Supplying Principles and Practices > USPS Supplying Practices Process Step 1: Identify Needs > Develop Preliminary Total Cost of Ownership Estimates

Develop Preliminary Total Cost of Ownership Estimates

Once the Postal Service has assessed resources, the next step is to gain an understanding of the total life-cycle cost of a product or service. Total cost of ownership (TCO) refers to the total cost incurred over the useful life of an item, encompassing development, purchase, use, maintenance, support, and disposal. A TCO analysis will assist the identification of costs and risks associated with each life-cycle stage, their relationships, possible cost-reduction levers, and alternative products or services. A TCO analysis is especially helpful for more complex purchases; it does not need to be performed for every purchase.

Cross-functional collaboration is especially important to ensure that the TCO accurately reflects all costs at each life-cycle stage. The Pricing Analyst will work closely with the Item Manager, and with representatives from responsible Postal Service organizations, as appropriate, to complete the initial TCO analysis. Collaboration should continue for subsequent updates to the TCO, as more information becomes available. The representatives will share specific knowledge of the subject under analysis and provide input to the cost-modeling process.

A TCO analysis exposes the hidden costs that may be overlooked during budget planning or when making purchase decisions. As a result, it becomes possible to yield higher savings by optimizing relevant cost elements throughout the entire project life cycle. A preliminary estimate of TCO will emerge during Process Step 1: Identify Needs; a more robust TCO estimate will be conducted during the Update/Refine Total Cost of Ownership (TCO) Analysis topic of the Prepare Project task of Process Step 2: Evaluate Sources.

When using TCO analysis for budget-planning purposes, it is important to keep in mind that the cost values are based on historical costs, planned operating factors, and cost projections adjusted for future conditions (using mail volume projections, inflation factors, and other adjustment tools).

When using TCO analysis to make purchase decisions, it should be noted that the analysis focuses on cost exclusively. There are three major implications:

• Qualitative factors, such as organizational need and product performance, must be examined closely. Planned organizational growth, reductions, and skill changes should be identified and factored into the cost models, as should product performance, which is a direct driver of many other factors such as labor, materials, output, and liability.

• TCO excludes business benefits other than cost savings. However, identification of Client goals and strategies will clarify these benefits and their relative value. Concerns like environmental cleanliness can drive costs up, but recognition and incorporation of that cost can be reasonably quantified and included in the TCO model. This inclusion has the benefit of ensuring that decision relationships are understood and supplier actions are identified.

• The cost model(s) should contain considerations for performance, speed, and reliability associated with each of the life-cycle cost elements illustrated in Figure 1.4. For example:

• Purchase costs should reflect a short requisition lead time and conformance with Client requirements.

• Operating costs should account for the swift and dependable execution of the product or service.

• Training costs should reflect timely and relevant training, given the customer service level under the contract.

• Maintenance costs should anticipate quick responses to problems and minimization of return rates, damage rates, rework rates, etc.

• Warehousing and distribution costs should reflect fast and accurate transportation to destinations and a high order-fulfillment rate.

• Environmental costs should account for prompt and responsible treatment of environmental standards.

• Salvage value should account for timely asset disposal and realistic recapture of value.

While the TCO analysis is a valuable tool for decision support on a wide range of purchases, it is most applicable to strategic purchases (with a focus on continuous improvement) and to critical projects (with an emphasis on life-cycle cost). The TCO analysis can be used to compare costs incurred under various scenarios and to assist the selection of the most cost-effective approach to obtain the desired product or service.

The basic process for developing a preliminary TCO estimate includes:

1. Identify major TCO cost elements that are applicable to the life-cycle of the product or service.

2. Design cost models that estimate each cost element.

3. Calculate the preliminary TCO, using results from the cost model(s).

Figure 1.4

Life-Cycle Cost Elements

These cost elements are defined as:

• Purchase costs - purchase price of a product or service

• Operating costs - costs of operating the product or service

• Training costs - costs of training users on the use of the product or service

• Maintenance costs - costs of maintaining the product or supporting the service

• Warehousing and distribution costs - costs of storing and distributing the product

• Environmental costs - costs of maintaining the product or service to environmentally friendly standards

• Salvage value (or the net salvage value) - the market value of an asset less the costs associated with its disposal

Design Cost Model(s)

Cost models exist to estimate each of the cost elements in the TCO equation. The Distribution Cost Analysis Tool (DCAT) Model, for example, is a cost estimation tool that can be used to evaluate post-purchase warehousing and distribution costs. The Pricing Analyst will work with the cross-functional representatives to determine the appropriate cost model(s) to use and perform the analysis.

Calculate the Preliminary TCO

Estimates of each of the cost elements in the product or service life cycle will feed into an equation that calculates the preliminary TCO. Not all of the cost elements in the standard TCO equation will necessarily be relevant to a given product or service. For example, most services do not incur any warehousing and distribution cost, which means "W" will be equal to zero in the resulting TCO calculation.

The following formula is a simplified approach to calculating TCO:

TCO = P + Present Value of (O + T + M + W + E - S)

Where:

P = Purchase costs

O = Operating costs

T = Training costs

M = Maintenance costs

W = Warehousing and distribution costs

E = Environmental costs

S = Salvage value

When evaluating competing alternatives, the scenario with the lowest TCO will be the best choice from a cost standpoint, subject to further strategic and Client evaluations.

Other Topics Considered

Develop Logistics Support Strategy topic, Decide on Make vs. Buy task, Process Step 1: Identify Needs.

Update/Refine Total Cost of Ownership (TCO) Analysis topic, Prepare Project task, Process Step 2: Evaluate Sources

Evaluate and Analyze Actual Total Cost of Ownership (TCO) topic, Investment Recovery task, Process Step 6: End of Life