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Total Cost of Ownership

Going Far Beyond Unit Pricing
By
Brendan Micor

Acquisition cost, or unit pricing, only represents a small proportion of the Total Cost of Ownership (TCO).  For those of us focused on the highest efficiency, there is a compelling need to break free from the narrow confines of price analysis and focus instead on achieving the lowest TCO—the sum of all costs associated with every activity of the supply chain.

Understanding the total cost of ownership is crucial in analyzing customers’ products and can add significant value to an organization. Too often, we confuse the concepts of price and cost and ignore the major difference: price is money coming in and cost is money going out. To reach a profit goal, we must subtract the money that goes out(cost) from the money that comes in (price).

Directly relating this equation to manufacturing, we procure direct materials such as raw materials and products, and we sustain overhead in the transportation, warehousing, inventory caring costs, purchasing administration, factory yield and usages. If we use the wrong cost driver in determining our profit yield, we will not receive the full value of our asset in relation to the cost of purchasing. To obtain the most favorable TCO, we need to utilize the proper cost metrics, including purchasing, logistics, manufacturing, quality, risks and so forth.

The challenge is that many of us do not fully understand how to best leverage SAP tools to reach an accurate TCO. As a result, we are surprised when our ROI isn’t what we expected. Too often, functional silo thinking dominates, and procurement focuses too narrowly on meeting its price quotas without taking into account the entire supply chain. Put simply, we can’t manage our business with only one set of numbers and assumptions. When that occurs, we end up struggling with disparate sources of data, increased errors, loss of supply chain visibility and lack of process accountability and ownership.

As an enterprise system, SAP looks at every single area, identifies where the shortfall or excess inventory is taking place, and suggests changes to support the balance of supply and demand. Through SAP, we gain the ability to evaluate not only unit price, but also all the other cost components that add up to total cost of ownership.

Embracing SAP to gain a transparent and consistent view of best practices requires a solid commitment. It asks of us that we align business behavior (e.g., working outside SAP, manual intervention and customized external rules) with business rules (e.g., lead times, lot sizing and Available to Promise (ATP). Determining your organization’s business rules and the associated master data is crucial for enabling Material Requirements Planning (MRP) to balance demand and supply. 

When business behavior, business rules and master data are not in sync, we usually have no choice but to resort to a traditional purchase order, which limits negotiating ability. Contrarily, when we do trust SAP to deliver visibility, real-time reporting and monitoring of supply chain procurement, we are able to actively streamline spend and make informed decisions based on real-life insights. SAPERP helps us to look at complete cost from purchase to disposal and factors these costs into a cost-benefit analysis. 

By quantifying and measuring costs, TCO widens the vast field of opportunities with many avenues and options for attaining win-win results. Through SAP—our one source of truth—we can uncover ways to modify the TCO approach to support each major purchase decision and achieve true savings.

We have also prepared a white paper with a deeper dive on how Total Cost of Ownership (TCO) can maximizing value while minimizing cost.

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