Total Cost of Ownership (TCO) is defined as the purchase price of an asset and all the costs involved in its operation. Buyers need to look at an item’s purchase price, its short-term price, as well as its long-term price and this is the total cost of ownership of that particular property. This paper will develop a TOC model for an auto company and explain pros and cons associated with applying such a model.
The total cost of ownership of a car is not only the price of the car but also expenses associated with through its use including repairs, insurance and fuel. A used car may appear to be a great bargain but it may actually be higher than costs associated with acquiring a new car especially if the car needs several repairs while a new car may have a two year warranty. Therefore, a TOC model is a tool that accounts systematically for all costs related to acquiring the car. It is important to realize that a less expensive car can cost a company more in the long-term than a car that is more expensive new car. In calculating the costs, six factors are usually considered and they include depreciation, fuel costs, interest costs, insurance costs, maintenance & repairs and sales tax of the car (Parsons, 2006).
According to Edmunds.com, the TCO of owning a 2009 Nissan Quest 4-door minvan for a period exceeding 5 years, assuming it runs 15,000 miles a year, is about $47,000 while the cost of owning a 2010 Volkswagen Jetta 4-door Sedan over the sesame period of time running on the same miles per year is about $35,000. Therefore, depending on the type of car ones buy, it may actually end up costing more than one may imagine (Michael, 2011).
Pros of Applying a TOC Model
- The TCO model provides a consistent and systematic framework of comparing alternatives thus will result to increased productivity and reduce overall costs overtime.
- The most significant advantage of this kind of model is its potential in cost saving improvement. The system helps in cost saving improvement as it is able to identify relative importance of different cost components. This will allow the company to design strategies to minimize cost driver rates.
- A purchasing company can use the TCO model to conduct sensitivity analysis that deals with cost management and decision making. Analysis on such information like the impact on cost improvement by choosing different suppliers or performance improvement by the suppliers by use of different but important criteria.
- A TOC model allows companies to develop their inter-organizational activity-based management opportunities, as there is an important close relationship between a limited number of reliable suppliers and the purchaser. Production philosophies emphasize the importance of a close relationship between the purchaser and some few suppliers (who are reliable). This is because knowledge of the criteria and its importance will give the supplier an incentive to lower his score.
- A TCO approach is also important is because it reduces the subjectivity in supplier section. Research has confirmed that other methods, like the mathematical models, approach the problem with in a more objective way than by rating the model in a subjective way. Good selection of the supplier is important given the high value of expenditures involved in purchasing cars (Federal electronics challenge and Parsons, 2006).
Limitations of a TOC Model
- Although TOC are likely to result in reduction of long-term costs, the model may itself add initial costs by soliciting procurement decision makers to collect and consider more information.
- Since the models are used in tracking long-term costs, it is not easy to capture the benefits associated with the TOC model in, say, a year’s budget.
- TCO models do not necessarily trace social or environmental costs and benefits (Parsons, 2006).