Total Cost Analysis

By Brandon Ostler

Agenda

• Total Cost Analysis defined • Nuts and Bolts • Brainstorming Exercise • Benefits of Total Cost Analysis • How it works • Real world example • Exercise • Summary • Readings List

What is Total Cost Analysis?

•

Total cost analysis

(total cost of ownership) is the sum of the costs related to the acquisition and use of materials, products, or services.

The Nuts and Bolts

• Three main components – Acquisition costs – Ownership costs – Post-ownership costs

Common Acquisition Costs

• Purchase Price • Planning Costs • Taxes • Financing Costs

Common Ownership Costs

• Downtime Costs • Risk Costs • Conversion Costs • Non-Value-Added Costs

Common Post-Ownership Costs

• Environmental Costs • Warranty Costs • Product Liability Costs • Customer Dissatisfaction Costs

Asset Cost Acquisition Costs

The Big Picture

Post-Ownership Costs Ownership Costs Asset Life Cycle

Quick Practice

Determine if the following are acquisition, ownership, or post-ownership costs: 1. Tariffs 2. Recalled products 3. Lost Sales 4. Frequently moving Work-in-process inventory 5. Contract Determination

Brainstorming Exercise

• Why would your organization want to conduct a Total Cost Analysis?

Who Benefits?

• Your firm – Service Providers – Retailers – Manufacturers • The end customer

How It Works

1. Find each component cost 2. Sum the cost of the three components 3. When purchasing, compare total cost from potential suppliers 4. If for a process, look for ways to reduce total cost

Real World Example

• ABC, a retail store, is deciding whether they should implement a new billing system or upgrade their current system. • Both systems are expected to last 3 years and both will need to be un-installed at the end of the third year. • What should they do?

Real World Example

New Billing System

Acquisition Costs

Hardware Initial Software Initial Training Transition Costs

Ownership Costs

Subsequent Upgrades Subsequent Training Maintenance Operations

Post-Ownership Costs

Un-install system Total Annual Costs Year 0

$4,688

$1,067 $2,000 $823 Year 1

$412

Year 2

$0

Year 3

$0

Total

$5,100

$1,067 $2,000 $823 $798

$0 $0

$412

$1,713

$1,000 $214 $101 $398

$0 $1,842

$1,000 $213 $220 $409

$0 $1,379

$500 $149 $330 $400

$1,500

$1,500 $1,210

$4,934

$2,500 $576 $651 $1,207

$1,500

$1,500 $4,688 $2,125 $1,842 $2,879

$11,534

Real World Example

Upgrade Current System

Acquisition Costs

Hardware Upgrades Initial Software Initial Training Transition Costs

Ownership Costs

Subsequent Upgrades Subsequent Training Maintenance Operations

Post-Ownership Costs

Un-install system Total Annual Costs Year 0

$200

$200 Year 1

$0

Year 2

$100

$100 Year 3

$0

Total

$300

$300 $0 $0

$0 $0 $2,152

$100 $42 $532 $1,478

$0 $2,792

$100 $45 $1,078 $1,569

$0 $3,130

$150 $38 $1,567 $1,375

$1,367

$1,367 $0

$8,074

$350 $125 $3,177 $4,422

$1,367

$1,367 $200 $2,152 $2,892 $4,497

$9,741

Real World Example

New billing system total cost: $11,534,000 Upgrade current system total cost: $9,741,000 ABC should upgrade their current billing system as they will incur the lowest total cost.

Exercise

Total Cost Analysis for Product XYZ

Price Tag After-sale allowances Contract Negotiations Operations Inventory Carrying Cost Customer Service

Supplier A

$300 $50 $400 $25 $50 $25

Supplier B

$150 $75 $550 $75 $100 $50 Which supplier has the lowest total cost? Which supplier has the highest cost of post-ownership?

Exercise Answer

Acquisition Cost

Price Tag Contract Negotiations

Ownership Cost

Operations Inv. Carrying Cost

Post-Ownership Cost

After-sale allowances Customer Service

TOTAL COST Supplier A $700

$300 $400

$75

$25 $50

$75 $850

$50 $25

Supplier B $700

$150

$175

$550 $75 $100

$125

$75 $50

$1,000

Summary

• Total Cost Analysis: – Three main cost components – Can bring out the “hidden” costs.

– Spotlight the potential cost problems before they become problems – Can be used to find cost savings

Readings List

• Steven M Bragg.

Cost Reduction Analysis: Tools and Strategies.

• Wouters, M. et al.

The Adoption Of Total Cost Of Ownership For Sourcing Decisions--A Structural Equations Analysis.

• Degraeve, D. et al.

The use of total cost of ownership for strategic procurement: a company-wide management information system.

• Lisa M. Ellram.

Total Cost Of Ownership; An Analysis Approach For Purchasing.

• David Burt, et al.

Supply Management.

Eighth edition. pp 303 320.