As a manufacturer owner in India, you have to make purchasing decisions every day. You explore the market and look for many options. You also have to see which items are cheaper than the others. This is where you can learn the total cost of ownership and how it can help you understand the reasonability of items and helps you find the lower initial cost. With this knowledge, you can make smart decisions for better efficiency.
In this blog post, we will learn about the total cost of ownership and its implementation in your manufacturing business.
What Is Total Cost Of Ownership (TCO)?
TCO, or Total Cost of Ownership, is an estimate of the total cost of any product or service. Total cost of ownership definition involves looking over all the expenses related to a product. These charges include initial purchase costs, maintenance costs, repairs, training, and downtime.
Further, TCO meaning in business considers licensing fees, disposal fees, energy consumption, and other hidden costs. It gives you detailed information about the initial costs too. This includes raw material procurement, product production, buyer and supplier maintenance costs, testing costs, training costs, and others before building or buying a product with TCO.
How Total Cost Of Ownership Works
The total cost of ownership is the sum of all expenses related to the product. Let’s understand the TCO meaning and calculation for a product.
- You start by calculating the initial costs. This is the upfront cost you pay to buy a product or service.
- Next, think about the operational costs, including maintenance and repairs. Think about employee training, consumables, and licensing fees, if any.
- Make sure to include the disposal costs, recycling fees, and data security costs.
- Calculate the final TCO using the formula below.
TCO = Initial Cost + Operating Costs - Disposal Costs
Finding the true value of the product and considering its life span plays an important role in calculating the total cost of ownership.
Why Is TCO Important For Businesses?
Here are some of the reasons why TCO Total Cost of Ownership is important for every business:
- You can find out hidden costs that add to your expenses and save money
- You can make the resource allocation process better by knowing what is happening beforehand.
- You can reduce the risk factor by estimating the downtime and security risks
- You get a chance to make better deals with clients and vendors.
- You can make a long-term plan for your business to facilitate profits.
- You can lower the cost of ownership based on calculation.
When Should Businesses Use TCO Analysis?
We now understand how TCO analysis can help us calculate the total estimated cost of a product or service. Let’s talk about when a business should do TCO Analysis and how it can help them.
- A business can use a TCO calculator to compare vendors and solutions. Examine the long-term costs and find the best deal for your business.
- If you are upgrading or renewing any software, hardware, or machinery, you can get help from a reliable TCO calculator. This step will provide cost-effectiveness to your decisions.
- Businesses adopting new technologies can find the financial impact on their business. They can find out the employee training cost, infrastructural expenses, hidden expenses, etc.
Key Components Of Total Cost Of Analysis?
Total cost of ownership talks about the financial impact of any asset. You may find three core components for TCO in business.
1. Physical Hardware Costs
In TCO analysis, hardware, and acquisition costs are the upfront expenses. They tell the identifiable cost and are readily available. For example, if you are purchasing software, you will be able to identify the purchase price, installation fee, shipping/handling fee, and initial configuration costs.
2. Fixed Operating Costs
Operating Costs include product maintenance and repair costs. Further, they apply to all consumable items that end with time and are bought again. Every item that consumes energy or is subscription fee-based comes with operational costs.
3. Human Resource Costs
For manufacturing, you need people who can carry out the tasks. Personal Costs may include the salary of the employees and training costs. Finally, you need people for technical support. You can either hire a team for the same or take external help.
How To Calculate The TCO?
As an SME owner, understanding how TCO calculation works can benefit you while comparing costs between products. Here's how you can calculate the Total Cost of Ownership.
1. Understand the initial price of the product or service. These are the upfront costs you pay to buy a product.
2. Next, include the installation and setup costs. Training expenses also come in this section.
3. Think about the operational costs associated with the product. Include electricity, consumable items, and labor costs here.
4. Every product and related industry requires maintenance and repair at regular intervals. Add audit costs, upkeep costs, and unexpected repair costs here.
