Total cost of ownership

What is total cost of ownership in procurement and supply?

Total cost of ownership is defined as:

A estimate used to help buyers to determine the end-to-end cost of providing a service or manufacturing a product. It includes all non-value adding processes and scrap/rework or other disposal costs. Purchase price and acquisition cost and usage cost and end of life cost.

Total cost of ownership can typically be categorised into four categories.

• Procurement costs: The amount paid to the supplier for the product, service or capital equipment.
• Acquisition costs: The cost for delivering the product, service or capital equipment to the customer’s location.
• Usage costs: The cost for converting the transaction into the finished product and through its useable life. For example, inventory, conversion, scrap, warranting and installation.
• End of life costs: The costs for when a product, service of capital equipment reaches the end of its usable life, such as disposal, clean up and project termination costs.

What is total cost of ownership in the supply chain?

You should consider your sourcing decisions when thinking about total cost of ownership in the supply chain. Many organisations would opt for a higher minimum order quantity, but a lower unit price. However, you’ll need to think about inventory costs, risk of obsolescence and excess product when thinking about your total cost of ownership.

You’ll also need to factor in lead times and performance of supplies, as well as supply chain disruption, trade barrier and any logistical costs. It’s important to think about the stability of your supplier and then risks it may pose if you’re not able to get a product. These should all be considered when calculating your total cost of ownership.

Think about your organisation’s goals, particularly sustainability. Will you be compromising on environmental impact if you opt for a lower price? How will this contribute to your brand reputation? Think about all aspects when it comes to the total cost of ownership in the supply chain as it will reduce costs in the long run.

There is no one best way to implement total cost of ownership. We’ve collated some tips below that will give you a starting point to help map out the process from start to finish.

1. Start by building a process map from the time that a product or service need arises, right through the life cycle. This will help you identify the total cost of ownership categories.
2. Estimate the cost elements for each of the categories you have identified.
3. Determine the type of metrics you’ll need to quantify each of the cost elements. This could be labour sourcing costs, hourly rate for sourcing activities, or time spent or will be spent.
4. Gather data for each identified metric and quantity. You can also collection information from other sources including surveys or internal databases. This is the most time-consuming part, so make sure you factor in enough time and resources at this stage.
5. Calculate the present value by using the present currencies. The sum will represent your total cost of ownership.

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