A total cost of ownership analysis (TCO analysis) helps companies identify the right metrics for decision-making and inhibits the probability of incorrect decisions. Purchasing decisions are difficult to make and often require the investment of research, time, and expertise to determine your company’s ideal option. When a company chooses to purchase a new product or service, it often involves a detailed cost-benefit analysis. It requires professionals to identify, assess, and select the product that provides the highest value at a fair cost. Experts advise companies to refrain from choosing the cheapest option and encourage selecting an option that may require increased investment at first but will provide higher value, be more durable, and enable better returns. A TCO analysis helps companies understand the potential costs incurred for one product or service over its lifetime. This cost includes fixture and operation, regular maintenance, labor, other indirect costs, and wastage. Although one potential option may be inexpensive to purchase, its care, labor, and indirect costs may be higher, leading to higher long-term costs instead of a more expensive purchase, with a longer life and lesser long-term costs. With a TCO analysis, companies can find and purchase the best, sustainable, and highest value-adding investment for their organization.
How do you do a TCO Analysis?
Identify Needs: To effectively conduct a TCO analysis, purchasers must first understand the needs that are to be met or fulfilled by this purchase. In doing so, they will gain a clear perspective of the product or service’s features or requirements and find an accurate choice to purchase. This step also helps professionals understand the value-added and opens avenues to more options or creative solutions. Understanding the underlying need, rather than the product wanted, can help purchasers find and assess alternative solutions or a wider variety of options. This step also involves identifying the drivers behind these needs and understanding the importance, price range, expectations, and overall performance needs of this purchase.
Define Objectives: This step of the TCO analysis involves significant research, negotiations, shortlisting, and other crucial activities. Purchasers must find their sourcing options, compare the value they provide, evaluate their cost, performance, and other criteria that are crucial to the company. It is also imperative to understand and set the scope of the product or service purchased and understand how it contributes to the company’s objectives. Commonly, some needs are prioritized over others, and the purposes help address those needs and drivers with a sustainable and valuable purchase. At this point, purchasers can detail the specifications of their requirements and evaluate the offers made by suppliers and vendors.
Identify Costs: When making a major purchasing decision, professionals must understand the various costs impacting their product or service over its lifetime, such as the different direct and indirect costs incurred over time. Direct costs entail the clear prices associated with the product, such as the purchasing price. In contrast, indirect costs include expenses incurred through usage and time, maintenance charges, or potential losses due to delays, failures, or other challenges caused by the purchase. To ensure accurate decision-making and an effective TCO analysis, companies must calculate as many direct costs, indirect costs, and potential risks as possible and account for them appropriately.
Analyze Performance: Having found and evaluated all the above data, purchasers must now collate the data and calculate their potential purchases’ financial performance. To accurately carry this out, companies must determine metrics to track business expectations and economic terms. Key Performance Indicators (KPIs) help assess how the potential product or service addresses the organization’s key components and needs and choose the best option. These metrics can include price, energy use, maintenance costs, size, and space utilized. Quantitative data helps make accurate and helpful decisions, and using these metrics helps achieve that. However, purchasers will need to assess qualitative factors and assess the two together.
Final Recommendations: Compiling the acquired data and assessing it will give the purchasers a clear perspective of their options’ strengths and weaknesses. At this point in the TCO analysis, professionals must consider potential shortcomings and trade-offs that will be needed. The ideal choice may be more immediately expensive than other alternatives but will provide more value over time than the others. Simultaneously, an inexpensive option may have higher output and speed but require regular maintenance, repairs, and labor, with a significantly higher probability of breakage or failure. Purchasers must carefully assess the various factors involved in the TCO for each option and choose the one that provides the highest value for fair costs and sustainable service in the long run.
Success Story – SpendEdge Advantage
A renowned oil and gas industry player sought to establish multiple petrol pumps across Eastern America and struggled to make major purchase decisions due to challenges with previous purchases. Having already established multiple pumps in the South, it had incurred significant losses due to their low-cost pumps’ failure and maintenance. To ensure they did not face the same issues again, the client chose to collaborate with SpendEdge and identify the company’s best purchase decision. With our TCO analysis, the company successfully weighed the advantages and disadvantages and identified the ideal long-term option for their business to invest in. Although the oil and gas industry client incurred higher investment costs, there have been minimal repair or maintenance requirements since establishment. With our experts’ insights, the client also improved their purchasing decision-making process and incorporated the TCO analysis process in all major decisions. The company successfully established and grew multiple pumps along the Eastern coast with their data-driven purchases and provided impeccable services to their end-consumers.
Creating a procurement model with TCO analysis can help you improve cost saving opportunities in the Oil and Energy industry. Request a FREE proposal to gain deep insights and customized solutions from our skilled experts at SpendEdge to align your business goals with procurement strategy.