Acquisition or purchase price is often the most visible part of procurement and because of this it is often thought that acquisition or purchase price equals to the procurement cost. However, this can easily lead astray since there are many other costs caused during procurement life-cycle, which should be taken into account when evaluating and comparing different procurement options.
With the Total Cost of Ownership thinking total costs are being perceived during procurement life cycle; at its simplest it means that as regards to procurement what costs acquired good or service causes:
- Before making procurement decision → cost of the procurement process
- During making an acquisition → purchase / acquisition price
- During use of the acquired goods or service → costs of the usage
- At the end of the life cycle of product or service → costs of stoping the usage
The total cost of ownership thinking can be applied to all types of procurement, but especially important TCO modeling is in procurements, which are significant in terms of money and long-term procurements.
Modeling of the total cost of ownership facilitates decision making and gives an indication of the economic importance of procurement to entire company. With the TCO view, low purchase price may turn to be expensive when considering other cost factors associated with procurement. For example, when comparing different sizes of packaging and packaging methods, the cheapest is not necessarily the best option, if it involves significant storage and handling costs.
Before making procurement decision → the costs of procurement process
These refer to the costs of finding a suitable good or service, possible visits to the supplier’s premises and factories, inspections to be carried out (supplier audit), evaluation of suppliers and the selection process. Costs may thus be incurred, for example. allocated working hours, travel and administration. The longer and more thorough the procurement process, the higher the costs. On the other hand, a thorough supplier selection phase is paramount, especially when the procurement is financially significant.
At the time of acquisition → purchase / acquisition price
The purchase price refers to the amount agreed between the buyer and seller company and on which the delivery and delivery of the goods and the performance of the service are based. The purchase price is the result of negotiations and both parties must have a common view of the price on which the contract is based.
During the use of the acquired good or service → costs during use
Types of costs associated with use may include, for example, training, installation, maintenance and service, warehousing, logistics (e.g., freight and ground transportation), and goods handling. Possible complaints, return and development costs are also included in the cost factors during use. Some of these costs can be estimated as hourly costs (EUR / hour), some can be fixed. For example, the training may be included in the contract at a fixed price, or if it is done with own resources, the related costs may be estimated as costs / person participating in the training, or as a time resource.
All of these cost factors incur different costs over the life of the good or service, which must be modeled when making a procurement decision. For example, when purchasing IT services, you need to consider installations, deployment support, training, upgrades, and customer support. For printers, ink cartridges usually represent a significantly higher cost than the purchase price. For raw materials, warehousing, logistics and handling costs can be significant cost factors. With regard to services, it is necessary to consider what the costs associated with using the service will be borne by the company itself, and what is the financial significance, for example, if the service is not in use or does not work as it should.