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Resources Blog The True Cost of Your Supply Chain

Understanding the True Cost of Your Supply Chain

Often cost is the only factor that organizations consider when making purchase decisions. However, the reality is that today’s global supply chains are an interconnected network of suppliers, manufacturers, distributors, and retailers that span industries and locations. This complexity makes it challenging to have visibility into all supply chain costs and to know the true cost of your supply chain.

Total Cost of Ownership (TCO) is a method to account financially for all the costs of every activity along the supply chain, including the purchase or acquisition price, plus additional costs incurred before or after the product or service delivery, such as transportation, inventory, storage, expediting, and oversight.

The most important insight that TCO offers to the supply chain manager is the understanding that the acquisition cost is often a very small portion of the total cost of ownership. The goal of calculating a TCO is to uncover hidden costs beyond price, and equip your company to make strategic sourcing decisions.

While TCO is not new, Gartner sees low adoption of this critical concept by supply chain leaders in sourcing and procurement. TCO is an essential tool that helps ensure that the cost savings obtained in supplier negotiations are reflected in the bottom line, and not simply transferred to other areas of the organization.

Image Credit: Gartner

What are the Components of Total Cost of Ownership (TCO)?

When it comes to total cost of ownership, the unit price is just the tip of the iceberg (see illustration above). The TCO involves all the payments and expenses that a company incurs to use and maintain a good or service. The broad categories of TCO are: 

  • Purchase price: Cost elements including direct material, direct labor, and overhead
  • Acquisition costs: Costs of getting the product to the point of use, such as inbound freight, sourcing, receiving, inspection, and storage
  • Usage costs: Costs of converting the purchased material into a finished product and using it throughout its life, such as scrap, final inspection, and warranties
  • End-of-life costs: Costs of terminating a product, such as disposal and excess inventory

There are many nuances to consider when looking at the Total Cost of Ownership for a supply chain; however, in general, a manufacturer will need to factor in most of these items:

Purchase Price
The purchase price includes the supplier’s manufacturing costs, overhead, and profit.

Shipping Costs
Shipping costs and complexity increase with distance. Ocean and air transport involve packaging, transfer, inspection, customs charges (including charges for examining freight), import duties, and storage costs. Companies often use agents or brokers (at the origin and destination) to help them with these tasks, which impacts the overall cost of the supply chain. 

Shipping Time
Travel time for a container vessel from Asia to the US can be extremely lengthy, especially when you factor in customs clearance and inland shipping. This impacts TCO because inventory cannot be accessed during transport time, creating the need for manufacturers to carry buffer inventory to cover customer demand. Shipping delays can also result in expedited freight and higher charges required to meet customers’ delivery dates

Customs InspectionTrade Regulation Costs
Trade incentives and restrictions are offered by the buying and selling countries, including those established through trade agreements (FTAs) between countries or groups of countries. There are also documentation requirements (and potential penalties for errors) for customs clearance in the importing country.

Inventory and Carrying Costs
It can be challenging to gain a full understanding of carrying costs for large-volume purchases that come from international vendors. Carrying costs include warehousing costs, such as rent and utilities, as well as labor, shrinkage, and insurance.

In addition to the cost of transport and shipping time, the storage available ⎼ both internationally and domestically ⎼ will impact your TCO. Other factors can be the levels of flexibility (and additional fees) at the supplier to implement product modifications and enhancements and at the logistics service providers (LSPs) for changing production and delivery plans. Seasonal supply fluctuations and adverse weather conditions may also affect the availability and cost of storage space and transport.

For manufacturers that source goods or components overseas, quality inspections may be required for incoming components. These costs should also be considered as part of your TCO.

Unforeseen or uncontrolled quality problems from a supplier may lead to:

  • Additional inspection requirements
  • Expensive product returns and shortages
  • Legal liability
  • Inability of supplier to meet certification, safety, or other regulatory issues

Efforts to anticipate, control, and resolve quality issues usually result in increased travel time and cost for this supplier.

Personnel, Labor, and Overhead
TCO includes a wide range of activities necessary to the cost of acquiring materials: administrative staffing, procurement staffing, support costs, demand planning and procurement automation software, the space required to house equipment and operators, as well as training, and troubleshooting costs of maintenance. Sometimes a purchase may require additional specialized labor and training depending on the associated software, technology, and storage needs. 

Currency FluctuationCurrency Fluctuation
When purchasing components or products overseas, the history of currency fluctuation must be taken into consideration. The price may be quoted for an annual contract, but during the year the foreign currency value versus the US Dollar may have changed, changing the price in US Dollars.

Intellectual Property
Protecting intellectual property (IP) rights is a necessary step in both the US and foreign markets. For small and medium enterprises (SMEs) in particular, protecting IP rights in the United States is easier than in most overseas jurisdictions. IP costs should be considered in the total cost of ownership.

Financial Costs
Payment may require financing and other costs such as bank fees, taxes, insurance premiums, and administrative fees.

Risk Management
There are potential risks associated with any supply chain – disruptions, lead time, volatility of demand, intellectual property theft, natural disaster, black swan events, and countless others. It is essential to build in contingency plans and a risk management program to deal with the unplanned and unforeseen. A risk management plan increases your TCO, but it also allows you to recover more quickly when the unexpected happens.

In some cases, it is necessary to consider what is involved in dismantling or recycling products or materials, as well as what is necessary to comply with the legal and environmental requirements in terms of final disposal of waste. It is not always as simple as throwing it away, sometimes complex and expensive processes must be carried out. 

How Can Chainlogix Help?

Understanding all of the components that make up your supply chain and their impact on your costs and risk is critical to understanding your TCO. Chainlogix can help you look at TCO for your unique supply chain and identify opportunities to lower risk and eliminate hidden costs. 

Our process always starts with a free analysis of your cost drivers. We will tell you where we believe we can make a difference. We believe transparency is essential to a successful partnership, so we will always be honest with you about where we feel we can make the most impact.

Additionally, we can help you implement second- and multi-sourcing strategies, eliminating margin stacking and reliance on a single supplier. We will leverage our existing relationships and our global presence to provide in-country services and monitor quality standards. Our areas of expertise also include inventory control, warehousing, and engineering design, ensuring a truly optimized supply chain.

Contact us today to get started on reducing your TCO.

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