant feedback about what the effects of their decisions are. What they are learning, can be applied right away when they continue with the rest of their training, or better yet, when they return to their organization. That is how you get return on education. Want to know more? Have a look at our business simulation games.