Eskom Procurement Book 2015

TOTAL COST OF OWNERSHIP (TCO)

6.2.3 THE HIDDEN COSTS

The obvious costs of purchasing internationally, which can alter any savings realised from the practice, are only part of the cost equation. Most sourcing experts acknowledge that sourcing offshore contains a variety of hidden costs that can undermine the effectiveness of any global strategy. So, what are the hidden costs of global sourcing [4]? These are illustrated in Table 6.1.

Table 6.1: Hidden costs of global sourcing. Hidden cost Reason Internal expenses

Higher skills, communication, and time required to evaluate and work with foreign suppliers. Gaining visibility into the financial stability of foreign suppliers can be difficult.

Supplier health

Post-contract lull Failing to monitor supplier and contract performance after signing an agreement can result in ‘cost creep’ or even performance failure. Duty and tariff changes Employing resources to determine correct duties and monitor changes adds to total cost. Contract non-compliance Internal non-compliance with a foreign contract reduces the total anticipated savings. True inventory costs Longer pipelines increase inventory carrying charges. Logistics volatility Managing the rapid changes in shipping costs adds an element of complexity. Technology Extended supply chains require greater tracking capabilities. Quality breakdowns Managing quality problems offshore can be more costly and complex to resolve, including the impact on corporate brand equity. Traditional cost models reveal that net cost savings from international buying average around 25%. The Procurement Strategy Council has extended this model by factoring in the impact of hidden costs not considered in the traditional model. Under this revised model the savings realised from foreign sourcing are only 4 to 6%. If the Procurement Council’s model is correct, it shows why total cost calculations must become an integral part of every international sourcing analysis.

6.2.4 THE REASONS WHY TOTAL COST MODELS ARE USUALLY WRONG

A popular misconception is that information from total cost models is better than having no total cost models at all. The reality is that total cost models, like forecasting models, almost always have some degree of unreliability. The question is, ‘How much unreliability is embedded in the model?’

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