Transcript Chapter 1

Chapter 3
TOTAL COST OF
OWNERSHIP (TCO)
DOSEN : IR. HOETOMO LEMBITO, MBA, CSLP
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Objektif Perkuliahan
• Memahami konsep TCO
• Memahami fungsi TCO dalam SCM
• Memahami keterkaitan konsep TCO
dengan aktivitas purchasing management
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Total Cost of Ownership
• Total cost of ownership is a philosophy
for really understanding all supply chain
related costs of doing business with a
particular supplier for a particular good or
service (Lisa Ellam, May 1999)
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Key Concepts
• Purchase Price: But One Component of
Cost
• The Importance of Total Cost of
Ownership in Supply Management
» Service Providers
» Retail
» Manufacturing
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Key Concepts
• Three Components of Total Cost
» Acquisition Costs
» Ownerships Costs
» Post-Ownership Costs
• TCO, Net Present Value Analysis (NPV),
and Estimated Costs
• Supply Management Action
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Total Cost and WCSM
• To achieve World Class Supply
ManagementSM, managers must shift their
focus in procuring materials, services and
equipment from price to total cost.
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Importance of TCO
• Service Providers
• Retail
• Manufacturing
• Supply Chains/Supply Networks
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Service and Retail Providers
• Understanding what drives the cost of overhead
expenditures is crucial to any service business
• Revenue must cover the direct costs, material
and labor, and overhead in order to generate a
profit
» TCO analysis of recurring material costs are often
overlooked and can yield great savings
» TCO analysis of the labor base can reap lower per
person costs, greater benefits, and improved morale
» TCO analysis of equipment purchases may help reduce
the expenditures for maintenance and parts over the
lives of the investments
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Manufacturing
• Manufacturers are concerned with all of
the same TCO issues as service and retail
firms, with some added issues
• Issues that are particularly important in
cost analysis for manufacturers are:
» Direct materials
» Manufacturing overhead
• Emphasis should be placed on the
variance between “should cost” and
actual cost.
» This should not be confused with price
variance
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Activity Based Costing
• A major problem in TCO analysis of
manufacturers is accurate allocation of
manufacturing overhead
• Many manufacturers have used activity-based
costing to help improve cost allocation
• Activity-based costing (ABC) is a technique for
accumulating cost for a given cost object that
represents the total and true economic
resources required or consumed by the object
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Supply Chain/
Supply Networks
• TCO analysis may
include the study of:
» Manufacturability
» Infrastructure
» Outsource decision
» Analysis of suppliers
beyond tier one
» Structure of foreign and
domestic
tariffs/duties/taxes
» Costs of delivery
» Foreign regulations
» Foreign
political/economic
stability
» Foreign exchange risk
» Language/communicati
on requirements
» Volatility of endcustomer demand
» Inventory carrying
costs
» Inventory risk
» Quality costs
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Three Components
of Total Cost
• Acquisition Costs
• Ownerships Costs
• Post-Ownership Costs
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TCO Components
• Acquisition costs
»
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»
»
Purchase price
Planning costs
Quality costs
Taxes
Financing costs
• Ownership costs
»
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• Post-ownership costs
» Environmental costs
» Warranty costs
» Product liability costs
» Customer
dissatisfaction costs
Downtime costs
Risk costs
Cycle time costs
Conversion costs
Non-value added costs
Supply chain costs
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Acquisition Costs
• Purchase Price
• Planning Costs
• Quality Costs
• Taxes
» Customs Duties and Tariffs
» Regional Trade Agreements
» Income-Base Shifting
• Financing Costs
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Ownership Costs
• Downtime Costs
• Risk Costs
