A deeper dive into Total Cost of Ownership (TCO): Part 1
Most companies make sourcing decisions based solely on price
In our last column, we discussed how “total cost of ownership” (TCO) could reveal the hidden costs of offshoring and quantify the real profit and loss impact of reshoring or offshoring. Now, we will take an in-depth look at the free online Total Cost of Ownership Estimator software—the basics, how it works, and how TCO analysis can positively impact a company’s reshoring or offshoring decisions.
Most companies make sourcing decisions based solely on price, often resulting in a 20 to 30 percent understatement of offshoring costs. The TCO Estimator guides companies through a comprehensive system for recognizing and adding all the costs associated with offshoring and reshoring. The relevant cost factors must be fully accounted for to provide a complete picture of total cost.
TCO analysis helps companies objectively quantify, forecast and minimize total cost. It takes into account: freight and duty; travel expense and time; inventory carrying cost; warranty; intellectual property (IP) loss; impact on product innovation from having manufacturing distant from engineering; and the losses from stock-outs due to long delivery times. TCO also quantifies many other factors, such as those associated with the risk of supply chain shocks or disruptions caused by natural disasters and political unrest. It also helps to forecast the impact of future wage and currency changes. Using this information, companies can better evaluate sourcing, identify alternatives, and even make a case when selling against offshore competitors.
To determine a single cost value for a part, component or finished product, you assign a value to each factor that is relevant to the specific case, answering 30 questions about the U.S. and the offshore source. Some factors such as price, weight and quantity are easily quantified. Others are more subjective, such as IP and natural disaster risk. Once you input your unique data into the Estimator, you will receive your total cost of ownership analysis complete with:
- Calculations of 30 cost factors for each source.
- An accumulation of all costs into cost categories.
- The current TCO for each source.
- Line charts showing each source’s current price and TCO, as well as a five-year TCO forecast.
- Line charts for each source showing your cumulative cost, starting with the “hardest” cost—price—and progressively adding in more subjective costs.
Sometimes companies must decide whether to invest in-house here or to outsource to a low-labor-cost contract manufacturer offshore. If the company finds in-house manufacturing cost is 30 percent higher than the offshore purchase price, it is almost impossible to make a positive return on investment (ROI) with spending on automation,
training and lean manufacturing initiatives here to overcome the cost difference. However, if the company measures with TCO and finds only a 5 or 10 percent difference, the ROI just went up dramatically, sometimes making in-house the most profitable choice.
Through reshoring and domestic sourcing, we can build strong local manufacturing companies and stronger, thriving communities by keeping people in the community employed and providing tax revenue for local governments and schools. Manufacturing has the highest multiplier effect of any sector (3.6, according to the Manufacturers Alliance for Productivity and Innovation), so creating manufacturing jobs creates the most jobs in other sectors, too.
In our next column, we will examine the benefits of TCO, who should use TCO, and take a look at a typical example of the automatically generated TCO output. Together, we can reinvest in U.S. manufacturing and get the manufacturing renaissance rolling!