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Total Cost of Ownership: A Directive for Supply Chain Leaders Gartner for Supply Chain
2 © 2020 Gartner, Inc. and/or its affiliates. All rights reserved. CM_GBS_1085721 Introduction Reducing supply chain costs is a priority for organizations operating with thin margins or where material costs are high. Many sourcing and procurement leaders focus on achieving short-term savings through cost reduction targets. Gartner research experts recommend using a total cost of ownership (TCO) model to focus instead on shared strategic goals. Through TCO, you capture all the associated costs incurred by a buying organization when purchasing goods or services from external providers. This is an essential input to effective cost-to-serve analysis, which helps quantify the cost/service trade-offs associated with varying levels of complexity in how your supply chain supports customers and products in your portfolio. While TCO is not new, Gartner sees poor adoption of this critical concept. We regard TCO as an essential tool for ensuring that the costs savings obtained in supplier negotiations are reflected in the bottom line, and not simply transferred to other areas of the organization. Shifting toward TCO is hard but not impossible, as shown in the following table.
3 © 2020 Gartner, Inc. and/or its affiliates. All rights reserved. CM_GBS_1085721 While there are multiple challenges and benefits of moving beyond simple/unit price, one thing is certain: Every dollar saved increases shareholder value, regardless if it was obtained through lower unit price, reduced freight or better working capital conditions. Rather than defining costs savings by unit or invoice price, sourcing and procurement leaders should focus on (and get credit for) all cost optimization efforts that result in an overall cost reduction for the organization. Cost Common components Pros Cons Simple price Unit price • Easiest to track • Standard definition • Lower-cost alternatives might prove more expensive Total landed cost (TLC) Simple price, plus: - Freight - Warehousing - Import duties • Captures all relevant acquisition costs • Simple to calculate and use in supplier selection and contract negotiations • Provides a better decision-making process • Increased complexity in obtaining source cost data • Detailed data is needed at the supplier and part level (e.g., packing standards and delivery terms) • Cost savings may be reported by other functions Total cost of ownership (TCO) TLC, plus: - Cost of quality - Expedited freight - Manufacturing downtime - Working capital - Scrap waste - Recycling - Warranty - Concessions - Maintenance Plus others • Helps identify additional savings opportunities • Provides optimal insight into supplier’s true cost performance • Elevates the perception of value being delivered by the sourcing and procurement organization • No standard definition • Multiple sources of data are needed • Costs considered will vary depending on spend category • Cost savings may be reported by other functions Source: Gartner Table 1. Pros and cons of different cost structures
4 © 2020 Gartner, Inc. and/or its affiliates. All rights reserved. CM_GBS_1085721 Identify Areas of Opportunity to Implement TCO The purpose of implementing TCO is simple: Understand, control and optimize as many costs as possible that are incurred by the buying organization across its multiple categories of spend. But TCO will vary greatly in practice depending on industry, spend category and internal processes that are performed at the buyers’ versus suppliers’ operations. The following figure shows a practical approach for identifying associated costs, where a noncomprehensive list of costs is shown under three main categories: acquisition costs, operating costs and disposal costs. Cost type categories and examples Source: Gartner Acquisition Operating Disposal • Unit price • Freight • Import duties • Warehousing costs • Payment terms • Inventory • Implementation services • Training • Installation • Recycling costs • Disposal costs • Sustainability • Circular economy • Expedited freight • Production program changes • Production yield (scrap) • Cost of poor quality: - Rejections - Concessions - Warranty - Recalls • Maintenance • Cost of use