5 Reasons to Use Total Cost of Ownership
Compelling arguments in favor of total cost of ownership (TCO) as an effective procurement approach in today’s business world.
Controlling costs and managing new acquisition expenses have become pivotal goals for companies over the last few years. Keen on creating shareholder value and boosting bottom lines even when economic conditions weren’t cooperating, purchasing organizations maintained a sharp eye on their organizational bottom lines as they made both long-term and one-time procurement decisions.
Using total cost of ownership or “TCO,” buyers can go beyond bottom-line cost and develop more comprehensive pictures of exactly what they’re buying, what value that acquisition provides the company, and how much it costs over the long run. Here are five reasons firms are using TCO on a regular basis:
To determine overall lifecycle cost of a product or service. Looking at the direct cost of a product doesn’t cut it anymore. In today’s global business environment, there are myriad other expenses and variables that should be factored into the equation. Gartner defines TCO as a “comprehensive assessment of information technology (IT) or other costs across enterprise boundaries over time.” For IT, for example, TCO includes hardware and software acquisition, management and support, communications, end-user expenses and the opportunity cost of downtime, training and other productivity losses. By considering direct costs, indirect costs, transaction costs, and disposal costs, TCO gives procurement professionals a more complete picture about a specific financial investment.
To dig down into more granular performance metrics. The concept of “performance metrics” (defined as a measure of a company’s activities and performance) has been a difficult one for companies to wrap their arms around. Total cost of ownership helps to fill that gap, according to Hector Lozada-Vega, associate professor of marketing at Seton Hall University’s Stillman School of Business in South Orange, N.J. Lozada-Vega expects an increasing number of companies to more closely examine the TCO of the goods and services that they’re acquiring and using in the coming years. “It’s an elusive concept for many organizations,” he points out, “but it’s a critical one for firms that want a holistic, accurate picture of their activities and performance.”
To compare and contrast different variables associated with a purchase. Although it may be tempting to compare cost alone when assessing vendor bids, buyers that take into account overhead, implementation costs, employee training costs, transportation fees, delivery times, operational costs, and other company- and industry-specific expenses will come away with a more accurate picture of how much they are spending (in both dollars and time) over the span of the contract.
To integrate sustainability into the procurement process. In What Total Cost of Ownership Offers Sustainable Procurement, global business consultancy BSR says TCO provides a framework and language for describing and measuring sustainability impacts in a way that procurement managers can readily understand. For example, TCO can be used together with lifecycle analysis (LCA) and similar approaches to uncover and communicate opportunities for both cost savings and sustainability benefits for things such as energy and water efficiencies. Where LCA and TCO truly align is in their focus on what is "behind the label" or "price tag," reports BSR, “to understand the true cost and impact of a product from end to end.”
Hector Lozada-Vega, associate professor of marketing at Seton Hall University's Stillman School of Business expects companies to more closely examine the TCO of the goods and services that they’re acquiring.To assess the ongoing costs of a specific purchase. Some acquisitions (such as MRO supplies) are designed for one-time use, but others (such as IT equipment) will be in place for months or even years. TCO helps buyers look beyond the purchase price at the cost of installing the equipment, maintaining it over time, training employees on how to use it, and tracking its location and use during the time that it’s in service. In Total Cost of Ownership (TCO): Definition, Meaning and Use, for example, author Marty Schmidt points out that ownership brings not only purchase costs, but also costs for installing, deploying, operating, upgrading, and maintaining the same assets. Ignore this and it won’t be long before equipment downtime and high training costs take their toll on any savings incurred from buying solely based on cost.
When procurement organizations use TCO to get a complete picture of the overall costs associated with a product or service acquisition, the benefits go beyond just cost reduction over time. Supplier relationships strengthen because they are no longer strained by extreme cost-cutting measures, competitive advantage improves, and the company gains visibility over its overall performance.
“TCO typically produces a win-win result,” says Lozada-Vega, “for both the buying organization and for its supplier-partners.”
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