• Cycle Time Costs
• Conversion Costs
• Non-Value Added Costs
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Ownership Costs
• Supply Chain Costs
» Forecasting
» Administration
» Transportation
» Inventory
» Manufacturing
» Customer service
» Supplier selection/relationships
» Global sourcing
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Post - Ownership Costs
• Environmental Costs
• Warranty Costs
• Product Liability Costs
• Customer Dissatisfaction Costs
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TCO, Net Present Value Analysis (NPV),
and Estimated Costs
• NPV analysis is frequently incorporated
into TCO analyses
• NPV analyzes present values of the initial
expenditure along with the likely future
revenue and expenditure streams
• The present value of a sum of future cash
flows discounted by a required rate of
return
» NPV greater than zero suggests accepting the
investment
» NPV less than 0 suggests rejecting the
investment
» NPV = 0 is the point of indifference
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Major Categories for the
Components of TCO
Total Cost of Ownership
Pretransaction Components
• Identifying need
• Investigating sources
• Qualifying sources
• Adding supplier to internal
systems
• Educating:
» Supplier ins firm’s
operations
» Firm in supplier’s
operations
Transaction Components
• Price
• Order
placement/preparation
• Delivery/transportation
• Tariffs/duties
• Billing/payment
• Inspection
• Return of parts
• Follow-up and correction
Posttransaction Components
• Line fallout
• Defective finished goods
rejected before sale
• Field failures
• Repair/replacement in field
• Customer
goodwill/reputation of firm
• Cost of repair parts
• Cost of maintenance and
repairs
Source: Lisa Ellram, “Total Cost of Ownership: Elements and Implementation,” International Journal of Purchasing
and Materials Management, Winter 1993.
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Tangential Reprographics Example
Tangential Reprographics
Net Present Value Analysis - Copier
Required rate of return
Year
20.00%
NOW
Cost of machine including
installation and testing (actual)
Manufacturer required overhaul
(estimated)
Cash inflows generated by using
machine (estimated)
Cash outflows incurred by using
machine (estimated)
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2
3
4
5
Present
Value
6
(120,000)
(120,000)
(9,000)
(5,208)
40,000
40,000
40,000
40,000
40,000
40,000
133,020
(7,000)
(7,000)
(7,000)
(7,000)
(7,000)
(7,000)
(23,279)
7,500
2,512
Salvage value (estimated)
Net present value of potential
investment
(12,955)
(Alternative Method)
Total of annual streams (from above)
(120,000)
Required rate of return
20
33,000
33,000
24,000
33,000
33,000
40,500
20%
20%
20%
20%
20%
20%
Sum of present value of annual
streams equals net present value of
potential investment
(120,000)
27,500
22,917
13,889
15,914
13,262
13,563
(12,955)
Internal rate of return
(120,000)
33,000
33,000
24,000
33,000
33,000
40,500
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15.66%
Hoetomo Lembito
TCO Formula
n
TCO = A + P.V.  (Ti + Oi + Mi – Sn)
i=1
A = delivered acquisition cost
P.V. = net present value
Ti = training costs in year i
Oi = operating costs in year i
Mi = maintenance costs in year i
Sn = salvage value in year n
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PVA Incorporated into a
TCO Analysis
Acquisition Cost = $120,000
PV Cash Outflows, yrs 1 - 6 =
23,279
PV of overhaul in yr 3 =
5,208
PV of salvage value in year 6 =
(2,512)
TCO =
$145,975
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PVA Formulas
• PVAnnuity = CF [ 1/r – 1/r(1+r)t ]
» CF = periodic cash inflow or outflow (must be the
same each period)
» r = discount rate per period (annual rate divided by
the number of periods in one year)
» t = total number of periods
• PV = FV / (1 + r)t
» FV = future value of single cash inflow or outflow
» r = discount rate per period (annual rate divided by
the number of periods in one year)
» t = total number of periods
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Concluding Remarks
• TCO is an analytical tool and a philosophy
• Accurate estimation of total costs requires
a cross-functional approach
• Supply management is a critical member
of such a cross-functional approach
• TCO is also applicable in one’s private life
enabling better decision-making
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