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Defining and Understanding Total Cost of Ownership (TCO)

Whether you are a retailer or consumer, the total cost of owning an item is an important factor to consider. Setting prices, budgeting and long-term planning all rely on understanding how much an item really costs beyond the initial purchase price. Maintenance, support and disposal of the item can all be accounted for in the total cost of ownership (TCO). Understanding the implications of the TCO is one way that your business can empower top-level salespeople, allowing them to put together detailed proposals for potential clients.

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An overview of TCO

Total cost of ownership is a calculation that incorporates the purchase price of an item, such as a business asset or consumer product, combined with a range of additional expenses that are paid out for the operation of the item over its lifetime. These can include:

  • Installation
  • Staff training
  • Transition costs
  • Insurance
  • Servicing
  • Maintenance
  • Repairs
  • Software and updates
  • Security plan
  • Support package
  • Fuel or power
  • Consumables
  • Warranty
  • Disposal

TCO is often associated with the cost of technology purchases and upgrades. Training staff on new systems and ensuring that the existing hardware has the specifications to run upgraded programs require full TCO calculations. However, there are a number of other items that require a detailed TCO calculation to assess their cost-effectiveness. These can include costly purchases such as vehicles as well as smaller items such as printers.

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Actions to take to reduce TCO

There are a number of options available if you want to reduce the TCO for the products you manufacture, including:

Increase the efficiency of yoursupply chain

Buying components from a number of different suppliers can cost unnecessary time and money. Time spent on research, separate delivery costs and wait times can make a manufacturing process less efficient. Checking each consignment, waiting for late deliveries and working with different vendors requires more work for your staff.

Finding a single supplier that can provide a range of components can reduce these time and financial costs. You may also be able to negotiate a better price if you are buying more from one vendor, and your purchase order, invoice payment and administrative costs can be reduced as well.

Use standardized components wherever possible

When designing or reviewing the manufacturing methods for a particular item, focusing on using standardized parts can bring down the manufacturing and repair costs associated with TCO. Using components that have been custom-designed and produced can increase manufacturing costs. Unique parts also require their own manufacturing runs,which means you likely need to only take large orders to be cost-effectiveand increased storage and inventory space is needed to store them.

Non-standard parts can also increase downtime as it takes longer to source replacements, and it costs more to buy them. If there are any special parts that could be replaced with standard versions, doing so can easily cover the costs of the research and initial investment as well as reduce TCO.

Outsource when possible

It is sometimes possible to reduce the initial costs of producing an item by outsourcing some aspects of the process. Completing elements of the building or construction off-site can save time, which can reduce the overall total time to build each item and reduce the TCO. The potential benefits of this kind of strategy can be assessed through careful research. Outsourcing can be combined with component review and supply chain evaluation to increase the potential savings of each element.

If you want to reduce the TCO of the products you manufacture, you can research alternatives specific to your sector and assess the effectiveness of making changes.

Tips about total cost of ownership

Total cost of ownership is an important consideration for a business as well as potential customers. By calculating the TCO of competing products, it is possible to ascertain which is the better value long term rather than relying solely on the initial purchase price. When manufacturing an item, some of the considerations needed to calculate TCO over its lifecycle could include:

  • Item value
  • Stability of demand
  • Supply source
  • Physical characteristics
  • Costs of processing orders
  • Life cycle and obsolescence
  • Management costs
  • Lead times and logistics

Maintaining accurate and detailed records of all the costs associated with producing an item is vital for any accounting activity. Sometimes, you may need to use estimated or average costs from the vendor in the initial stages of the decision-making process. These can be replaced with actual figures once the item has been purchased in order to forecast.

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If you want to know more about total cost of ownership, these questions can give you a more rounded view of why and when you might use it:

Who needs to use TCO calculations?

Anyone considering making a significant purchase should consider the TCO of the item they are buying. This is true of businesses that need to factor in the TCO to forecast for the potential use and sale of an asset bought with company funds.

Consumers also consider TCO, whether they are individuals or businesses, so it’s an important factor for manufacturers to consider. The nature of some items means that they have a high TCO, such as vehicles. There are other items where the TCO isn’t as obvious, such as buying new IT software that needs all staff to receive training and downtime while the system is installed.

Calculating the TCO of a high-value item should always be a factor, whether you are the manufacturer, the retailer or the end-user.

What impact does TCO have on a business plan?

Some marketing strategies rely on TCO being significantly higher than the initial purchase price. These include items such as printers that require ink cartridges that are only available from the manufacturer. This is an established business model where vendors offer low introductory prices for items where the TCO is relatively high. This encourages customers to buy, encouraging them to rely on supply, service or maintenance packages that generate long-term income for the initial supplier.

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