The Total Cost of Ownership (TCO) is the big story that ultimately determines the efficiency and cost effectiveness of your supply chain. By quantifying and measuring costs, there is no doubt that determining TCO is a complicated and time intensive process, but it is one that pays off in the end. With diligence, the TCO can be thoroughly completed and improve your supply chain understanding.
What is TCO?
Let’s start with the basics. TCO includes all costs associated with a product from raw materials to final destination delivery. Some of these costs include shipping related expenses, inventory and storage fees, raw materials, quality costs, travel costs, intellectual property enforcement and protection, risk management, financial impacts, and currency fluctuations.
When you consider all costs associated with a specific good, you may identify problem areas as well as the most efficient steps in the supply chain.
What’s involved in this analysis?
A critical look at every step in the supply chain helps to determine TCO. Numerous variables make the analysis complex, often leading to conversations with several key players, from the CFO and Trade Compliance Advisors to suppliers, 3PL providers, and Customs brokers to name a few. Let's consider several important areas for consideration.
Sourcing offshore, nearshore, or deciding to
The mode of transportation selected to get the materials to the manufacturer will also impact shipping costs considerably. What is the most cost-effective shipping option for moving your raw materials to the manufacturer? In our test scenario, we’ll decide that
Origin and Destination
Are the products coming from overseas and into the United States, and therefore involve cross-border trade? If so, we’ll have to factor in:
- Additional shipping expenditures, which include Customs brokerage fees,
transportationand other associated costs;
- The finished product will have to be transported via air or ocean from China to the United States. In this case, you'll need multi-modal transportation, and to determine if it will be
a lessthan container load (LCL) or full container (FCL )load; but let's assume you select ocean FCL to rail, and then arrange a truck to get the goods to your warehouse;
- You may need to speak with your Customs broker, 3PL, and anyone involved in determining the transportation of your goods to ensure you've collected all cost factors associated with originating your goods and moving them to the destination.
Port of Entry
Before the goods arrive at their final destination (the warehouse), the products will need to clear US Customs at the port of entry (POE).
- At the POE, all goods will undergo scrutiny for compliance with the various importing requirements of Customs and Border Protection (CBP) and the Participating Government Agencies (PGAs), such as the FDA, EPA, USDA, and many others.
- Exporting requirements of the country of origin will also apply; in this scenario, it is China. This step has additional costs and fees associated with duties, taxes, entry filings and summaries, and any additional processing costs associated with importing into the United States.
The shipping time also impacts TCO for a couple of reasons. Have you heard the phrase “time is money”? It couldn't be more accurate in this case, the longer it takes for your product to become available to the market, the more money it is going to cost while in transit. Note these costs.
Don’t forget you also need enough inventory to “buffer” until your restock arrives and to ensure that you can meet demand. The shelf life of your goods is a cost you incur, and end-of-life or obsolete inventory are expenses that accumulate over time. Products become obsolete, and customers reduce or stop buying certain products when a newer item replaces it.
Work with your accounting team to determine the depreciation of the shelf life of your product, decide those costs, and then record that amount.
Your company prides itself on its high-quality goods available to your customers. You want to keep your customers happy—key to this success is regular communication with the manufacturer and supplier.
Don’t forget to consider unexpected quality costs when analyzing your TCO. These costs may include:
- unhappy customers;
- increased inspections due to product quality issues that arise;
- product returns and shortages;
- legal liabilities;
- safety and regulatory issues;
- time and oversight;
- lost market share;
- loss of customers;
- impact on the brand image;
- include reproduction costs within the TCO.
This is not the scenario you hope to occur, but to accurately prepare TCO, you must consider these costs. Let’s imagine for a minute the product turns out to have some significant safety issues, and now you are facing some legal responsibilities. You must go to China to meet with the manufacturer and work through the product safety problems, and rework the entire lot. What would this cost you? Capture that number.
Supply Chain Relationships
What kind of relationships do you have with your suppliers and manufacturers? Does supplier relationship management require you to travel several times a year to ensure your products are meeting your quality standards and market demands? Does it help you to avoid the previously described scenario? TCO includes the expenses associated with strengthening your global supply chain relationships—auditing suppliers, travel, labor, and all other associated costs.
Did you know that 2.5% of global imports are counterfeit goods? Counterfeit goods affect and take away value from authentic goods. So, how does this affect TCO? It’s expensive to protect your products from counterfeiting and pirating. Fortunately, the United States has one of the largest Intellectual Property (IP) infrastructures of major developed countries. Determining and estimating the loss of sales to pirated and counterfeit goods can be used in the TCO analysis. IP is a TCO and a risk management issue.
Risk management entails analysis to help prevent negative issues from arising. Some are very specific and can be predicted and planned for, while others are less predictable and precise. Some risk management issues include mitigation costs, excess inventory, multiple supplier sources, transportation costs and fluctuations, currency exchange rate fluctuations, interruptions in the supply chain, and logistics uncertainties.
Any financial change will affect the overall TCO analysis, including:
- any impact on cash flow;
- emergency air freight;
- obsolete inventory;
- predictable future costs;
- opportunity costs and lost orders;
- demand fluctuations;
- economic stability;
- political stability/instability;
- natural disasters;
- carrying costs for in-transit products;
- carrying costs of inventory on-site.
Some of these costs are found in financial statements, while others, such as natural disasters and political unrest, are less predictable. Costs of goods are sometimes more predictable, and often includes price packaging, duty, planned freight, transportation, fees and insurance.
We talked about currency rates playing a role in TCO, but what about payment terms? Knowing your payment terms, i.e. a letter of credit or payment advances will apply to the TCO. For example, if you sign an annual contract, then you are obligated to pay under the agreed upon rate regardless of currency rate fluctuations up or down. Fees associated with importing fall under the financial data category.
- Do you need to purchase cargo insurance, a surety bond, duties, and Customs broker fees?
- Will you need to store your products because of quality or transportation issues and now you face demurrage, storage, or drayage fees
These are just a few more items to consider when looking at TCO.
So, why do this? It takes a lot of time to gather all of the details, and coordinate between different people internally and externally. You probably noticed that many of these factors fall into multiple categories, so you'll need to make some decisions about how you intend to categorize each cost and be consistent across products.
Does it save you money? Yes, it will, both in the short and long term. Through this objective process, you have the ability to identify and address problem areas that could expose you to risk, disruptions, and minimize total costs.
- TCO encourages and promotes collaboration throughout the supply chain, from the seller, manufacturer, suppliers, 3PL providers, and Customs brokers.
- Successful relationships result in high-trust partnerships, increased communications, and mutually beneficial alliances.
What’s stopping you? Remember, all of the expenditures expressed above, and think of the other values unique to your business. Consider combining all expenses into a spreadsheet—this is your TCO. If you want to improve your company’s bottom line, consider taking some time to analyze the data and find potential opportunities for cost-savings. So, get out there and start gathering data!