The lowest purchase price concept is the most obvious, yet the most primitive approach to evaluating procurement strategies. It includes the stated price of the item, offered discounts and the timing of the payment. Although it is an important aspect of procurement decision-making, it is only a tip of the iceberg of costs associated with a purchase.
Total Cost of Ownership (TCO) incorporates service cost and life cycle cost in addition to the previously described purchase price. TCO comprises of pretransactional, transactional and posttranslational components, allocating cost to each of them. Among the most significant elements to be considered are the services and value-adding activities provided by the suppliers. The ability to deliver just-in-time, keeping the product at supplier’s premises, or performing additional activities, such as packaging, should be “debundled” from the purchase price in order to perform appropriate analysis. Each element in this case, should be considered separately (the activity referred to as menu pricing) in order not to overlook the best option by targeting the lowest purchase price. When calculating TCO, life cycle cost of the product should also be taken into consideration. Some of them incur before the item has been purchased, while others have to be paid long after the item was used. Such costs may include administrative costs related to finding suppliers, making the purchase, receiving the goods and checking them upon receipt. Cost associated with the items, which do not comply with quality standards and thus should be reworked or scrapped should also be considered. TCO is affected by the warranty and service, offered by the suppliers, and costs incurring after the useful life of the product, such as the cost of recycling and material recovery.
TCO is a useful tool in procurement decision-making. It allows getting the full picture of the cost structure while evaluating each element separately. It makes targeted improvements in processes possible, giving an opportunity to cooperate with the suppliers and make the whole supply chain more efficient.
Bowersox, D.J., Closs, D.J., & Cooper, M.B. (2009). Supply chain logistics management.
New York: McGraw-Hill/Irwin.
Enarsson, L. (2006). Future logistics challenges. Copenhagen: Copenhagen Business School