Written by: Terry Weiner
The following post is #7 of a series and discusses supply chain total cost of ownership. This series of posts provides an overview of the Supply Chain Optimization process and previews some of the concepts and tools that are part of the Manufacturing Extension Partnership (MEP) Supply Chain Optimization Initiative. Click here to read earlier posts.
The Importance of Total Cost of Ownership (TCO)
Total Cost of Ownership (“TCO”) is a concept that examines all of the costs related to the acquisition,transportation, and storage of products within the supply chain.
How is it different than the way we have always looked at supplier prices? Traditional costing methods such as Purchase Price Variance (PPV) typically miss between 20 to 40 percent of the actual costs of acquisition. These methods only take into account the price for which the supplier is willing to sell the item. It usually includes the supplier’s manufacturing costs, overhead costs, and profit, but it may or may not include factors such as your costs for transportation and many other associated costs to bring the product to your location.
Let’s take a look at a few of the additional costs that are included in TCO.
Shipping costs and complexity tend to increase with distance. When borders intervene and ocean (or air) transport becomes involved, the complexity goes up significantly because of multi-modal shipping with potential transfer, inspection, storage and documentation requirements associated with each mode involved. A company importing goods must comply with a range of U.S. government requirements as well as the export regulations of the country of origin. Upon arrival in the United States, arrangements must be made to file entry documents at the port of entry, pay the estimated import duties, and secure the release of the goods from U.S. Customs and Border Protection. Companies often employ agents or brokers to assist them with these tasks. Each step in this chain of events involves costs that are often missed when determining the true cost of a product.
Travel time for a container vessel from Asia to the U.S. is between two and four weeks. Documentation, customs clearance, handling, and inland shipping can add 18 to 32 days to the total shipping time from most emerging market regions, and another 6 days once goods reach the United States. The impact that shipping time has on cost involves the need to carry sufficient buffer inventory to cover customer demands until replenishment inventory arrives.
The cost of buffer inventory is often absent from the traditional determination of cost. Costs involve not only the dollar value of the inventory itself, but also the financing cost of the investment and carrying costs related to storing excess inventory.
Unforeseen or uncontrolled quality problems from a supplier may lead to:
- Lower product quality – increased inspection, unhappy customers
- Potentially costly product returns and shortages
- Possible legal liability
- Inability of supplier to meet certification, safety or other regulatory issues
Efforts to anticipate, control, mitigate or resolve the above quality issues will result in increased travel and oversight time and cost for this supplier.
Travel Costs for Supplier Oversight
Executives and other employees may need to travel to further develop or strengthen relationships; to oversee design, production, or shipping; or to resolve unforeseen issues like supply chain disruptions or production errors. Travel, labor and other related costs need to be included in the total cost of ownership.
When purchasing product from a foreign country with the payment due in currency of that country, the history of currency fluctuation must be taken into consideration. As an example, the price may be quoted for an annual contract, but during the year currency value versus the U.S. Dollar may have changed making the price higher in U.S. Dollars. In order to protect against currency fluctuation, you may choose to purchase a position on the foreign currency at the present price.
Protecting intellectual property (IP) rights is often a necessary step in both the United States and foreign markets. The United States has the world's strongest IP infrastructure, with the clearest and most cost-effective system for obtaining and enforcing IP rights. For small and medium enterprises (SMEs) in particular, protecting IP rights in the United States is easier than in most overseas jurisdictions.
IP costs should be considered in the Risk Management Plan and the total cost of ownership.
Payment terms may be important to your choice of sources. Having to purchase a letter of credit or payment in advance requires financing and other costs prior to the availability of product for sale such as taxes, surety bond premiums, customs broker fees, and storage expenses.
A Risk Management Plan needs to take into consideration measures to prevent the interruption of the supply chain. These mitigation costs are part of the total cost of ownership. Long distance supply chains often introduce vulnerabilities and may necessitate securing larger inventories or multiple sources to safeguard against potential disruptions like transportation cost fluctuations, currency exchange rates, or logistic uncertainties, or other risks.
Managing an efficient, optimized supply chain requires us to understand the total cost of ownership and how it impacts the strategic sourcing process. It also helps to determine what improvements can be made with existing key suppliers to reduce our current total cost of ownership.
In future posts, we will look at the following components of the Supply Chain Optimization Initiative - Link by Link:
|What are the "Twin Killers" of an Efficient Supply Chain?||
|How do I Assess Supply Chain Maturity?|
|How Can You Determine Supply Chain Optimization vs. Supplier Development?||The Final Link - Creating Supply Chain Visibility|
Terry Weiner is a Senior Consultant with California Manufacturing Technology Consulting® (CMTC). He has over 20 years experience in process improvements, quality management implementation and supply chain optimization.