The Federal Strategic Sourcing Initiative (FSSI) Understanding the Elements of Total Cost of Operations (TCO)

1. TheFederal Strategic Sourcing Initiative (FSSI) Understanding the Elements of Total Cost of Operations (TCO)

2. Workshop Objectives • Provide a brief overview of strategic sourcing and the Federal Strategic Sourcing Initiative (FSSI) • Provide a comprehensive definition of Total Cost of Operations (TCO) • Explain the key elements of TCO • Clarify the difference between cost elements and cost drivers • Present illustrative examples of acquisition decisions based on TCO analysis • Share the benefits that can be achieved by incorporating TCO analysis into the procurement process

3. Prelude What is TCO? • Total Cost of Ownership • The total cost of owning and operating an asset over its expected period of use, i.e., lifecycle cost. • Also includes costs to acquire and dispose of the asset • Total Cost of Operations • Similar to Total Cost of Ownership, but recognizes that certain assets might be leased or provided as part of a contracted operation. • Provides a useful cost framework to evaluate: • Policy options • Business process alternatives • Investment alternatives, e.g., in-house vs contract; own vs lease • Acquisition alternatives, e.g., vendor vs vendor; contracting options

4. The Federal Strategic Sourcing Initiative is an OMB-initiated program that was established in November of 2005 2005 OMB Mandate • An OMB memo issued May 2005 required agencies to identify no fewer than three commodities to be purchased through strategic sourcing by October 2005 (excluding software purchased through SmartBUY). The memo stated that: • Agencies needed to leverage spending to the maximum extent possible • Sound business decisions needed to drive spending Federal Strategic Sourcing Initiative (FSSI) • In November of 2005, as a direct result of the OMB mandate, FSSI was established with a mission to improve the federal government acquisition value chain, increase socio-economic participation and ultimately lower total cost of operations and/or ownership for strategic sourcing vehicles • FSSI is governed by OFPP and the Strategic Sourcing Working Group under the Chief Acquisition Officer’s Council • More than 60 Federal agencies, boards and commissions actively participate in the FSSI • Use of FSSI vehicles is non-mandatory, but agencies are encouraged to look at FSSI solutions first • Currently, three FSSI vehicles exist with GSA serving as the Executive Agent: • Express and Ground Domestic Delivery Services – GSA Schedule 48 BPA • Office Supplies – GSA Schedule 75 BPAs • Wireless Telecommunications Expense Management (TEM) Services – IDIQ, multiple award contract

5. Strategic sourcing is a process that strives to optimize an organization’s supply base while reducing Total Cost of Operations and improving mission delivery Strategic sourcing is the collaborative and structured process of critically analyzing an organization’s spending and using this information to make business decisions about acquiring commodities and services more effectively and efficiently http://www.whitehouse.gov/omb/procurement/comp_src/implementing_strategic_sourcing.pdf

6. The benefits of strategic sourcing and drivers of TCO are numerous and go far beyond simple reductions in unit costs Primary Benefits of Strategic Sourcing Reduction in Cost Per Unit Change in Consumption/ Volume Change in Consumption/ Volume Improved Operating Efficiency Improved Focus on Socio-economic Goals Reduced Procurement-Related Operating Expense • Pricing Improvements • Lower unit price • Volume rebates • Payment term discounts • Supply Chain Savings • Cost of capital • Warehousing costs • Shipping costs • Reduced Lifecycle Costs • Maintenance costs • Operating costs • Disposition costs • Demand Management • Eliminate demand • Reduce consumption • Encourage substitution • Change product mix • Specification Review • Eliminate “gold-plating” • Simplify specifications • Alternative products • Socio-economic Goals • Structured analysis of small/disadvantaged business opportunities • PO Processing • Accounts Payable • Receipt/Warehousing • Standardized procurement process • Other operating efficiencies • Performance Monitoring • Structured metrics and periodic review of contractor performance Reduced Non-Procurement Related Operating Expense DRIVERS OF TCO

