Tracking total cost of ownership proves elusive
By Brian Milligan -- Purchasing, 9/2/1999
Companies can save money and promote quality if they calculate total cost of ownership and use it to guide purchasing decisions. But many purchasing pros today say their organizations are largely in the dark when it comes to making such calculations, let alone using them.That's the troubling feedback from purchasing managers responding to a recent Purchasing Magazine survey. PMs continue to search for foolproof systems that measure so-called "total cost of ownership," otherwise known as price and cost of acquisition, plus cost of use. Many say at their companies there's a lot of room for improvement.
The supply management executives queried by Purchasing say changes must be made as their organizations try to measure the total cost of ownership for purchased goods. They say their organizations don't have all the tools and support needed to properly measure total cost of ownership. And many say they are striving to improve their company's system for measuring cost, which could be any costs associated with poor quality, field failure, or many other factors.
"We are trying to become better at this by implementing better processes and controls," says Phil Werner, purchasing manager for Pirod, Inc., a castings manufacturer in Indiana.
It's hard to exaggerate the low opinion that purchasing pros have of their companies when it comes to measuring total cost of ownership (TCO). Asked to rate this competency on a scale of one to 10, with 10 being the best, 48% gave their corporation a "5" or lower. None of those queried chose "10."
Forty-six percent of survey respondents say that their company's efforts to measure TCO doesn't meet expectations, compared with 36% who say their company's efforts meet expectations. None of those surveyed say their company's efforts exceed expectations.
Most of those surveyed express doubts on how they categorize their company's system for measuring TCO. Forty-four percent say it is both objective and subjective.
This irks purchasing managers' many of whom say TCO should not be taken lightly. Of those surveyed, 22% say their company doesn't even attempt to base its purchasing decisions on measured total cost of ownership.
Calculating costs
Purchasing managers also came up with a dizzying array of how their companies calculate TCO. This isn't surprising when you consider that most companies have tried in recent years to devise their own systems for measuring TCO, so that the systems can guide purchasing decisions. But surveyed purchasing managers indicate that their systems are vague, inaccurate, or otherwise untrustworthy.
Most purchasing pros who took part in the survey say they do not attempt to assign actual dollar costs to activities as they measure it. Sixty-two percent, for example, say they do not attempt to calculate real costs associated with activities like rework, storage, or expediting late deliveries.
Some purchasing managers, like Werner, say that not having a quantitative measurement system leads to inaccurate calculations and vague reporting. "So far my company leaves too much of this to a feel," Werner says.
Robert Larson, purchasing/materials manager for The Turkey Store in Wisconsin, says establishing some sort of calculation or basis to go by would probably help the company make better forecasts and calculations in the long run. "We have not taken the time to formally establish a model to do this," he says.
Thirty-six percent of those surveyed, however, say their system for measuring TCO does assign actual dollar costs to activities. Those who do this say they are able to achieve some success by assigning costs to different activities like rework and transportation and by managing all costs associated with procuring as well as making products.
"We are a manufacturer, so all steps are calculated as a percent of the base cost or on a time basis," says Timothy Keuning, operations manager for the New York-based Autronics Plastics, Inc.
But even the most confident purchasing managers believe there is a troubling inaccuracy to this system. They say a better system--fostered by the right computer systems and software--would be appreciated.
"The purchasing and quality departments have made attempts to assign costs to activities, but we are never very confident that we capture the true overhead costs," says Jack Pinkerman, corporate sourcing manager for Zymark Corp. in Massachusetts.
"While in most cases, we can capture costs associated with TCO, it is quite labor intensive with our current computer system," says Bret Hoover, purchasing manager for MagiKitch'n Inc. in Pennsylvania.
Part of the problem of calculating TCO seems to come from the fact that purchasing managers must rely on important information provided to them by other departments in their organizations. This information, again, can lead to the "hit or miss" quality of the results.
Seventy-two percent of those surveyed say they rely on information from other departments as they track cost of ownership. Many of these managers--44%--say they get this information by word of mouth. "We get it any way possible, including verbal if the need for speed is there," says Terry Sappington, director of production purchasing for the Indiana-based Damon Corp.
The managers say they depend on information provided by engineering, accounting, service, production, assembly, logistics, finance, production control, quality manufacturing, customer service, and marketing departments, to name a few.
Adding it all up
Companies are taking varied approaches to adding up TCO. Airborne Express's Gary Post says his company has had some success by designing its bid process on a line item basis so it can compare all suppliers equally.
Some purchasing managers say they are able to make most of their TCO additions by adding together the cost of goods, freight, and storage. Some, like Alexia Clary, purchasing manager for Amphenol's Communications and Network Products Division in Connecticut, say it is imperative to take in total cost of planning, expediting, and processing.
But even more important, they say, is the ability to add up the cost of quality. This area can be harder to calculate, they say, but they attempt to do so by taking in the number of rejects, scrapped products, reworked items and ultimately, returned goods. By adding these to the equation, along with the cost of internal labor, they are able to get close to TCO, they say.
Some purchasing managers, like Larson of the Turkey Store Co., say the lack of a specific formula has slowed them down. Larson says so-called "soft" numbers on rework and cost to supplies has led to a vague system.
Others, like Sappington of Damon Corp., say they do not have a specific formula, but are trying to develop one. Sappington admits this has led to a sort of hit and miss track record. "We have nothing formal yet," Sappington says. "However, communication between all disciplines has improved. We at least think about TCO now. And we'll get better. We must!"
If there is room for improvement in these systems, perhaps the best place to start is with better communication. Singh believes this simple and important step could go a long way toward improving the process.
"It will take ongoing improvement, better data management, and increased recognition," Singh says. "Growing awareness on the part of middle management down the chain."
Specific problems
Most of those surveyed say their companies have encountered some very specific difficulties as they attempt to measure TCO. The difficulties range from outdated management practices to an inability to accurately forecast costs, and purchasing pros say they must be overcome if the problems are to go away.
Many say simple, archaic management practices are at the route of the problem. Werner, for example, says those in management positions must avoid "old thinking" and learn to look at TCO in a new light.
"The ways of doing things at this company need to change, but many senior people are hesitant," Werner says. "They can't see the reasons for change."
Purchasing pros who took part in the survey say as they attempt to measure TCO, they find it difficult to consistently and accurately spread overhead costs. Others say that they constantly have difficulty calculating expected costs or labor vs. what the company really needs in terms of costs and labor. Again, some, like Amphenol's Clary, say the right computer software helped them deal with these situations.
Addressing the problem
Some of those surveyed say their organizations are now starting to take the situation more seriously. Purchasers like Keuning of Autronics Plastics say their companies plan to have a more sophisticated accounting system in place by 2001. Such a system will go a long way toward making things better, they say.
Others say advanced computer networking will solve the problem and help their organizations develop a better understanding of TCO.
"We are getting computer networking, it's being installed right now," says Bhagwan Singh Battu, purchasing manager for the Illinois-based Universal Metal Service Corp. "We should have better records in the future."
Without such systems, purchasing pros like Sappington believe the system cannot work.
"First we must get our information systems under control," says Sappington of Damon Corp. "Then we can begin to examine more hard data.
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