Total Cost of Ownership: The search for the true expense
November 2011The pursuit of the truth has traditionally been the domain of attorneys and philosophers – but in the past few years purchasing agents, controllers and corporate strategists have been taking up that cause. They are hot on the heels of the true costs of a product or a service – from cradle to grave, so to speak. And these costs – as every car owner knows – are not shown in any price list. The true costs of a VW Golf can be calculated with a moderate amount of effort, from a few parameters – that is if you don’t just consult a table published by an automobile club. The search for the entire truth is entirely different when you’re dealing with investment goods like machinery and equipment. Simple calculation models and tables are indeed available. But there are many different approaches and methods for life cycle cost analyses, all aimed at achieving a detailed picture of costs and outputs. Significantly, “total cost of ownership” ( TCO) is not limited solely to a figure expressed in euros, dollars or yen. Far more, it stands for a fundamental attitude. Various analysis and optimizing instruments support the basic purchasing procedure but they also collect the data needed for complex outsourcing decisions, developing and designing processes and products, and establishing long-term partnerships with suppliers.
New relationships between sellers and buyers
Machines and equipment are usually part of an integrated process chain and are critical to the availability, performance and ultimately the success of an entire system – and the company as a whole. Thus it seems quite apparent that for investment goods buyers a machine’s list price loses significance while the total cost of ownership becomes ever more relevant.
Experts anticipate that in the automotive industry, for example, decisions on machine tools will soon be reached exclusively on the basis of costs over the entire life cycle. Consequently, vendors are paying greater attention to TCO in their products and processes, in order to achieve market success. The catchword here is “design to TCO”. TCO offers a way to achieve a competitive advantage over vendors who base their sales strategy solely on a lower list price. The spread of TCO’s concepts can also make a very fundamental change in the relationships between the vendor and the buyer. Simple barter – “money for goods” – is replaced by multidimensional concepts, based on long-term cooperation and information feedback. Such concepts are coming into being even today. The new idea is “money traded for availability”, combined with “usage data traded for optimization”. If everything goes as planned, the result will be one of the rare, true win-win situations for both partners. In order to make sure everything goes off well, certain preparations will have to be made in advance and certain criteria observed.
Successfully introducing and implementing TCO
From the user’s viewpoint, a number of decisions will have to be made along the life cycle of machines and equipment. The costs – or more precisely the total costs of ownership – play a major and far-reaching role here. Regardless of whether as the basis for long-term investment analyses, for short-term maintenance decisions, or for the continuous improvement process. Total cost of ownership is an indispensable instrument in transparent cost management for equipment. Ideally, the TCO approach will build on previously established structures in a company, augment the processes already in place, and redefine points of emphasis. Broken down into its individual components, one can identify four phases in a machine’s life cycle: requisition, procurement, use, and disposal. Within these individual phases there are numerous key players, instruments, statistics and processes. All are necessary to achieve dynamic and transparent management of overall costs. Valid data form the indispensable basis for introducing andimplementing a TCO approach. These include relative figures that reflect the progress of the main cost factors (maintenance work and energy outlays) along with machine availability. Considered in addition to the classical cost figures – such as the hourly maintenance rate – are new consumption data (such as information on energy use) and the hours during which a machine is available for operation. It should be noted, however, that the number of statistical values and the depth of their usefulness can change, depending on the type of machine and the company. This will have to be examined in advance.
Example of application along the machine’s life cycle
The classic TCO approach is rooted in purchasing activities. More recently, however, some machine owners have been putting their faith in anchoring the TCO concept more widely throughout the company, accompanied by a division of the internal tasks. Purchasing cannot and should not bear sole responsibility for total costs. It is of course active in the fi rst two phases – requisition and procurement. As the unit responsible for negotiating, one of its assignments is to request all the data relevant to TCO, collect the data, and to consider it when making the purchasing decision. Once the machine has been bought, the maintenance units have authority for use and disposal. They are charged with making sure the machine is available. At the same time they obtain, by following and analyzing the TCO statistics agreed on, not only a monetary basis for negotiations with the supplier and improving the machine’s processes, but valuable machine data, as well.
The purchasing and manufacturing departments develop the concept for a new machine. But whenever TCO is taken into account, specialists for the main cost factors – maintenance and energy – are also at the table. Each party contributes technical and cost-relevant aspects and figures in order to draw up specifications that are technically and economically optimized, and complete. The objective of the specifications is a machine that meets TCO expectations.
Success factors: Interdisciplinary teams; data warehouse already on hand
Conflict potentials: Time and capacities; data
The specifications, expanded to include aspects associated with maintenance and energy use, reflect not only the capital outlays, but the long-term overall costs of the machine, as well. This permits an in-depth evaluation of vendors’ bids. Once a decision has been made in favor of a given supplier, it is necessary to stay within the limit values for maximum annual maintenance costs, annual costs for spare parts and wearing parts, and energy consumption. These limits are set down in a TCO agreement. There are two fundamentally different approaches regarding its form and content:
a) Contractual agreement: The contract sets down key fi gures and conditions relevant to TCO (see above), which the supplier is obliged to maintain. If these levels are exceeded, the supplier will have to shoulder additional costs. In return, the user reveals utilization data for the machine. The advantages for the user are certainty as to costs and availability. The disadvantages: data will have to be recorded and validated. The suppler has competitive advantages with the availability of usage data but bears potential cost risks.
b) Cooperation agreement: The goal here is to achieve a winwin situation. The agreed TCO limit values are guideline values used to steer the continuous improvement process, machine availability, and cost optimization. If the values show a negative deviation, then the machine builder and user will sit down together to solve acute problems through cooperative efforts. Advantages: The supplier bears no cost risk; he obtains employment data for his machine and can use these to optimize his line. The user has a machine that is readily available and can reduce costs by optimization and avoidance strategies initiated early on.
Success factors: Data transparency; cooperative communication with the supplier; trust
Conflict potentials: Drawing up the contract; collecting data
During a machine’s utilization phase figures plotted against time are usually collected for control purposes and productivity management. Things get fuzzier, however, when time is converted into money. That is why the TCO approach provides for continuous cost management. It registers the actual costs incurred during the machine’s use. These are compared with limit values; if they are exceeded, the appropriate measures are launched. Depending on the terms of the agreement (see “Procurement”), this may be at the machine manufacturer’s expense and may serve as the basis for a continuous improvement process.
Success factors: Ongoing data acquisition process
Conflict potentials: Defining the machine’s loading situation
There are several approaches to minimizing costs here, depending on the machine’s life span: modernization, rebuilding, sale, scrapping or cannibalization. Newer concepts, including the “modular machine”, will make it possible to reduce equipment costs considerably, since it will be necessary to replace only individual modules and not the complete machine.
Success factors: Reuse, data histories
Conflict potentials: A wide-open field up to now!