What is the main insight that the total cost of ownership TCO offers to the supply chain manager?

What if procurement and sustainability managers in your company spoke the same language? It's likely that the concept of total cost of ownership (TCO) would find its way into the conversation. For procurement managers, TCO captures the costs associated with a product over its lifetime—from the development and design of a product through its use, maintenance, and disposal. Similar to the way sustainability managers think about the impacts of a product on the environment and society throughout its lifecycle, TCO takes a long-term view of the value a product brings to a company by evaluating the direct and indirect costs of a product at the time of purchase. Over the next few months, BSR's new Center for Sustainable Procurement (CSP) will be exploring ways the TCO model and its application could support the incorporation of sustainability information and data into procurement decisions. Is there an opportunity to align TCO and lifecycle assessment (LCA) information to form a total impact and ownership model?

How TCO Works

According to Shoshanah Cohen, director of Stanford's Global Supply Chain Management Forum, TCO expands the traditional procurement approach to account for more than just purchase price. "It captures all direct and indirect costs associated with taking ownership of a product or material, helping companies understand what they are actually getting for their money," she explained. In effect, TCO includes the purchase price as well as costs associated with shipping, insurance, taxes, storage, and disposal of materials at the end of the product's useful life. Rather than distributing the costs into different buckets (or budgets) based on materials used or labor associated with the product, TCO counts all costs associated with the product. If done well, this model can help managers avoid rushing into a decision that at first glance appears to be of good value, when analysis of the operational and product development costs could paint a very different picture. For a company like Hilton Worldwide (a major funder of BSR's CSP), this model is important for the purchase of a range of goods. Alec Burnett, a procurement expert and Hilton supply management's director of brand relations for full-service and luxury brands, pointed out that TCO can uncover critical cost savings for the company when a procurement manager is evaluating two seemingly similar products at very different purchase prices. Consider linens, which comprise a significant expense for the company and are typically evaluated based on two characteristics: thread count, and whether the material is cotton, synthetic, or a blend of both. "There are 15 to 20 other attributes that measure quality, performance, and longevity of the product and increase or decrease the cost of ownership," Burnett said. "If product A has an expected life of five years, based on normal laundering, but you choose product B, which lasts only half of this time, you will need to replace the linens twice as often." In this scenario, TCO usefully accounts for the costs of disposing of and replacing the product—as well as any factors affecting this, such as fluctuations in the cotton commodity market. This can have a substantial impact on the company's costs over the lifetime of the product.

The Challenges Associated With Using TCO

Although almost every company recognizes the value of TCO as a decision-making tool, Cohen noted, "It isn't implemented across the board." The electronics industry tends to use it due to the industry's cost-conscious nature and the rapid changes in technology leading to the obsolescence of products. But other industries may find TCO daunting. "The ability to gather and allocate all data associated with a product is the most difficult," said Cohen. "If you receive a truckload with 50 different products, TCO requires a company to allocate costs of freight, handling, and insuring to each." For Hilton, this is less of a challenge because the company has extensive historical data on the costs to ship, maintain, use, and replace products at a corporate and brand level. Burnett said the greater challenge for Hilton is inventory management, particularly for a product that has been custom-designed for the company. "When you are aligning with a specific supplier to produce something to a specification, it is important to find a balance between what is the minimum amount to be held while being conscious of uncontrollable situations such as a sudden growth in demand and/or fluctuations in the material market for a product—both of which could heavily impact costs and supply-gap management," Burnett explained.

A total cost of ownership (TCO) analysis is vital to examine the financial impact of implementing new technologies in business. In information technology, assessing the TCO provides a broader view of the investment and the value of the product over its lifespan. For ROI estimation, identifying the TCO is essential, which is sadly often neglected or underestimated.

Understanding the Total Cost of Ownership

According to Investopedia, TCO is the purchase price of an asset or product, plus the costs of operation. A TCO analysis helps businesses determine the difference between short-term (purchase price) and long-term (total cost of ownership) costs of a product or system. It helps make an informed purchasing decision when selecting the right vendor from multiple alternatives. In general, a lower total cost of ownership offers better value in the long run.

Why Is TCO Important?

Knowing the upfront cost of a purchase is easy; it’s the hidden costs that are hard to anticipate. A TCO analysis helps in understanding the indirect expenses, such as maintenance, support and license fee, that would add up during the lifecycle of the product.

Businesses use the TCO to analyze the viability of potential business deals or purchases over the long term. This analysis provides an insight into which solution would bring a positive ROI and supplement business growth. It also helps you stay prepared for unexpected financial surprises.

TCO: How Is It Calculated?

To come close to a realistic TCO, you must identify and include all the elements associated with the purchase while calculating the total cost of ownership.

To help you understand the concept of TCO better, let’s consider a simple example.

A company plans to purchase a new coffee vending machine for the workplace. To determine the TCO of the vending machine, the company should include additional costs apart from the initial purchase price such as:

• Installation
• Coffee beans
• Milk
• Water
• Cups
• Energy
• Maintenance
• Repair
• License/subscription

TCO in IT

“Gartner defines total cost of ownership as a comprehensive assessment of information technology or other costs across enterprise boundaries over time. For IT, TCO includes hardware and software acquisition, management and support, communications, end-user expenses and the opportunity cost of downtime, training and other productivity losses.”

The components of TCO may vary depending on your industry and business needs. Be sure to include the following components while analyzing the TCO for your next technology investment.

Acquisition Costs

These are the costs of the software or application, including software licenses or subscription fees. It also includes the costs of installation and employee training.

Operating Costs

These are recurring costs throughout the lifespan of the software. It includes setting up, maintenance as well as updates of the product, ongoing training with every software update, support services and security of your software.

Resource Costs

You will need knowledgeable personnel or professionals to run the software to gain optimum results. Hiring in-house technicians or third-party consultants to manage the software translates into additional costs.

Spanning Backup: Lowest TCO in Its Class

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Learn more about Spanning’s lowest TCO offerings for Google Workspace and Office 365, or dive in and get started today.

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