Cost of ownership gsa

Federal Acquisition Service

U.S. General Services Administration

The Federal Strategic Sourcing Initiative (FSSI) Understanding the Elements of Total Cost of Operations (TCO)

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Provide a brief overview of strategic sourcing and the Federal Strategic Sourcing Initiative (FSSI)

Provide a comprehensive definition of Total Cost of Operations (TCO)- Explain the key elements of TCO- Clarify the difference between cost elements and cost drivers

Present illustrative examples of acquisition decisions based on TCO analysis

Share the benefits that can be achieved by incorporating TCO analysis into the procurement process

Workshop Objectives

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What is TCO? Total Cost of Ownership

- The total cost of owning and operating an asset over its expected period of use, i.e., lifecycle cost.

- Also includes costs to acquire and dispose of the asset

Total Cost of Operations - Similar to Total Cost of Ownership, but recognizes that certain assets might

be leased or provided as part of a contracted operation.- Provides a useful cost framework to evaluate:

• Policy options• Business process alternatives• Investment alternatives, e.g., in-house vs contract; own vs lease• Acquisition alternatives, e.g., vendor vs vendor; contracting options

Prelude

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The Federal Strategic Sourcing Initiative is an OMB-initiated program that was established in November of 2005

An OMB memo issued May 2005 required agencies to identify no fewer than three commodities to be purchased through strategic sourcing by October 2005 (excluding software purchased through SmartBUY). The memo stated that:

– Agencies needed to leverage spending to the maximum extent possible– Sound business decisions needed to drive spending

Federal Strategic Sourcing Initiative (FSSI) In November of 2005, as a direct result of the OMB mandate, FSSI was established with a mission to

improve the federal government acquisition value chain, increase socio-economic participation and ultimately lower total cost of operations and/or ownership for strategic sourcing vehicles

FSSI is governed by OFPP and the Strategic Sourcing Working Group under the Chief Acquisition Officer’s Council

More than 60 Federal agencies, boards and commissions actively participate in the FSSI Use of FSSI vehicles is non-mandatory, but agencies are encouraged to look at FSSI solutions first Currently, three FSSI vehicles exist with GSA serving as the Executive Agent:

- Express and Ground Domestic Delivery Services – GSA Schedule 48 BPA- Office Supplies – GSA Schedule 75 BPAs- Wireless Telecommunications Expense Management (TEM) Services – IDIQ, multiple award contract

2005 OMB Mandate

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Strategic sourcing is a process that strives to optimize an organization’s supply base while reducing Total Cost of Operations and improving mission delivery

Strategic sourcing is the collaborative and structured process of critically analyzing an organization’s spending and using this information to make business decisions about acquiring

commodities and services more effectively and efficiently

A group of senior Federal executives participating in the 2006 Public Sector Strategic Sourcing Roundtable defined strategic sourcing in the federal government as: A Systematic Process for analyzing and developing optimal strategies for buying goods and services

A Data Driven Process that relies on fact-based analysis for decision making rather than “hunches”

A Holistic Process that addresses customer needs, market conditions, organizational goals and objectives, and other environmental factors

Based on Market Intelligence and takes into account small business capabilities

Inclusive of Customer Requirements A Cross-Functional Approach that incorporates the perspectives and expertise of acquisition

specialists as well as end users

About Supporting an Organization’s Mission through procured goods and services

About Developing Organization-wide Strategies

http://www.whitehouse.gov/omb/procurement/comp_src/implementing_strategic_sourcing.pdf

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The benefits of strategic sourcing and drivers of TCO are numerous and go far beyond simple reductions in unit costs

Primary Benefits of Strategic Sourcing

Reduction in Cost Per Unit

Change in Consumption/

Volume

Improved Operating Efficiency

Improved Focus on Socio-

economic Goals

Pricing Improvements• Lower unit price• Volume rebates• Payment term

discounts

Supply Chain Savings• Cost of capital• Warehousing costs• Shipping costs

Reduced Lifecycle Costs• Maintenance costs• Operating costs• Disposition costs

Reduced Procurement-Related Operating Expense

Reduced Non-Procurement Related Operating Expense


Volume

Socio-economic Goals • Structured analysis of

small/disadvantaged business opportunities

• PO Processing• Accounts Payable• Receipt/Warehousing• Standardized

procurement process

• Other operating efficiencies

Performance Monitoring• Structured metrics and

periodic review of contractor performance

Demand Management• Eliminate demand• Reduce consumption• Encourage substitution• Change product mix

Specification Review• Eliminate “gold-plating”• Simplify specifications• Alternative products

DRIVERS OF TCO

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What is Total Cost of Operations?

