Total Cost of Ownership: A Tool Manufacturers Shouldn’t Ignore
If you’re a manufacturer, you’re likely feeling pressure to reduce costs wherever possible. Total Cost of Ownership (TCO) is a calculation that can help you make more informed financial decisions.
What is Total Cost of Ownership?
In a nutshell, TCO goes beyond the purchase price of a good or service to examine its complete cost — from purchase to disposal. To do this, TCO estimates the direct and indirect costs and benefits related to the purchase of goods or services, less any income you receive. It involves accounting for all costs and benefits over the lifetime of the particular good or service.
In addition to assessing the costs and benefits of a particular purchase, TCO can be used to evaluate investments, business models, and maintenance options and solutions on a comparable cost basis. It can also help you understand the different cost drivers that may occur throughout the life of a purchase.
For instance, say you want to add a new product to your lineup, but you lack the machinery necessary to produce it. So do you buy the machinery, or do you outsource production? TCO can help you weigh the costs and benefits of each option.
How is Total Cost of Ownership calculated?
Calculating TCO begins with researching, estimating and calculating all costs associated with the purchase: direct costs, indirect costs, opportunity costs, cost of change and hidden costs. These could include things like labor (who’s going to operate the machine?), geographical location (is your outsourced production overseas or local?), and responsiveness (how quickly will the machine or outsourced production facility respond to your needs?).
The next step, of course, is to calculate the income generated from the purchase. (This will vary depending upon the specific nature of the purchase.)
When should Total Cost of Ownership be used?
We recommend considering TCO before making any major business decisions such as a large machinery purchase. It may also be useful to incorporate TCO in your day to day operations along with your year-end planning.
Needless to say, when it comes to the world of manufacturing, TCO is a valuable tool that should never be overlooked.
Andrew Thom, CPA, is AEM’s Manufacturing Segment Leader. When he’s not navigating southern Minnesota waterways in his kayak, he’s helping clients navigate changes in their business. You can reach Andy at 507.304.6830 or at firstname.lastname@example.org.