7. What is Total Cost of Operations?

8. One of the primary goals of strategic sourcing is the reduction of Total Cost of Operations WHAT IS TOTAL COST OF OPERATIONS? • Total Cost of Operations (TCO) is a comprehensive, full cost accounting estimate designed to help consumers and commodity managers assess costs • TCO consists of costs incurred throughout the life cycle of a service or commodity, including acquisition, deployment, operation, support and retirement • TCO identifies costs which are made up of two major components - direct and indirect: • Direct costs traditionally are made up of labor and capital costs • Indirect costs are more of the “soft” costs associated with an acquisition and tend to be more difficult to measure and rationalize Understanding TCO broadens our baseline understanding of spend and identifies sourcing opportunities beyond purchase price

9. TCO of a commodity goes beyond purchase price, it also includes acquisition costs, lifecycle costs, end of life costs and other ILLUSTRATION TOTAL COST OF OPERATIONS (TCO) ELEMENTS(Conceptual Example) For some commodities, cost elements beyond purchase price may be significant, at times equaling or exceeding initial purchase cost over the commodity lifecycle

10. Different commodities can vary significantly in their composition of TCO elements ILLUSTRATION NOTES TOTAL COST OF OPERATIONS (TCO) ELEMENTS(Conceptual Example) • Many buyers will focus on achieving a competitive purchase price and will overlook opportunities to improve other cost elements • For some commodities, purchase price is not the largest cost element • Therefore, it is important to consider all cost elements, including (but not limited to): • Internal procurement, contract management and billing/invoicing processes • Internal management of the commodity • Operational costs (cost of use, spare parts, maintenance, etc.) • Disposal costs Example A – Furniture

11. Key Elements of Total Cost Analysis: Understanding Cost Elements vs. Cost Drivers

12. Understanding the total cost of a commodity involves the identification of cost elements and cost drivers COST ELEMENTS VS COST DRIVERS • Cost drivers can at times be significant sources of savings for some commodities • Drivers of cost within suppliers’ operations can be very important for commodities where unit price is still likely to be the largest component of our total cost

13. When identifying the various cost elements of TCO, it is also important to consider the percentage of TCO that is comprised of each the costs elements For a common piece of office equipment - a network printer – there are multiple TCO components that should be considered when conducting an acquisition. What percentage of the total cost do each of these components make up? NETWORK PRINTER COST COMPONENTS 5%* 50%* 45%* Source: Prudential Equity Group Research, Oct 2006; Lexmark International; Censeo Analysis * Percentages referenced above are based on an industry report from Lexmark International; this break out will not be true in all scenarios – End of Lifecycle Costs are also components that impact the TCO of a network printer, but the estimated percentage was not provided in the referenced industry report The percentage break out of TCO components does not always align with initial assumptions and can impact the results of a total cost analysis

14. As demonstrated in the previous example, consumables, maintenance & IT support, and equipment costs are the key cost elements of desktop printers • RELEVANT TOTAL COST COMPONENTS • Purchase Price: • Hardware: Annual depreciation cost of printers • Acquisition Process Costs: • Acquisition: Estimated acquisition costs associated with requirements validation & contracting purchasing activity • Lifecycle Costs: • Operations & Maintenance: • IT Support: Cost estimate of in-house IT help desk support provided to local and network printers • User Support: Cost estimate of work effort associated with toner and paper replenishment performed by users • Property Mgmt: Estimated property management personnel costs associated with managing printers • Consumables: • Paper and toner costs • Power: Estimated power costs associated with devices • End of Life Costs: • Disposal: Cost of product disposal at end of life • Understanding internal costs related to purchasing and managing a commodity is important in identifying savings opportunities DESKTOP PRINTER TOTAL COST OF OPERATIONS BREAKDOWN Purchase Price & Acquisition Costs - Device Lifecycle Costs – Operations & Maintenance Lifecycle Costs - Consumables Total Cost of Operations Source: Prudential Equity Group Research, Oct 2006; Lexmark International; Censeo Analysis * Percentages referenced above are based on an industry report from Lexmark International; this break out will not be true in all scenarios – End of Lifecycle Costs are also components that impact the TCO of a network printer, but the estimated percentage was not provided in the referenced industry report

15. Key Elements of Total Cost Analysis: Conducting A Complete TCO Evaluation – In The Workplace

16. With most acquisitions, unit price is often the only cost component considered NETWORK PRINTER COST COMPONENTS $725.20 Source: Censeo analysis Based on the data above, Device C would be the best value

