Table of Contents
Defining and Calculating TCO
Total cost of ownership (TCO) is an assessment of all costs, both direct and indirect, involved with an item over the useful life of that item. Most frequently, TCO is used at the beginning of the purchase process to evaluate which is the most cost-effective choice. When TCO is calculated at the time the selection decision is being made, many of the included costs are estimated, because they have not yet been incurred.
Applying TCO to Inventory
The descriptions that follow show how to calculate the total cost factors for inventory materials. They represent only some of the techniques that have been used successfully. There are many ways to approach these issues; if you are already using another method successfully, then continue to use it. If you currently don't have a method to calculate these factors, then consider the ones presented in this issue of NAPM InfoEdge.
Applying TCO to Capital Equipment
The purchase of capital equipment contains additional areas of cost that should be considered when calculating total cost of ownership. A piece of equipment will be operational in your facility for many years. Calculating the total cost of the equipment over its entire operating life will give you a more cost-effective choice than will figuring initial cost only.
TCO and International Sourcing
In addition to the cost factors described for inventory and capital equipment, another set of costs will be incurred if either is purchased from an international source. The following areas of cost, known as "total landed cost," may be incurred when dealing with international shipments.
MARY LU HARDING, C.P.M., CPIM, CIRM
Mary Lu Harding is a principal of Harding & Associates in Bristol, Vermont. Formerly, she worked for Digital Equipment Corporation as a purchasing manager with technology expertise. Ms. Harding co-authored Purchasing, is a contributor to the C.P.M. Study Guide, 6th edition, and developed the NAPM instructional videotape on systems contracting. She has also contributed to NAPM Insights and Purchasing Today™, has written and reviewed questions for the C.P.M. certification exam, and has developed courses for NAPM. Ms. Harding has been a presenter at several NAPM Annual International Conferences, and has held leadership positions in NAPM.
- Harding, Michael and Harding, Mary Lu. Purchasing, Barron's Business Series, Inc., 1991
- NAPM 80th Annual International Conference Proceedings, "Purchasing from Off-Shore Sources: Total Landed Cost," National Association of Purchasing Management, 1995
- NAPM 75th Annual International Conference Proceedings, "Total Cost vs Price: Understanding the Difference," National Association of Purchasing Management, 1990
FOR FURTHER READING
- Ellram, Lisa, Ph.D., C.P.M. Total Cost Modeling in Purchasing, Center for Advanced Purchasing Studies, 1994
- NAPM Insights, April 1994, "Total Cost Revisited: Don't Forget Disposal!"
- NAPM Insights, May 1994, "ABC and ABM: New Tools for Managing Purchasing Costs"
- NAPM Insights, September 1994, "Decision Trees: Another Tool in the Planning Process"
- NAPM Insights, October 1994 and November 1994, "Hedging Your Bets"
- NAPM Insights, October 1994, "Learning Their ABCs"
- NAPM Insights, October 1994, "Selection of Currency and Hedging Strategy in Global Supply"
- NAPM 80th Annual International Conference Proceedings. "Analyzing Purchasing Performance Using Activity-Based Costing," National Association of Purchasing Management, 1995
- NAPM 80th Annual International Conference Proceedings. "Effects of Activity-Based Costing on Purchasing," National Association of Purchasing Management, 1995
- Purchasing Today™, January 1996, "Cost Reduction Resources"
- Purchasing Today™, May 1996, "Calculating Total Unit Cost"
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