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WHAT IS TOTAL COST OF OPERATIONS?• Total Cost of Operations (TCO) is a comprehensive, full cost accounting

estimate designed to help consumers and commodity managers assess costs• TCO consists of costs incurred throughout the life cycle of a service or

commodity, including acquisition, deployment, operation, support and retirement• TCO identifies costs which are made up of two major components - direct and

indirect:– Direct costs traditionally are made up of labor and capital costs

– Indirect costs are more of the “soft” costs associated with an acquisition and tend to be more difficult to measure and rationalize

One of the primary goals of strategic sourcing is the reduction of Total Cost of Operations

Understanding TCO broadens our baseline understanding of spend and identifies sourcing opportunities beyond purchase price

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PurchasePrice

Supplier'sCost

Supplier'sProfit

Acquisition Process Costs

ContractManagement

Costs

Bid & AwardCosts

Lifecycle Costs

End of Life Costs

Total Cost of Operations

Cost

s to

Buy

er $

OperationCosts

ManagementCosts

Disposal/Closeout

Costs

ContractManagement

CostsSupplier's

Profit

Supplier'sCost

Bid &Award Costs

Disposal /Closeout Costs

ManagementCosts

OperationCosts

TCO of a commodity goes beyond purchase price, it also includes acquisition costs, lifecycle costs, end of life costs and other

TOTAL COST OF OPERATIONS (TCO) ELEMENTS(Conceptual Example)

ILLUSTRATION

For some commodities, cost elements beyond purchase price may be significant, at times equaling or exceeding initial purchase cost over the commodity lifecycle

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Different commodities can vary significantly in their composition of TCO elements

• Many buyers will focus on achieving a competitive purchase price and will overlook opportunities to improve other cost elements

• For some commodities, purchase price is not the largest cost element

• Therefore, it is important to consider all cost elements, including (but not limited to):

- Internal procurement, contract management and billing/invoicing processes

- Internal management of the commodity

- Operational costs (cost of use, spare parts, maintenance, etc.)

- Disposal costs

NOTES

0

20

40

60

80

100

Example A -Refrigerator


Purchase Price

End of Life Costs

Lifecycle Costs


Purchase Price

End of Life Costs

Lifecycle Costs

Example B -Laptop Computer

TOTAL COST OF OPERATIONS (TCO) ELEMENTS(Conceptual Example)

ILLUSTRATION

Example A – Furniture

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Key Elements of Total Cost Analysis: Understanding Cost Elements vs. Cost Drivers

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Understanding the total cost of a commodity involves the identification of cost elements and cost drivers

What are they? Examples

COST ELEMENTS

Components of total cost of operations (TCO) – “buckets” of cost that can be quantified

Transportation costs Purchasing administration

costs Inventory costs Supplier certification costs

COST DRIVERS

Factors or activities that can be changed and have an impact on the magnitude of the cost element

Distance shipped Number of suppliers Number of purchase orders Number of different SKUs

COST ELEMENTS VS COST DRIVERS

• Cost drivers can at times be significant sources of savings for some commodities• Drivers of cost within suppliers’ operations can be very important for commodities

where unit price is still likely to be the largest component of our total cost

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When identifying the various cost elements of TCO, it is also important to consider the percentage of TCO that is comprised of each the costs elements

TCOElement Description Estimated

% of TCO

Purchase Price & Acquisition Process Costs - Device

Hardware includes the actual price paid for the product

Lifecycle Costs -Operations and Maintenance Costs

Operations and Maintenance costs include maintenance, repair,

help desk, asset management, upgrades, licensing, etc.

Lifecycle Costs-Consumables

Consumables (e.g. paper, ink, toner, cartridge) are a significant

part of the office imaging cost

NETWORK PRINTER COST COMPONENTS

5%*

50%*

45%*

Source: Prudential Equity Group Research, Oct 2006; Lexmark International; Censeo Analysis

* Percentages referenced above are based on an industry report from Lexmark International; this break out will not be true in all scenarios – End of Lifecycle Costs are also components that impact the TCO of a network printer, but the estimated percentage was not provided in the referenced industry report

For a common piece of office equipment - a network printer – there are multiple TCO components that should be considered when conducting an acquisition. What percentage of the total cost do each of these components make up?

