THE TOTAL COST OF OWNERSHIP

For most people when negotiating or planning for items to procure, price becomes a major factor. There is nothing wrong with considering price in whatever you buy after all it’s an expense and expenses in business means less profit if not properly factored in. The two main approaches that parties to a procurement set up often use, when trying to justify the price of an item, are price analysis and cost analysis.

Price analysis

This approach seeks to determine if the price is ‘fair’ and the way a buyer will go about this is by relating the price to:

1. What other suppliers or sellers are selling at
2. Price previously paid by the buyer for the same items
3. The price of any alternatives or substitute goods

Cost analysis

This approach means looking at a price in terms of how it relates to the suppliers cost of production. Imagine you intend to purchase office furniture or indeed any furniture for that matter and you have the carpenter break down the cost of materials all the way so that you can understand the production cost and relate it to the price. This will be an example of cost analysis.

This technique makes more sense in the sort of negotiations where a supplier decides to justify their price by a need to cover their costs, basically, cost based pricing.

Remember while cost transparency, the idea of supplier sharing their costs with the buyer, may foster trusting relationship between the two, most suppliers will not be willing to do this and so you may be left with price analysis as a choice if these two were your plan to determine if the price is good.

Why total cost of ownership?

Cost and value are larger concepts than purchase price and focusing your attention on price alone can blind your vision to things total cost of ownership (TCO) or total cost of acquisition (TCA), simply put Total lifecycle cost of whatever you are buying.

Price asked by the supplier is not, in most cases, the only price you get to pay when you acquire a given item. You always need to ask yourself what are the other costs which aren’t immediately apparent but I will incur throughout the lifecycle of this item I intend to purchase? This line of thought would them mean that the ‘right price’ is one that shows value for money for the total benefits derived from the asset over the whole life of the asset.

The chief among other reasons why you would always need to think beyond price and focus on total cost of ownership is that price simply represent the sum paid to the seller or the supplier to get access to ownership of whatever it is that you are paying for, but the total cost of ownership or acquisition if you like can expand to include the following:

• Pre-acquisition costs – you could incur these sorts of cost as you conduct your research into what you want to buy, they can fall under sourcing costs or even the cost associated with preparation for tenders

RELATED: steps in tendering process

• Acquisition cost – This will include your cost of financing the purchases (you should factor in borrowing cost if you are using debt capital) delivery, installation and commissioning costs, these are the costs incurred in starting the operations.
• Operating costs – such as labour, material, energy usage among others, in short, costs associated with operating the asset you have procured.
• Maintenance costs
• Disposal costs

What you should be having in mind at this point is that price, when thinking about acquisition, is just a tip of the cost iceberg. The submerged part is what actually brings you down.

There are occasions where price asked by the supplier could reflect some of the costs we’ve mentioned, for instance, the supplier’s price may include the delivery, installation and commissioning cost. As a buyer make sure you get to know the package of benefits you get with the given price

The question in this case would be along the lines of ‘what benefits come with the associated price?’ now that you  have the total cost of acquisition in mind such that you can see what trade-offs are to be made.

Remember, while a low price may seem like a deal it could end up meaning a high ownership cost to you. Always take whole-life costing into account especially when procuring capital assets this way you think beyond price and into total cost of ownership.