Analyzing Total Cost of Ownership in the Purchasing Sector
The concept that analyzes all costs related to the acquisition, transportation and storage of products in the supply chain is known as the Total Cost of Ownership (or TCO).
This calculation allows buyers to differentiate the purchase price from the long-term cost of purchasing a product, which relates to maintenance and repair costs in the future.
In the 1980s, an IT company carried out this cost study to calculate the expenses related to the support given to customers by the company after selling hardware and software, discovering that it could cost between 5 and 8 times the purchase price. In this article, we will present the main contributions of this concept to the purchasing department.
Concepts and Trends
The concept of cost was created in the 1940s by the Gartner Group, a North American Information Technology consulting company. At the time, the objective of the methodology was to quantify the qualitative performance of the organization as a whole, however over the years it has evolved to include other sectors, acquiring new angles.
In the purchasing department in particular, the TCO calculation includes the direct and indirect costs of purchasing a product and goes beyond the procurement process to include those incurred throughout the supply chain – ensuring a smooth integration in the final assembly. Transport, taxes, customs costs, insurance and packaging are included, among other costs such as inventory expenses, determined based on three main factors: occupied space, handling and depreciation.
When thinking about values applied in the purchasing sector, that is, the budget, it is important to remember that although the final price of each purchase is important, not taking into account the TCO of an acquisition can significantly impact annual expenses – since methodologies such as the Purchase Price Variance analysis tend to disregard between 20% and 40% of the actual costs of an acquisition, as they do not normally include factors such as transportation expenses and many others related to shipping the product to its final destination.
There are some additional costs that allow us to calculate the total cost of ownership (TCO):
The analysis begins with the negotiated price of the item excluding any discounted amount related to high volume purchases and payment on time, for example.
Transaction costs are not easily perceived. They represent services provided by suppliers, including the optimal inventory calculation processes, material requisitions, preparation and transmission of the purchase order request to the manufacturer, as well as shipping, handling and receiving documentation.
This is the most overlooked item in the total cost of ownership. Where do you generate the most value? What opportunities are missed if you distance yourself from your core competencies?
The concept of opportunity cost refers to a possible loss of income in case the supplier chosen to purchase a certain product does not have quality materials, for which maintenance will be required in the short term. Because of that, it is important analyzing the benefits between a more expensive supplier – but with better quality service or product or a lower purchase cost.
It is necessary to consider the cost of transportation and storage of the product, both international and domestic, in addition to paying attention to the time required for its arrival at the final destination.
Seasonal fluctuations in demand and supply as well as adverse seasonal weather conditions that can affect the availability of space and its cost and availability of transportation should also be analyzed.
Currency fluctuation costs
When purchasing products from a foreign country with payment in that country’s currency, the history of currency fluctuation must be taken into account. In order to safeguard against this variation, you can choose to buy in foreign currency at the current price at the time the purchase order is issued.
Commercial regulation costs
It is essential to list the commercial incentives and restrictions offered by the countries in which the supplier is located, including those established through commercial agreements between countries or groups of countries.
Other values that must be considered are import and export expenses, which include customs charges, import duties and customs brokerage services (both at origin and destination).
How to apply this calculation in the department
The purchasing professional needs to list all the costs mentioned above – whether they are favorable or not – regarding the supplier and the indirect material, in order to map and analyze the TCO.
This data analysis will generate more assertiveness to the activities and decisions of the purchasing department, such as the choice of manufacturing origin, distribution of materials, as well as the best supplier and acquisition advantages.
With this evaluation, it is possible to determine suppliers of lower cost and higher quality, that is, those that give more return to the company.
Once you get the right information, it will be possible to produce a complete report with the Total Cost of Ownership in order to improve decisions and maximize the results of the sector. Below are the 3 main steps to define your Total Cost of Ownership:
1) Organize the goals you want to achieve with TCO
2) Define what are the relevant costs
3) Choose a period for the calculation
Now that you understand the importance of these indicators, you can count on a company like Soluparts, specialized in negotiating with the main suppliers in the world, obtaining better commercial conditions in the acquisition of indirect materials.
We offer a manufacturer’s warranty and work to avoid any type of inconvenience in the event of a replacement part. Talk to one of our experts for more information.