The percentage break out of TCO components does not always align with initial assumptions and can impact the results of a total cost analysis

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As demonstrated in the previous example, consumables, maintenance & IT support, and equipment costs are the key cost elements of desktop printers

RELEVANT TOTAL COST COMPONENTS• Purchase Price:

–Hardware: Annual depreciation cost of printers • Acquisition Process Costs:

–Acquisition: Estimated acquisition costs associated with requirements validation & contracting purchasing activity

• Lifecycle Costs:–Operations & Maintenance:

•IT Support: Cost estimate of in-house IT help desk support provided to local and network printers

•User Support: Cost estimate of work effort associated with toner and paper replenishment performed by users

•Property Mgmt: Estimated property management personnel costs associated with managing printers

–Consumables: •Paper and toner costs•Power: Estimated power costs associated with devices

• End of Life Costs:–Disposal: Cost of product disposal at end of life

Understanding internal costs related to purchasing and managing a commodity is important in identifying

savings opportunities

Source: Prudential Equity Group Research, Oct 2006; Lexmark International; Censeo Analysis

DESKTOP PRINTER TOTAL COST OF OPERATIONS BREAKDOWN

* Percentages referenced above are based on an industry report from Lexmark International; this break out will not be true in all scenarios – End of Lifecycle Costs are also components that impact the TCO of a network printer, but the estimated percentage was not provided in the referenced industry report

Purchase Price & Acquisition Costs - Device

Lifecycle Costs –

Operations & Maintenance

Lifecycle Costs -

Consumables

Total Cost of

Operations

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Key Elements of Total Cost Analysis: Conducting A Complete TCO Evaluation –

In The Workplace

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With most acquisitions, unit price is often the only cost component considered

Device A Device B Device C

Device B&W Printer – medium size

B&W Printer – medium size

B&W Printer – medium size

Volume 100 100 100

Unit Price/Device Cost

$1,031.00 $783.75 $725.20

Source: Censeo analysis

$725.20


Based on the data above, Device C would be the

best value

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But to truly obtain best value, it is critical to evaluate all TCO cost components before completing an acquisition

Device A Device B Device CDevice B&W Printer – medium size B&W Printer – medium size B&W Printer – medium size

Usage* 4,000 pg/month 4,000 pg/month 4,000 pg/month

Volume 100 100 100

Product Support 4-Yr Extended Warranty 4-Yr Onsite Warranty 4 Yrs Onsite Product Support

Purchase Price Device $1,031.00 (34% of total cost) $783.75 (28% of total cost) $725.20 (19% of total cost)

Acquisition Process Costs Procurement $150.00 (5% of total cost) $150.00 (5% of total cost) $150.00 (4% of total cost)

Lifecycle Costs

Est. 4-Yr Consumables Cost $1,425.67 (47% of total cost) $1,282.50 (46% of total cost) $2,811.60 (72% of total cost)

4-Yr Product Support Cost $408.00 (13% of total cost) $538.20 (19% of total cost) $144.00 (4% of total cost)

End of Life Costs Disposal $50.00 (2% of total cost) $50.00 (2% of total cost) $50.00 (1% of total cost)

Total 4-Yr Estimated TCO $3,064.67 $2,604.45 $3,880.80

* Usage estimates are based on avg # users per device (8), typical # of pages per user (500) resulting in the estimated total # of monthly pages (4,000). Projected Consumables Costs assume utilization of high-yield cartridges where available.

Source: Censeo analysis

$2,804.45


A complete analysis of TCO indicates that Device B truly is the best value

solution

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Key Elements of Total Cost Analysis: Conducting A Complete TCO Evaluation –

In Daily Life

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The process of conducting a TCO analysis can be applied in everyday life

TOTAL COST OF OPERATIONS (TCO) EVALUATION

TCO analysis indicates that the cheaper car to buy is actually the more expensive car to own and operate

Example A(Non hybrid)

Example B(Hybrid)

Purchase price Sticker Price: $22,151

Sticker Price: $23,650

Acquisition process and lifecycle costs*:

- Depreciation- Taxes and Fees- Insurance Premiums- Fuel- Maintenance- Repairs- Interest on Financing - Stimulus - Auto Assistance

Ownership Amendment

$9,981 $1,600 $10,216 $10,700 $3,050 $671 $3,840 $1,500

$10,549 $1,635 $10,216 $5,600 $3,050 $671 $3,953 $1,500

Purchase price after TCO analysis Price: $40,058(cost is 53 cents per mile to drive)**

Price: $35,658(cost is 48 cents per mile to drive)**

*End of Life Costs are not included in this example**Cost of ownership is assumed over a five year period and 15,000 miles a year

Source: http://www.edmunds.com/advice/buying/articles/59897/article.html

When purchasing a car consumers often consider only

one variable – sticker price – and based on the sticker price

in the example to the right, Example A, the non-hybrid is

the more economic choice

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Method of Commuting

Cost Components

Estimated Cost (per day)

Total Estimated Commuting Cost (per day)

Drive ParkingGas

$10$5 (each direction)

$20

Public Transportation

Fare Parking

$3.50 (each direction)$5

$12

Estimated Daily Cost of Commuting

When selecting a means of transportation, it is important to understand how different cost drivers can influence the TCO

But are these the only cost drivers?

