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Total Cost AnalysisBy Brandon Ostler
Agenda• Total Cost Analysis defined• Nuts and Bolts• Brainstorming Exercise• Benefits of Total Cost Analysis• How it works• Real world example• Exercise• Summary• Readings List
What is Total Cost Analysis?• Total cost analysis (total cost of ownership) is the
sum of the costs related to the acquisition and use of materials, products, or services.
The Nuts and Bolts
• Three main components– Acquisition costs– Ownership costs– Post-ownership costs
Common Acquisition Costs
• Purchase Price• Planning Costs• Taxes• Financing Costs
Common Ownership Costs
• Downtime Costs• Risk Costs• Conversion Costs• Non-Value-Added Costs
Common Post-Ownership Costs
• Environmental Costs• Warranty Costs• Product Liability Costs• Customer Dissatisfaction Costs
The Big PictureAcquisition Costs Ownership Costs Post-Ownership Costs
Asset
Cost
Asset Life Cycle
Quick Practice
Determine if the following are acquisition, ownership, or post-ownership costs:
1. Tariffs
2. Recalled products
3. Lost Sales
4. Frequently moving Work-in-process inventory
5. Contract Determination
Brainstorming Exercise
• Why would your organization want to conduct a Total Cost Analysis?
Who Benefits?• Your firm
– Service Providers– Retailers– Manufacturers
• The end customer
How It Works
1. Find each component cost
2. Sum the cost of the three components
3. When purchasing, compare total cost from potential suppliers
4. If for a process, look for ways to reduce total cost
Real World Example
• ABC, a retail store, is deciding whether they should implement a new billing system or upgrade their current system.
• Both systems are expected to last 3 years and both will need to be un-installed at the end of the third year.
• What should they do?
Real World ExampleNew Billing System Year 0 Year 1 Year 2 Year 3 Total
Acquisition Costs $4,688 $412 $0 $0 $5,100
Hardware $1,067 $1,067
Initial Software $2,000 $2,000
Initial Training $823 $823
Transition Costs $798 $412 $1,210
Ownership Costs $0 $1,713 $1,842 $1,379 $4,934
Subsequent Upgrades $1,000 $1,000 $500 $2,500
Subsequent Training $214 $213 $149 $576
Maintenance $101 $220 $330 $651
Operations $398 $409 $400 $1,207
Post-Ownership Costs $0 $0 $0 $1,500 $1,500
Un-install system $1,500 $1,500
Total Annual Costs $4,688 $2,125 $1,842 $2,879 $11,534
Real World ExampleUpgrade Current System Year 0 Year 1 Year 2 Year 3 Total
Acquisition Costs $200 $0 $100 $0 $300
Hardware Upgrades $200 $100 $300
Initial Software $0
Initial Training $0
Transition Costs $0
Ownership Costs $0 $2,152 $2,792 $3,130 $8,074
Subsequent Upgrades $100 $100 $150 $350
Subsequent Training $42 $45 $38 $125
Maintenance $532 $1,078 $1,567 $3,177
Operations $1,478 $1,569 $1,375 $4,422
Post-Ownership Costs $0 $0 $0 $1,367 $1,367
Un-install system $1,367 $1,367
Total Annual Costs $200 $2,152 $2,892 $4,497 $9,741
Real World Example
New billing system total cost: $11,534,000
Upgrade current system total cost: $9,741,000
ABC should upgrade their current billing system as they will incur the lowest total cost.
ExerciseTotal Cost Analysis for Product XYZ
Supplier A Supplier B
Price Tag $300 $150
After-sale allowances $50 $75
Contract Negotiations $400 $550
Operations $25 $75
Inventory Carrying Cost $50 $100
Customer Service $25 $50
Which supplier has the lowest total cost?
Which supplier has the highest cost of post-
ownership?
Exercise AnswerSupplier A Supplier B
Acquisition Cost $700 $700
Price Tag $300 $150
Contract Negotiations $400 $550
Ownership Cost $75 $175
Operations $25 $75
Inv. Carrying Cost $50 $100
Post-Ownership Cost $75 $125
After-sale allowances $50 $75
Customer Service $25 $50
TOTAL COST $850 $1,000
Summary
• Total Cost Analysis:– Three main cost components– Can bring out the “hidden” costs.– Spotlight the potential cost problems before
they become problems– Can be used to find cost savings
Readings List• Steven M Bragg. Cost Reduction Analysis: Tools and Strategies.• Wouters, M. et al. The Adoption Of Total Cost Of Ownership
For Sourcing Decisions--A Structural Equations Analysis.• Degraeve, D. et al. The use of total cost of ownership for
strategic procurement: a company-wide management information system.
• Lisa M. Ellram. Total Cost Of Ownership; An Analysis Approach For Purchasing.
• David Burt, et al. Supply Management. Eighth edition. pp 303-320.
