In the realm of asset management, Total Cost of Ownership (TCO) is a critical metric that provides a comprehensive view of the true costs associated with 1) acquiring, 2) operating, 3) maintaining, and 4) disposing of assets. While many organizations focus primarily on the initial purchase price, a thorough TCO analysis reveals the broader financial implications over the asset’s lifecycle. Effective TCO management not only helps in making informed purchasing decisions but also contributes to long-term financial sustainability and operational efficiency.
Understanding and optimizing TCO involves a detailed approach that encompasses various factors beyond the upfront costs. These factors include operational expenses, maintenance and repair costs, energy consumption, downtime, and eventual disposal or retirement costs. By taking a holistic view, businesses can uncover hidden costs, identify opportunities for cost savings, and enhance the overall value derived from their assets.
This deep dive into optimizing TCO will explore best practices and strategies that organizations can employ to achieve more accurate and actionable insights into their asset-related expenditures. We will examine the key components of TCO, methodologies for optimization, and practical examples of how these practices can be applied effectively.
When it comes to calculating TCO, there is no single, useful model for all products and sectors. Each of them has certain values and factors to be taken into account, so the way of calculating the TCO and the elements to be taken into account will be adapted to the product or service (IT, vehicles, etc.). It is much better to take into account the particularities of each sector and, from there, to draft a model. However, the total cost of ownership usually consists of 8 key elements:
1) Purchase price. It is the supplier’s cost price and margin.
2) Associated costs. Such as transportation, packaging, customs duties, payment terms, etc.
3) Acquisition cost. Refers to the operation of the purchasing department.
4) Cost of ownership. Such as inventory management, depreciation costs, etc.
5) Maintenance costs. It can be spare parts, maintenance, etc.
6) Usage costs. It means the use value, operation, services, etc.
7) Non-quality costs. Some of them may be non-compliance with deadlines, non-conformity processes, etc.
8) Elimination costs. They make reference to recycling, resale, disposal, etc.
Taking TCO into account when making an acquisition for a company remains, to this day and since the 1990s, one of the most popular strategies among purchasing decision-makers to create value. Let’s take a look at all the benefits it can offer:
1) Argument in favor of negotiations with suppliers.
2) Management tool to optimize direct or indirect costs, for example, to avoid waste.
3) Decision-making support for outsourcing.
4) Evaluation of ROI (Return On Investment) or ROTI (Return On Investment Over Time).
5) Improved long-term financial performance.
An example of a business investment that requires a thorough TCO analysis is the investment in a new equopment or system. This has an initial purchase price, which is the one we use as a reference to think about the possibility of purchase. There are, however, certain additional costs;
1) the costs of new equipment or system, 2) installation, transition costs, 3) employee training, 4) security costs, 5) disaster recovery planning, 6) ongoing support, 7) future upgrades… Using these expenses as a guide, the company can compare the advantages and disadvantages of purchasing such system, as well as the overall benefit it may create in the long term.
Let’s imagine again a hypothetical situation: a company needs to calculate the TCO to see if it is profitable to purchase a new part for its department. To do this, they will have to analyze the entire system of expenses that are likely to be incurred during the life cycle of ownership of that asset. Use these questions to guide you in a first approach to TCO analysis:
1) What am I buying?
2) What is its approximate life cycle?
3) What are the additional costs?
With this first draft of TCO you will be able to see the capital and operating expenses. You will then be able to determine how long it will take the company to recover the investment costs of this potential new asset.
TCO, or total cost of ownership, is the purchase price of an asset plus operating costs which are often never taken into account. Evaluating the total cost of ownership helps the company, which is considering making an investment, to have a broader view of what the product is and its value over time.
Buyers should look not only at the short-term price of an item (purchase price), but also at its long-term price, which would be the total cost of ownership. These are the long-term costs and expenses incurred during the useful life of the product and its final disposal. Based on TCO, the item with the lowest total cost of ownership would be the one with the best long-term value.