5. Add downtime costs and their impact on your business returns.
6. Finally, consider the cost of the product after its lifespan ends. Include costs of disposal and recycling. Include the money you can earn after the product's working period ends, and it can be used as a resource for another good. All of the above details will help in calculating TCO purchasing.
Factors Used To Calculate The TCO?
Here are some factors you should consider before calculating the total cost of ownership in procurement.
1. Acquisition costs, including the purchase price, installation, fee, shipping, etc.
2. Operating Costs like maintenance and repair.
3. Human working cost- salaries.
4. Recycling fees. This represents the cost of a product when it is no longer useful and can be sold to another buyer or recycled to create another product.
5. Hidden Costs like downtime, low productivity season, etc.
6. Upgradation costs, if any.
Lets understand this better with a TCO calculation example. Imagine you are a PCB manufacturer and have to purchase an Automated Optical Inspection (AOI) machine. Here's what you should consider:
1. Initial Investment in buying the machine
2. Labor Costs
3. Work and rework costs
4. Machine maintenance costs
5. Electricity costs
Benefits Of Considering Total Cost Of Ownership
In a SME, you want to pick a product or service that gets you the most value for your investment. Here's where Total Cost of Ownership can help you. Below are benefits of total cost of ownership:
1. Reduce Hidden Costs
TCO allows you to see the product purchase price. You can check the related expenses, operational costs, and hidden fees, and examine expected maintenance. If you know what your product is going to cost after purchase, you can save the maximum.
2. Improving Work Efficiency
Get insights and look out for the areas that reduce waste purchases and streamline your business processes like management and purchase. You are working towards increasing the overall efficiency of your business with TCO.
3. Risks and Budgeting
Find out risks related to your business after product purchase. Learn about the product history and focus on reviews from other consumers. If you see a case of product breakdown or high maintenance, you can change your purchase decision. You can budget your purchases better and invest where the returns are high with this method.
Example Of Total Cost Of Ownership
Let’s take a total cost of ownership example to understand this concept better. Suppose you are an electronics manufacturer and want to purchase a Surface Mount Technology (SMT) Line for PCB Assembly. You have two options.
The first one is Manual Soldering. The initial investment costs here are 5 Lakhs. Further, you have to spend an estimated 20 Lakhs for consumables, rework, labor, and electricity. This option has a lifespan of 5 years.
The second option is purchasing an automated SMT Line. You will spend 50 lakhs initially on the machine and reflow oven. Further, labor, solder paste (used in lesser amounts), electricity, and maintenance would cost you 15 Lakhs.
The first option might look cheaper initially. However, consider the reduced rework costs, labor costs, and improved efficiency over the years using TCO. You will find out that the automated SMT Line gives you more benefits and profits.
Total Cost Of Ownership Across Various Industries
Total Cost of ownership is valuable and of great use in multiple industries. Here is a list of some of these ventures where the total cost of ownership plays a vital role.
1. Information Technology: The IT industry has software and hardware requirements. You have to think about the initial costs, licensing fees, and maintenance charges. Further, you have to upgrade your equipment with the market. Therefore, take upgrade costs into account.
2. Manufacturing Industry: The manufacturing industry works with a lot of machines and hardware equipment. Further, these devices run high on power and take a lot of electricity. You have to consider the above factors and downtime costs to find the total cost of ownership. Cost breakdown can help you choose the right machines and improve business efficiency.
3. Real Estate Market: Imagine that you have to buy a property. If you consider only the purchase price, you may regret your decision. You have to think about the local taxes, property taxes, insurance rates, and loan interest rates. Further, you may require renovations and include furnishing costs for calculation. Investing in a property is a major decision, and you should consider all expenses before moving forward.
Hidden Aspect Of The Total Cost Of Ownership
Total Cost of Ownership calculation includes multiple cost factors other than the main ones. These hidden parts shall not be forgotten. Let's talk about these factors and include them in the total.
1. Downtime: Maintenance costs hold the maximum focus for any investment. However, downtime can happen in any industry. You may come across software and hardware issues that bring everything to a stop.