Commuting to work is a daily activity for most individuals. In nearly all instances, there are a number of expenses incurred with a daily commute. These expenses will vary based on method of transportation, distance traveled, number of options available, etc. These expenses may also drive us to choose one method of transportation over another.For this exercise, assume that there are only two commuting options available, to drive or to utilize public transportation. Based on the “out of pocket” expense incurred on a daily basis, let’s calculate the cost of a daily commute:

Based on an initial assessment, there are multiple cost components that

should be considered for

both methods of transportation

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In our assessment of the daily cost of commuting, it is important to remember that all costs may not be apparently obvious

Method of Transportation

Drive Public Transportation

Parking $10 $5

Fare $0 $3.50 (each direction)

Gas $5 (each direction)

$3 (each direction)

Car Insurance $5.68 $5.11

Depreciation of the car $1.69 $1.69

Maintenance and repair of the car

$5.50 $4.95

TOTAL $32.87 $29.75

Estimated Daily Cost of Commuting

In our calculations of the cost of a daily commute, have we considered all costs?

Cos

t Com

pone

nts

*Figures for “drive” method assumed for a 2009 Honda Civic over a five year period and 15,000 miles a year Source: http://www.edmunds.com/advice/buying/articles/59897/article.html

• There are a number of additional cost drivers that were not immediately apparent in this example

• These additional costs can have a significant impact on total cost, and only by assessing all drivers can one truly understand the total cost and make an informed decision between the two alternatives

• Time is another cost element that was not considered. Time can be assessed as an opportunity cost.

Because of limited contracting resources within the government, time is a critical element in any acquisition and cost analysis

NOTES

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Understanding the Benefits of TCO

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Once we understand cost elements and drivers and identify specific actions we can take to impact total cost, savings estimates can be developed to support recommended changes

Price Volume Rebates Payment term discounts

Cost of Capital Warehousing Costs Shipping costs

Maintenance costs Operating, energy and other costs Disposable costs

Elimination Substitution Change in mix

Cost of processing purchase orders Cost of processing accounts payable Cost of receipt/warehousing

Other Operating efficiencies

Total Savings

Related to Purchased Goods and

Services


Volume

Reduced Lifecycle Costs

Reduced Procurement

Related Operating Expense

Reduced Non-Procurement

Operating Expense

Reduction in Cost per Unit

Improved Operating Efficiency

Reduced Supply Chain Costs

Reduced Prices

SAVINGS CALCULATION FRAMEWORK – TOTAL COSTS

Examples

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Understanding TCO and how to apply the concept to acquisition decisions can result in significant savings opportunities, specifically unit cost reduction and planned changes in consumption and volume

• Unit price reductions can be achieved by:

– Negotiating payment terms to gain pricing improvements and discounts

– Optimize the supply chain

– Reducing lifecycle costs through the management of maintenance costs, operating costs, and disposal costs

• Planned changes in consumption and volume can be achieved through:

– Demand management, eliminating demand and reducing consumption

– Specification review, simplifying specifications and suggesting alternative products

NOTES

The following slide provides an example of how unit price reductions and changes in consumption/volume can result in reduced lifecycle costs and efficiencies

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$10K

$20K

$30K

$40K

$50K

Status QuoScenario 1 -

Low quality withfull replacement

Disposal of Roof(End of Life Costs)

Acquisition(Acquisition Costs)

Minor Repairs(Lifecycle Costs)

RoofReplacement(LifecycleCosts)

InitialRoof

(PurchasePrice)


Low quality withpartial replacement


Acquisition(Acquisition Costs)

Minor Repairs(LifecycleCosts)

Major Repair(Lifecycle Costs)

RoofReplacement(LifecycleCosts)

InitialRoof

(PurchasePrice)


Low quality withpartial overlay


Acquisition (Acquisition Costs)

Minor Repairs(LifecycleCosts)

MajorRepair

(LifecycleCosts)

InitialRoof

(PurchasePrice)

High Quality Roof20 - year

InitialRoof

(PurchasePrice)


