Eskom Procurement Book 2015

TOTAL COST OF OWNERSHIP (TCO)

SYNOPSIS Procurement managers are integrally involved in making purchase decisions and, when they do, they must ensure they understand the Total Cost of Ownership (TCO), not just the purchase price. TCO is a calculation designed to help people make more informed financial decisions when procuring products or services. It is also one of the most important concepts in purchasing and supply management. Rather than simply looking at the purchase price of an object, TCO adds to the initial purchase price other costs expected to be incurred during the life of the product, such as service, repair, and insurance. Various TCO models exist and are used to determine the true cost of ownership of a product or service. 6.1 INTRODUCTION This chapter will explore the concept of TCO, which is defined here as a philosophy for developing an understanding of all relevant supply chain-related costs of a particular transaction or process. In the supply chain, TCO often focuses on the cost of doing business with a particular supplier for a particular good or service. TCO considers total cost of acquisition use/administration, maintenance and disposal of a given item or service. TCO modelling requires determining all the costs related to the procurement of a given product or service or group of products and services to allow for an accurate estimate of true costs, for cost comparison purposes and as a critical tool for use in supplier negotiation. 6.2 TOTAL COST OF OWNERSHIP (TCO) While the concept of total cost applies whether companies engage in domestic or international buying, the added complexity that surrounds international purchases also means greater opportunity to experience a wider set of total cost elements. With so many cost variables to consider, the job of consolidating this information into a useful package can be intimidating [1]. One study has identified over a dozen total cost categories with over 125 separate cost elements embedded throughout these categories [2]. TCO is a topic companies simply cannot ignore as they search for new sources of supply. This section defines the concept of total cost, including reasons to measure it. Next, three common types of total cost models are presented. Following this, the cost elements that typically comprise a total cost model are presented followed by a case example that shows the development of a total landed cost model.

6.2.1 TOTAL COST

Total cost includes expected and unexpected elements that increase the unit cost of a good, service, or piece of equipment. Total cost systems attempt to capture these cost elements. The logic behind the development of total cost systems

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