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The Advantages and Disadvantages of the Total Cost of Ownership Essay

Advantages:

1)Take all cost elements into consideration, because it extends the procurement to the whole life cycle of product within a firm.

2)Reflects the real cost of the purchasing rather than the pure acquisition.

3)It helps to define a rational purchasing policy for the buyer, for instance, how to allocate the purchasing volume, and to whom, and etc.

4)It can be a tool to evaluate outsourcing deals.

5)Can be used in negotiations with suppliers, by making visible some of the committed costs induced by that supplier.

Disadvantages:

1)It is a complex system, and not easy to implement. Especially, if a company has a lot of purchasing items.

2)It is a static system, and any changes in internal/external environment, e.g. maintenance cost, might influence the outcome, which, however, cannot be implemented immediately.

3)Deterministic model that relies on mostly uncertain data.

a.It is almost impossible to accurately allocate the occurred cost to each specific element, which is the basis for TCO calculation.

b.It is almost impossible to forecast the future expense or income for a specific purchasing.

c.Complex to setup and requires input from all departments involved in the entire life cycle of the product/investment.

d.Only accurate if plenty of historical data is available.

e.Often misses or underestimates the ‘taking out of service’ cost

4)TCO system has impact on selected vendors, and their reaction might influence the whole system. However, their reaction cannot be precisely predicted.

5)The system ignores some other elements beyond mathematical measurement. For instance, business risk, opportunity cost, loss from negotiation with eliminated suppliers, and etc.

6)Waste of time: look at all steps in life cycle, rather than concentrating immediately on areas with largest impact on TCO

2.Some elements missing, additional elements? For typical production companies.

1)Management expenses related to purchasing;

2)Cost related to co-development for materials supply;

3)Matrix contains only the “happy day” costs, but not the “bad day” costs like delivery problems, complaining to supplier, quality problems, sending back deliveries, troubleshooting, repairing, re-designing, re-testing, complaint handling with own customers, credit notes to own customers, natural losses and etc.

4)Batches level between supplier levels and order levels.

5)Internal logistic levels are different from supplying levels.

6)Reception: litigation costs for breach of contract, and receiving cost.

7)Possession: internal transportation costs, and picking cost.

8)Utilization: production delay cost.

9)Elimination: waste collection cost

3.Define Total Cost of Ownership for some other projects? Could be applied to other industries?

Apply to:

1)Use TCO in JIT environment and when integration with suppliers/buyers is important for the value chain

2)Use TCO to assess value of vertical integration

3)Use TCO if company adds relevant value on top of purchased material before it can sell its own product

4)Use TCO if buying a product commits you to buying extra services later e.g. car with gas, repair and maintenance, insurance, …

5)Use TCO for products with long life cycle within the organization e.g. PC’s, machines.

Cannot be applied to:

6)Lack of negotiation power, fro instance, with monopoly supplier; if supply is behind demanding, and etc.

7)Buy service from banking, insurance, and consulting.

8)Company with very simple process, e.g. pure re-selling and wholesale.

9)Companies spend a small proportion of total spending on purchasing.

10)Too competitive internal environment, for instance, each department has an individual budget.


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