17. But to truly obtain best value, it is critical to evaluate all TCO cost components before completing an acquisition NETWORK PRINTER COST COMPONENTS $2,804.45 A complete analysis of TCO indicates that Device B truly is the best value solution • * Usage estimates are based on avg # users per device (8), typical # of pages per user (500) resulting in the estimated total # of monthly pages (4,000). Projected Consumables Costs assume utilization of high-yield cartridges where available. • Source: Censeo analysis

18. Key Elements of Total Cost Analysis: Conducting A Complete TCO Evaluation – In Daily Life

19. The process of conducting a TCO analysis can be applied in everyday life TOTAL COST OF OPERATIONS (TCO) EVALUATION When purchasing a car consumers often consider only one variable – sticker price – and based on the sticker price in the example to the right, Example A, the non-hybrid is the more economic choice *End of Life Costs are not included in this example **Cost of ownership is assumed over a five year period and 15,000 miles a year Source: http://www.edmunds.com/advice/buying/articles/59897/article.html TCO analysis indicates that the cheaper car to buy is actually the more expensive car to own and operate

20. When selecting a means of transportation, it is important to understand how different cost drivers can influence the TCO Commuting to work is a daily activity for most individuals. In nearly all instances, there are a number of expenses incurred with a daily commute. These expenses will vary based on method of transportation, distance traveled, number of options available, etc. These expenses may also drive us to choose one method of transportation over another. For this exercise, assume that there are only two commuting options available, to drive or to utilize public transportation. Based on the “out of pocket” expense incurred on a daily basis, let’s calculate the cost of a daily commute: Estimated Daily Cost of Commuting Based on an initial assessment, there are multiple cost components that should be considered for both methods of transportation But are these the only cost drivers?

21. In our assessment of the daily cost of commuting, it is important to remember that all costs may not be apparently obvious In our calculations of the cost of a daily commute, have we considered all costs? NOTES Estimated Daily Cost of Commuting • There are a number of additional cost drivers that were not immediately apparent in this example • These additional costs can have a significant impact on total cost, and only by assessing all drivers can one truly understand the total cost and make an informed decision between the two alternatives • Time is another cost element that was not considered. Time can be assessed as an opportunity cost. • Because of limited contracting resources within the government, time is a critical element in any acquisition and cost analysis Cost Components *Figures for “drive” method assumed for a 2009 Honda Civic over a five year period and 15,000 miles a year Source: http://www.edmunds.com/advice/buying/articles/59897/article.html

22. Understanding the Benefits of TCO

23. Examples Once we understand cost elements and drivers and identify specific actions we can take to impact total cost, savings estimates can be developed to support recommended changes SAVINGS CALCULATION FRAMEWORK – TOTAL COSTS • Price • Volume Rebates • Payment term discounts • Cost of Capital • Warehousing Costs • Shipping costs • Maintenance costs • Operating, energy and other costs • Disposable costs • Elimination • Substitution • Change in mix • Cost of processing purchase orders • Cost of processing accounts payable • Cost of receipt/warehousing • Other Operating efficiencies Reduced Prices Reduction in Cost per Unit Reduced Supply Chain Costs Reduced Lifecycle Costs Change in Consumption/ Volume Total Savings Related to Purchased Goods and Services Reduced Procurement Related Operating Expense Improved Operating Efficiency Reduced Non-Procurement Operating Expense

24. Understanding TCO and how to apply the concept to acquisition decisions can result in significant savings opportunities, specifically unit cost reduction and planned changes in consumption and volume NOTES • Unit price reductions can be achieved by: • Negotiating payment terms to gain pricing improvements and discounts • Optimize the supply chain • Reducing lifecycle costs through the management of maintenance costs, operating costs, and disposal costs • Planned changes in consumption and volume can be achieved through: • Demand management, eliminating demand and reducing consumption • Specification review, simplifying specifications and suggesting alternative products The following slide provides an example of how unit price reductions and changes in consumption/volume can result in reduced lifecycle costs and efficiencies

