Eskom Procurement Book 2015

TOTAL COST OF OWNERSHIP (TCO)

landed cost analysis could well reveal a different picture. The buyer would need to consider all the hidden costs, including inventory carrying costs and increased logistical handling, which erode unit price savings. Unless a total landed cost model is developed it is not possible to know for certain that the correct decision has been reached. Total landed cost models should also be used when doing business with international suppliers on an ongoing basis. After all, the factors that affect the sourcing decision in the first place are dynamic and subject to change. Some companies update their total landed cost models whenever cost factors, such as transportation and exchange rates, change. Keeping these models current is an ongoing challenge. A potential issue with total landed cost models involves whether to include only costs that the buyer incurs or whether to include all the costs incurred from the point of origin to the point of destination. One school of thought argues that it is best to include only those costs that are incurred directly by the buyer. If a supplier maintains the title and risk of loss for a shipment until it reaches the buyer’s dock door, why include the inventory carrying charge for the inventory? Isn’t that the supplier’s concern? Another argument will say it makes sense to have visibility to all supply chain costs - it’s hard to improve what is not measured. And it is probably safe to conclude that the costs assumed by the supplier are driving up the supplier’s unit price. A buying company can have parallel total landed cost models. One model could include the direct costs that the buyer is going to experience firsthand. The second model, which will have a higher total landed cost model than the first one, should include all the costs that are spread across the supply chain. Spreadsheet software is ideal for developing total landed cost models. One of the best known models used to capture the true cost of doing business with a supplier on a continuous basis is the Supplier Performance Index (SPI). While total landed cost models often consider total cost during the evaluation phase of supplier selection, SPI measures costs incurred during a supplier’s ongoing performance. SPI calculations are useful when tracking supplier improvement over time, quantifying the severity of performance problems, deciding which suppliers should leave the supply base, and establishing minimum acceptable levels of supplier performance. This approach applies to domestic and international suppliers. The SPI is a total cost model that presents its output in the form of an index or ratio. It assumes that any quality or other infraction committed by a supplier during the course of business increases the total cost (and hence the total cost performance ratio) of doing business with that supplier. This approach is more applicable after supplier selection because it is populated with cost occurrences that have happened rather than are expected to happen. If a company can track

6.3.2 SUPPLIER PERFORMANCE MODELS

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