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Chapter 3

Chapter 3. TOTAL COST OF OWNERSHIP (TCO). DOSEN : IR . HOETOMO LEMBITO, MBA, CSLP. Objektif Perkuliahan. Memahami konsep TCO Memahami fungsi TCO dalam SCM Memahami keterkaitan konsep TCO dengan aktivitas purchasing management. Total Cost of Ownership.

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Chapter 3

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  1. Chapter 3 TOTAL COST OF OWNERSHIP (TCO) DOSEN : IR. HOETOMO LEMBITO, MBA, CSLP

  2. Objektif Perkuliahan • Memahami konsep TCO • Memahami fungsi TCO dalam SCM • Memahami keterkaitan konsep TCO dengan aktivitas purchasing management

  3. 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) TCO

  4. Key Concepts • Purchase Price: But One Component of Cost • The Importance of Total Cost of Ownership in Supply Management • Service Providers • Retail • Manufacturing

  5. 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

  6. 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.

  7. Importance of TCO • Service Providers • Retail • Manufacturing • Supply Chains/Supply Networks

  8. 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

  9. 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

  10. 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

  11. 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/communication requirements Volatility of end-customer demand Inventory carrying costs Inventory risk Quality costs

  12. Three Components of Total Cost • Acquisition Costs • Ownerships Costs • Post-Ownership Costs

  13. TCO Components Acquisition costs Purchase price Planning costs Quality costs Taxes Financing costs Ownership costs Downtime costs Risk costs Cycle time costs Conversion costs Non-value added costs Supply chain costs Post-ownership costs Environmental costs Warranty costs Product liability costs Customer dissatisfaction costs TCO

  14. Acquisition Costs • Purchase Price • Planning Costs • Quality Costs • Taxes • Customs Duties and Tariffs • Regional Trade Agreements • Income-Base Shifting • Financing Costs

  15. Ownership Costs • Downtime Costs • Risk Costs • Cycle Time Costs • Conversion Costs • Non-Value Added Costs

  16. Ownership Costs • Supply Chain Costs • Forecasting • Administration • Transportation • Inventory • Manufacturing • Customer service • Supplier selection/relationships • Global sourcing

  17. Post - Ownership Costs • Environmental Costs • Warranty Costs • Product Liability Costs • Customer Dissatisfaction Costs

  18. 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

  19. Major Categories for the Components of TCO Pretransaction Components Identifying need Investigating sources Qualifying sources Adding supplier to internal systems Educating: Supplier ins firm’s operations Firm in supplier’s operations Total Cost of Ownership • 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.

  20. Tangential Reprographics Example

  21. 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

  22. 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

  23. 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

  24. 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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