We have recently seen supply chain disruptions caused by a shortage of over-the-road truck drivers, a shortage of rail capacity and shipping delays. Many companies have had to take expensive remedial measures to ensure the flow of raw materials and components. As companies work through these problems many of them are reevaluating their supply chains. A helpful tool for this reevaluation is the methodology of Total Cost of Ownership (TCO).
Total Cost of Ownership is a formal evaluation used to quantify all the costs of a major asset or system from the day it is purchased to the end of its life. TCO is usually employed for large assets such as IT infrastructure, large pieces of machinery, buildings, or major acquisitions such as another company.
While this evaluation is most often used for large capital assets, it can also be used to evaluate the supply sources for product components. The theoretical concept is the same, but the associated costs would be slightly different. In the evaluation of a source of supply the costs under consideration would include maintenance costs, disposal costs, transportation costs, training costs, and upgrade costs as well as the initial costs of purchase. Just because a system or part has the cheapest price doesn’t mean it is the “best buy”. Transportation costs, inspection costs, inventory carrying costs (perhaps because of long transportation cycles) and the labor cost to utilize the part in the final product all influence the true cost of the system, or the component part, to the company. We all have seen situations where the cheapest purchase part winds up costing extra labor for assembly; or when shipping delays or vendor capacity cause slowdowns in your production.
So how do we determine the TCO for a purchased part? The answer depends on the use of the part. One method of identifying potential cost factors is to develop a form of Value Stream Map (VSM) for the part. In Lean Manufacturing theory, a value stream map is used to identify the constraints (non-value added activities) in the value stream’s flow. If you start with the vendor and chart the flow of the part to its final use on the assembly line you could expect to see factors such as: the time the part spends in each location (how long is your money tied up before you can assemble the part in the product); the number of people handling the part (this can give you clues for the potential for breakage); The physical distance the part moves between each stage (distance equals time); the type of inspection that must be used to verify the proper quality standards; The stages of paperwork that must be completed to get the part to you (if it is coming from overseas, how does the freight forwarder and customs inspection affect the transport time?). There may be additional factors involved in procurement and use of the part.
With the value stream map you can more clearly see the costs of non-valued added activities. If you compare the VSMs for several different sources of supply you can get a complete picture of the most economical source. You may be surprised to find that the “cheapest source” is in fact the more costly when you take into account other factors such as inventory time, handling and inspection; breakage in transportation and quality risks.
Now that you have the outline for a complete evaluation of your sources of supply are you ready to look into the true cost of procurement?
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