How to evaluate the Total Cost of Ownership
In procurement today, one valuable approach that is widely used in private market procurement remains underutilized by government agencies: Total Cost of Ownership (TCO). Even though TCO allows purchasers to move toward sustainable and long-term cost savings strategies rather than short-term benefits and the lowest price, many agencies still select suppliers based on price without looking at the full value a supplier can offer.
In our latest white paper, Total Cost of Ownership (TCO), the NIGP Business Council examines various aspects of TCO and provides guidance for agencies interested in integrating TCO into their procurement practices and evaluation criteria. Using real-life examples, we demonstrate that by implementing TCO practices on a regular basis, agencies can determine the overall lifecycle cost of a product or service, dig deeper into performance metrics, compare and contrast different variables associated with ownership, integrate sustainability into the procurement process and assess the ongoing costs of a specific purchase.
By examining this topic, we hope to increase awareness and inform procurement professionals about TCO, influence broader acceptance and use of TCO in government procurement practices and find ways to help agencies introduce TCO concepts into their procurement processes. We hope to move agencies toward long-term sustainable cost savings strategies that bring greater value than the potential short-term benefits of lowest price supplier selection.
Value of TCO in Procurement
Agencies using TCO can realize each procurement’s full potential through value creation. To achieve best value, each agency first must determine what value looks like to them. To begin the process of quantifying value, agencies need to conduct a discovery phase that engages and leverages the input of all stakeholders and end-users in the process. The collaboration between stakeholders empowers everyone involved to incorporate best practices and best value in the procurement. During the discovery phase, to develop sustainable long-term cost strategies and benefit gains despite competing and conflicting priorities, procurement professionals can ask themselves:
- What are the agency’s priorities as outlined by their leaders?
- What is the agency’s business case for sustained benefit gains?
- What do cost-savings look like?
- Is it inventory carrying cost reductions or, better yet, elimination?
After examining product cost categories, the group can determine whether value is:
- The product’s cost, availability, efficacy, and timely delivery,
- The supplier’s ability to provide training and support, responsiveness, experience and references,
- Benefits or gains over the life of the product, not just in the first year, or
- Other issues that need to be considered.
Suppliers will need this information to know whether they can meet the agency’s vision of value, both tangible and intangible, and how they plan to integrate that value proposition. With this information, they should be able to explain to purchasers how their solutions will lower operating and maintenance costs, save time or improve quality.
Integrating TCO into the Procurement Process
To integrate TCO into a procurement process, it is recommended that procurement professionals:
- Evaluate and consider all true costs and benefits, and consider variables that include non-cost items; the needs of end-users; demand; and delivery/lead times.
- Engage end-user departments within the agency to perform a spend analysis and spend mapping.
- Research the data available to determine your criteria for TCO. Reach out to the end-user or requesting department to determine their needs and to suppliers to find out what type of data is available.
- Create a specifications template to solidify your criteria for judging suppliers’ responses.
- Solicit data from suppliers by sending them the template and a timeline for its completion.
- Research the suppliers’ solutions and check their references.
- Upon receiving the completed specifications template, make a decision based only on the agreed upon criteria and the data provided.
- Use a state, local or existing alliance or cooperative purchasing contract to reduce the cost of the procurement, expedite the procurement process, and leverage pricing.
- Issue an RFI/RFP to allow other criteria to be used if you are unable to use an existing contract.
Recommended TCO practices
Below are some recommended practices that agencies may want to consider when integrating TCO into internal processes:
- Actual Purchase Price: Find out the real price the agency is paying for products from a supplier.
- Consistent Shipping: For products that have previously been procured from specific suppliers, ask end-users if they consistently receive all of the products they ordered complete and on time.
- Contract Issues: Cooperative or existing contracts offer an opportunity to procure the correct solutions to achieve an agency’s long-term goals rather than the lowest cost solution, which may be shortsighted.
- Cooperative Purchasing Agreements: Cooperative agreements, which often use a variety of TCO areas to evaluate supplier proposals in response to RFP terms, can streamline procurement decisions, taking cost out of purchasing decisions.
- Direct and Indirect Costs: For each purchase, identify known direct and indirect costs and their applicable rate/cost to help you fairly and consistently evaluate competitors.
- Product Quality: Evaluate the quality of a product that was purchased. Purchasing a slightly higher-priced item that lasts significantly longer than a lower-priced alternate could be a better choice over time.
- Rebates: Find out if there is a rebate on the purchasing volume and any beneficial impact it would have, and then apply the rebate or discounts to the product’s life cycle.
- Supplier Support: Consider whether the supplier is a known entity, easy to purchase from, and able to reach out with support, training, product knowledge, and other types of activities to support the agency’s needs.
- Supplier TCO Methodology: Ask prospective suppliers to provide their specific methodology to address the TCO factors for a particular product and/or service.
Realizing Savings through Supplier Relationship Management
Effective supplier relationship management and information-sharing allows suppliers to understand your current state of operations. This shared understanding can lead to discussions about how to continue driving down costs through the proper product selection, training, equipment use and maintenance. With effective contract management and supplier performance data, you will have easier access to TCO information for a specific commodity or service that you can compare against new proposals.
Integrating TCO into Evaluation Criteria
For each specific procurement involving a TCO analysis, your agency can discuss the important TCO components of the product, operation, and support with the end-users and combine the information received from suppliers to construct a specific, agency-based TCO formula. After incorporating the TCO criteria for each product or service and developing the formula, the agency can quantify the benefits for using a TCO basis in your cost evaluation. You will want to be sure that their specific procurement code allows for a “best value” evaluation of the proposals since best value typically includes a calculation of TCO. Each supplier should be judged only on the common/agreed to criteria communicated to all. By developing a simple scorecard to assess purchasing prices and practices, an agency can easily shed light on some TCO areas, especially if that information is already available within the agency.
Quick Wins when Incorporating TCO
There are several steps an agency can take to begin using TCO practices even while working on the longer-term and more complex aspects of TCO:
- Determine what your current cost of operation is to have a baseline for comparison purposes.
- Use the internal information your agency already has to evaluate any tangential benefits you get from working with specific suppliers.
- Approach TCO as “risk mitigation.” By mitigating risk, you can avoid a public and costly project failure that was awarded to a supplier whose bid price was too low to complete the stated requirements.
- Consider TCO as an agency benefit tool outside of the cost of specific purchases.
- Look for opportunities to design the implementation plans to be phased in to create quick wins with quantifiable value.
- Focus on developing effective contract and/or supplier management.
Breaking through challenges
When incorporating TCO into procurements, we recognize that some purchasers may encounter challenges, such as limited access to essential data or a regulatory environment that restricts the use of TCO. But if your agency is able to put the recommended practices into place, many of these challenges will be mitigated for you and the supplier. By integrating into your procurement process the ideas and recommended practices outlined in the NIGP Business Council’s Total Cost of Ownership (TCO) white paper, you should be able to uncover hidden costs and critical cost savings, better reduce and control costs, develop a complete and clear picture of investments, establish strategic relationships with suppliers, minimize risk and drive positive organizational change.
The NIGP Business Council serves the NIGP membership and procurement profession through sharing resources and business expertise in support of NIGP’s educational, research and advocacy mission. The Business Council connects the supplier’s perspective with the public procurement community and is dedicated to improving the buyer/supplier relationship.