Acquisition(Acquisition Costs)Minor Repairs(Lifecycle Costs)

ROOFING SCENARIOS 20-YEAR LIFETIMECOST COMPARISON

($ per SF)

1 2 3 4

In the example below, understanding the TCO elements of lifecycle costs and specification requirements can result in significant cost savings when making an acquisition decision

• Reduction in Cost per Unit and Lifecycle Costs:

– Investing in higher quality materials, workmanship, and warranty coverage upfront will cost more in year one, but will provide the lowest “lifetime” TCO

Change in Consumption/Volume:

– For major facility capital investments like HVAC equipment or roofing, clearly identifying and assessing specifications can result in cost savings by reducing consumption (and limiting replacements of parts or full structures)

NOTES

EXAMPLE

Source: Censeo Analysis

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TCO can also help evaluate the benefits of operational decisions such as changes in consumption/volume and improved operating efficiency

• Change in consumption/volume and improved operating efficiency can be achieved in a number of ways:

– Through the implementation of an online ordering system to reduce paper and manual transactions and improve invoice processing and auditing

– Business Process re-engineering

NOTES

The following slides provide an example of how to calculate savings gained through improved operational efficiencies

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Reducing processing times improves operational efficiency

1) Employee walks to copier room to obtain a FedEx letter

2) Employee returns to their desk and clicks on FedEx Online

3) After 3 clicks the label prints out on the employees printer

4) Employee walks back to the copy room to place the outgoing letter in a designated place

5) At a designated time a mailroom employee walks the halls and picks up all out going FedEx packages and mail and returns all to the mailroom

6) FedEx then picks up all outbound shipments

All time was studied and this took on average 1 minutes and 22 seconds to complete

REVISED SHIPPING STEPS

IMPROVED OPERATIONAL EFFICIENCY– PROCESSING TIMEShipment of FedEx Packages

1) Employee walks to copier room to obtain FedEx letter and requisition form

2) Employee walks back to their desk to complete the form 3) Employee secures requisition form to the letter with tape 4) Employee walks back to the copy room to place the

outgoing letter in a designated place 5) At a designated time a mailroom employee walks the halls

and picks up all out going FedEx packages and mail and returns all to the mailroom

6) In the mailroom the mailroom employee keys into a FedEx system the destination address

7) The mailroom employee records the tracking number on the requisition form

8) The form is returned to the original sender 9) The form is secured in a file cabinet 10) FedEx then picks up all outbound shipments

All time was studied and this took on average 14 minutes and 42 seconds to complete

PREVIOUS SHIPPING STEPS

Source: This example is provided courtesy of Federal Express Corporation

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Reduced labor costs is an example of the savings that can be achieved through improved operational efficiency

• STEP 1: Divide the hourly labor rate of the individual conducting the procurement (based on GS level and pay grade) by 60 min in an hour to generate the estimated labor rate per minute.

• STEP 2: Next, work with subject matter experts to estimate the current and future processing time of the given transaction and subtract the current time from the future processing time. Then, multiply the variance by the labor rate per minute identified in Step 1.

• STEP 3: Identify the total number of transactions that are processed per year. Multiply this number by the labor cost savings per unit identified in Step 2.

These calculations result in the annual estimated labor rate savings

achieved through improved processing time

Savings CalculationsSAVINGS CALCULATION

IMPROVED OPERATIONAL EFFICIENCY– PROCESSING TIMEReduced Labor Costs Associated With Shipment of FedEx Packages

1

2

3

Source: This example is provided courtesy of Federal Express Corporation

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STEPS TO CONDUCT A TCO EVALUATION

1) Before beginning any acquisition, through market research or product analysis, identify the key cost elements that comprise the total cost of operations for this commodity – beyond just price

2) Identify the cost drivers for this commodity – which of these can we control/influence?

3) Once the cost elements and drivers have been identified, assess each of these components and assign an estimate percentage of total cost– if the assigned percentage is not significant (falls below 5%) eliminate it from your evaluation

4) Identify the appropriate timeline to measure the total cost of this acquisition

5) With a revised, prioritized list of TCO components, assess the true cost of the commodity

6) Compare and save!

There are a number of key steps that should be completed as part of any acquisition to ensure a thorough TCO evaluation has been conducted and best value achieved

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GSA FAS - FSSI Program Management OfficeFSSI website: www.gsa.gov/fssi

Michel Kareis, PMP FSSI Program Manager [email protected] (703) 605-3669

Office of Management and Budget (OMB)

Jack Kelly [email protected] (202) 395-6106

Points of Contact