About the Author(s)
Jessica Davis Pluess, Manager, Research
September 11, 2012
What if procurement and sustainability managers in your company spoke the same language? It's likely that the concept of total cost of ownership (TCO) would find its way into the conversation. For procurement managers, TCO captures the costs associated with a product over its lifetime—from the development and design of a product through its use, maintenance, and disposal. Similar to the way sustainability managers think about the impacts of a product on the environment and society throughout its lifecycle, TCO takes a long-term view of the value a product brings to a company by evaluating the direct and indirect costs of a product at the time of purchase. Over the next few months, BSR's new Center for Sustainable Procurement (CSP) will be exploring ways the TCO model and its application could support the incorporation of sustainability information and data into procurement decisions. Is there an opportunity to align TCO and lifecycle assessment (LCA) information to form a total impact and ownership model?
How TCO Works
According to Shoshanah Cohen, director of Stanford's Global Supply Chain Management Forum, TCO expands the traditional procurement approach to account for more than just purchase price. "It captures all direct and indirect costs associated with taking ownership of a product or material, helping companies understand what they are actually getting for their money," she explained. In effect, TCO includes the purchase price as well as costs associated with shipping, insurance, taxes, storage, and disposal of materials at the end of the product's useful life. Rather than distributing the costs into different buckets (or budgets) based on materials used or labor associated with the product, TCO counts all costs associated with the product. If done well, this model can help managers avoid rushing into a decision that at first glance appears to be of good value, when analysis of the operational and product development costs could paint a very different picture. For a company like Hilton Worldwide (a major funder of BSR's CSP), this model is important for the purchase of a range of goods. Alec Burnett, a procurement expert and Hilton supply management's director of brand relations for full-service and luxury brands, pointed out that TCO can uncover critical cost savings for the company when a procurement manager is evaluating two seemingly similar products at very different purchase prices. Consider linens, which comprise a significant expense for the company and are typically evaluated based on two characteristics: thread count, and whether the material is cotton, synthetic, or a blend of both. "There are 15 to 20 other attributes that measure quality, performance, and longevity of the product and increase or decrease the cost of ownership," Burnett said. "If product A has an expected life of five years, based on normal laundering, but you choose product B, which lasts only half of this time, you will need to replace the linens twice as often." In this scenario, TCO usefully accounts for the costs of disposing of and replacing the product—as well as any factors affecting this, such as fluctuations in the cotton commodity market. This can have a substantial impact on the company's costs over the lifetime of the product.
The Challenges Associated With Using TCO
Although almost every company recognizes the value of TCO as a decision-making tool, Cohen noted, "It isn't implemented across the board." The electronics industry tends to use it due to the industry's cost-conscious nature and the rapid changes in technology leading to the obsolescence of products. But other industries may find TCO daunting. "The ability to gather and allocate all data associated with a product is the most difficult," said Cohen. "If you receive a truckload with 50 different products, TCO requires a company to allocate costs of freight, handling, and insuring to each." For Hilton, this is less of a challenge because the company has extensive historical data on the costs to ship, maintain, use, and replace products at a corporate and brand level. Burnett said the greater challenge for Hilton is inventory management, particularly for a product that has been custom-designed for the company. "When you are aligning with a specific supplier to produce something to a specification, it is important to find a balance between what is the minimum amount to be held while being conscious of uncontrollable situations such as a sudden growth in demand and/or fluctuations in the material market for a product—both of which could heavily impact costs and supply-gap management," Burnett explained.
Sustainability Lessons from TCO
What does TCO teach us about how sustainability information can be integrated into procurement? First and most obviously, TCO provides a framework and language for describing and measuring sustainability impacts in a way that procurement managers can readily understand. For example, TCO can be used together with LCA and similar approaches to uncover (and communicate) opportunities for both cost savings and sustainability benefits for things such as energy and water efficiencies. Where LCA and TCO truly align is in their focus on what is "behind the label" or "price tag" to understand the true cost and impact of a product from end to end. TCO offers an opportunity to bridge the pressures on procurement to cut costs and sustainability objectives of minimizing negative environmental impacts. Another meaningful lesson from TCO for sustainable purchasing is the importance of collaboration. "At Hilton, products affect many different cost centers, which is why every attempt is made to involve all of our [internal] stakeholders early on," Burnett explained. "They might not agree, and rarely do we hit that sweet spot where everyone is able to meet their objectives, but the most important thing is that we have all of the information from operations, guest experience, and other departments to make an educated decision. It is important to get the full picture of a product's total cost before a decision is made." Going forward, the CSP will be investigating opportunities to align the language and needs of procurement professionals with sustainability objectives. Does your company use TCO in purchasing? Have you thought about its implications for integrating sustainability into procurement decisions?
For more information about the CSP, read our feature article on "Going From 'What' to 'How' in Sustainable Procurement" and visit the Center for Sustainable Procurement web page.