Eskom Procurement Book 2015

TOTAL COST OF OWNERSHIP (TCO)

is that unit cost or price never equals total cost. Based on this proposition it becomes important to understand the size of the gap between a unit price and its corresponding total cost. It is also important to know, in some detail, what makes up that gap. Those involved in international purchasing are fully aware that variables, such as long lead times and distance, carry additional costs and risks that are not as relevant to domestic purchases. Supply managers are increasingly realising that they need to quantify these cost elements, as abstract as some may be, wherever possible. One expert has noted that the ‘soft costs’ that are rarely included in off-shore cost models are starting to become painfully clear [3]. Almost every purchasing measurement system includes price-related measures rather than total cost measures. Price is by far the easiest of any metric to identify across a supply chain. Without a total cost system, however, it is difficult to make sourcing decisions that do not contain a fair amount of subjectivity. It becomes next to impossible to select a higher price sourcing option (but a lower total cost option) without a total cost system supporting that decision. Having a ‘gut feel’ that a higher price supplier will be the lower total cost supplier will not work and companies must obtain total cost data to make objective decisions based on total cost. The reasons for measuring total cost are clear. A recent study by a leading trade journal found that over 80% of companies that employed total cost analysis reduced their total landed cost [3]. • Identify the impact of different cost elements, including quality non- conformances. • Track in real terms cost improvements over time. • Gain management’s attention regarding the areas where cost reduction efforts will have their greatest payback. • Target specific areas for improvement or elimination. • Make fact-based rather than subjective supply chain decisions. • Gain a better understanding of the supply chain. Companies operate in a volatile world business market with price fluctuations that are influenced by the world economy. Importers can and do experience product and logistics cost increases. A survey by Archstone Consulting and the Supply Chain Management Review reports that 35% of manufacturers experienced a 25 to 50% increase in material and component costs from foreign suppliers over a three year period. Over 50% of survey respondents reported up to a 25% increase in product costs. Similar increases were reported for logistics and transportation costs [3]. Therefore, in uncertain times, the need to understand every element of cost is great. Total cost models help companies to:

6.2.2 MEASURING TOTAL COST

131 CHAPTER 6