2. Security: Running a business includes consideration of the security risks related to every asset or service. Data breaches, malware attacks, and other things need prevention.
3. Disposal: You should consider what would happen to the product after it stops working. You may face a disposal fee for some assets for recycling and cleanup. Consider these costs for the total cost of ownership.
What To Consider While Building A TCO Calculator
Building a TCO calculator can help you reduce stress and find out the total cost of ownership for any product that you use. Here are some considerations for a TCO Calculator.
- Define the product first. Include the necessary hardware, software, vehicle, machinery, or building.
- Make a cost strategy and think about the acquisition, operation, personal, and other costs. A calculator should have a section to add all expenses.
- Develop a calculator with personalization and customization features. Personalization features may include industry selection (automobile, textile, etc. ), adjustable raw material, stocks, and other costs, and multiple financing options.
- A TCO calculator should represent the final results. Make a calculator that showcases the cost breakdown and required summary.
Making Informed Purchasing Decisions With Total Cost Of Ownership Analysis
The Total Cost of Ownership calculation is important for every business. Your software solution can be analyzed using a TCO calculator. After all, you have to think about every expense and find out if you are getting the required Return on Investment (ROI). If you are running a small manufacturing enterprise in India, you should know what software you should use to help with your operational tasks.
Having a tool that can manage all your tasks from sales, inventory, production, planning, and purchase can transform your business. Here's where TranZact comes in. TranZact helps you keep track of buyers and stores their information for sending quotations on WhatsApp or email. TranZact helps you in Lead Management.
Send approval requests for purchase orders, get help in production planning, and get information about your raw materials and stock status. Get TranZact now and enjoy the benefit of tools like the Sales and Purchase module, Production module, Inventory module, and others.
FAQs
1. What is the total cost of ownership (TCO) analysis?
TCO analysis is all the expenses associated with an asset, product, or service. You can calculate the return on Investment on a product based on the TCO calculation. You are finding out if a product will be worth its cost during its lifespan and disposal.
2. What is the objective of TCO?
There are multiple objectives associated with TCO. You get the true cost of the purchased product or service here. Moreover, the total cost of ownership allows small businesses to make informed decisions about hardware, software, and other purchases, like ERP.
3. What are the three components of TCO?
The three components of total cost of ownership are Acquisition Costs, Operating Costs, and Personnel Costs. The acquisition is about the purchase price of the products. Further, operating costs are all about maintenance and repair. You can consider training and support expenses with Personnel costs.
4. How does considering TCO lead to informed purchasing decisions?
TCO allows you to find out about hidden costs for any business. You are able to compare between options for every asset. Further, you can make the required decision, getting the best out of the desired value.
5. How do you calculate TCO?
You can create a TCO calculator to calculate the total cost of ownership. You will include the initial buying costs, expenses, and usage across the product lifetime, component costs, and others for the final addition.
6. What are the benefits of TCO?
Benefits of TCO include saving money by using TCO analysis for better purchase decision-making. Further, you can benefit from using better resource allocation and budgeting.
7. What is the total cost of ownership (TCO) example?
For a TCO analysis example, imagine that you are a toy manufacturer and have to buy a new molding machine. One machine has an initial cost of Rs. 50 Lakhs, while the other costs Rs.70 Lakhs. The first machine is useful for 3 years and has high operational costs. However, the second machine can work well for 5 years and has lower operational costs. The second machine has disposal costs as well. After the TCO analysis, you will get the benefit and better return on investment by buying the second machine.
8. What are the challenges of total cost of ownership?
You may face multiple challenges while considering the total cost of ownership. Some of these challenges include market research for the right cost, cost comparison between the same product from different sources, etc.
9. Why is the total cost of ownership important in procurement?
Total Cost of Ownership (TCO) is important in procurement as it provides a complete view of all costs involved over a product's lifecycle. This helps with better-informed, cost-effective decisions. This approach helps with accurate budgeting, risk management, and long-term savings.