25. In the example below, understanding the TCO elements of lifecycle costs and specification requirements can result in significant cost savings when making an acquisition decision EXAMPLE ROOFING SCENARIOS 20-YEAR LIFETIME COST COMPARISON ($ per SF) NOTES • Reduction in Cost per Unit and Lifecycle Costs: • Investing in higher quality materials, workmanship, and warranty coverage upfront will cost more in year one, but will provide the lowest “lifetime” TCO • Change in Consumption/Volume: • For major facility capital investments like HVAC equipment or roofing, clearly identifying and assessing specifications can result in cost savings by reducing consumption (and limiting replacements of parts or full structures) 3 1 2 4 Source: Censeo Analysis

26. TCO can also help evaluate the benefits of operational decisions such as changes in consumption/volume and improved operating efficiency NOTES • Change in consumption/volume and improved operating efficiency can be achieved in a number of ways: • Through the implementation of an online ordering system to reduce paper and manual transactions and improve invoice processing and auditing • Business Process re-engineering The following slides provide an example of how to calculate savings gained through improved operational efficiencies

27. Reducing processing times improves operational efficiency IMPROVED OPERATIONAL EFFICIENCY– PROCESSING TIME Shipment of FedEx Packages PREVIOUS SHIPPING STEPS REVISED SHIPPING STEPS • Employee walks to copier room to obtain FedEx letter and requisition form • Employee walks back to their desk to complete the form • Employee secures requisition form to the letter with tape • Employee walks back to the copy room to place the outgoing letter in a designated place • At a designated time a mailroom employee walks the halls and picks up all out going FedEx packages and mail and returns all to the mailroom • In the mailroom the mailroom employee keys into a FedEx system the destination address • The mailroom employee records the tracking number on the requisition form • The form is returned to the original sender • The form is secured in a file cabinet • FedEx then picks up all outbound shipments • All time was studied and this took on average 14 minutes and 42 seconds to complete • Employee walks to copier room to obtain a FedEx letter • Employee returns to their desk and clicks on FedEx Online • After 3 clicks the label prints out on the employees printer • Employee walks back to the copy room to place the outgoing letter in a designated place • At a designated time a mailroom employee walks the halls and picks up all out going FedEx packages and mail and returns all to the mailroom • FedEx then picks up all outbound shipments • All time was studied and this took on average 1 minutes and 22 seconds to complete Source: This example is provided courtesy of Federal Express Corporation

28. Reduced labor costs is an example of the savings that can be achieved through improved operational efficiency SAVINGS CALCULATION IMPROVED OPERATIONAL EFFICIENCY– PROCESSING TIME Reduced Labor Costs Associated With Shipment of FedEx Packages Savings Calculations • STEP 1: Divide the hourly labor rate of the individual conducting the procurement (based on GS level and pay grade) by 60 min in an hour to generate the estimated labor rate per minute. • STEP 2: Next, work with subject matter experts to estimate the current and future processing time of the given transaction and subtract the current time from the future processing time. Then, multiply the variance by the labor rate per minute identified in Step 1. • STEP 3: Identify the total number of transactions that are processed per year. Multiply this number by the labor cost savings per unit identified in Step 2. • These calculations result in the annual estimated labor rate savings achieved through improved processing time 1 2 3 Source: This example is provided courtesy of Federal Express Corporation

29. There are a number of key steps that should be completed as part of any acquisition to ensure a thorough TCO evaluation has been conducted and best value achieved STEPS TO CONDUCT A TCO EVALUATION • Before beginning any acquisition, through market research or product analysis, identify the key cost elements that comprise the total cost of operations for this commodity – beyond just price • Identify the cost drivers for this commodity – which of these can we control/influence? • Once the cost elements and drivers have been identified, assess each of these components and assign an estimate percentage of total cost– if the assigned percentage is not significant (falls below 5%) eliminate it from your evaluation • Identify the appropriate timeline to measure the total cost of this acquisition • With a revised, prioritized list of TCO components, assess the true cost of the commodity • Compare and save!

30. GSA FAS - FSSI Program Management OfficeFSSI website: www.gsa.gov/fssi Michel Kareis, PMP FSSI Program Manager michel.kareis@gsa.gov (703) 605-3669 Office of Management and Budget (OMB) Jack Kelly jkelly@omb.eop.gov (202) 395-6106 Points of Contact

31. Questions?