It’s all too easy to assume that when you procure a product or material for your business, that the cost stops at the initial bill. However, the cost of your procurement rarely stays at the number on the price tag. In fact, hidden costs can account for 60% of the purchase price. Once you know this, the next thing you probably want to find out is why are the costs increasing, and secondly, how can I minimise this cost? Unfortunately, calculating the total cost of ownership is seldom straight-forward as there are a variety of factors impacting every product you procure. A good place to start is to consider all the different aspects of ownership, which you can find here.
Calculating Total Cost of Ownership Formula
Once you understand what may be impacting the costs, you need to understand how to find out exactly how much you are paying, which will then set you on track to deliver sustainable profitability to your business without the pitfalls of unseen costs. But what formula should you use for calculating the total cost of ownership?
Initial cost: The initial cost is exactly what it sounds like, and where all too many assume the cost stops. It’s essentially the number on the price tag.
Cost of operation: This covers any cost relating to the operation of the product. For example, if you’ve installed new software, do you have to spend money on staff training? And how much time is needed to run the software? The answer to this is usually dependent on how complex the product is.
Cost of maintenance: How much maintenance does the product need? For example, will certain parts of the product need replacing or updating every few months or years? This may not seem like a huge cost, but if there’s the aspect of maintenance for much of your procurement, the cost can amount to a more significant sum.
Cost of downtime: The cost of downtime goes hand-in-hand with the cost of maintenance; if you fail to maintain products, you’re much more likely to incur the cost of downtime. Downtime results in lost productivity, just how much it accounts for is dependant on how many people are relying on the product and how integral it is to their work. For example, if you have a big problem with IT equipment across your business, it’s more likely to have a big and costly impact.
Cost of production: The cost of production relates to how efficient and therefore cost-effective an item is. If you’ve bought two similar items for the same cost, one may work faster than the other, and therefore has a lower cost of production. For example, if you own a cafe shop and have two coffee machines and one is faster at making coffee, you’ll serve more customers and make more money from the faster machine which is more productive.
Remaining costs: The remaining costs in calculating total cost of ownership relates to the lifecycle of the product. How long is it going to work for, and when it’s no longer in use, are there disposal costs to consider? It may also be worth considering how much it will take to replace the item- will the price go up during your ownership of the product? If there’s a strong case for the cost of the same product increasing significantly, it’s better to spend more initially to get a similar product with more longevity that you won’t need to repurchase.
Problems and solutions
While the formula for calculating total cost of ownership may seem straight-forward, applying it can be challenging as everything needs to be accounted for, which if done properly, can take up a lot of time and resources. The time it takes to calculate the total cost of ownership of all your procurement can then have a knock-on effect on the productivity of your team, who could better repurpose their time if the task was outsourced. The solution? Use procurement consultancy services to take away the pain of doing it all yourself.
You may also need to overhaul your current procurement strategy. For example, if you tend to always go for the cheaper options but haven’t considered that their total cost may be higher, your procured products and materials may not be as cost-effective as you initially perceived. If you’re not sure where to start in improving your procurement processes, it may be worth getting a procurement diagnostic.
You may see calculating total cost of ownership as a pain, but for your business to be as profitable and sustainable as possible, it’s a necessary one. By outsourcing the task, you can remove the burden of doing it yourself and succeed in growing your business further and turn your attentions improving your processes to maximise on efficiency and productivity without the burden of unseen costs draining your resources.