How to Minimize Total Cost of Ownership
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Many organizations struggle with competing measures of success. These competing metrics, objectives and expectations can create conflicts among departments, often hindering an organization's overall success.
The process of specifying products offers a revealing example of this struggle. An organization's procurement department might achieve success by purchasing materials at the lowest available cost. By comparison, minimizing the total cost of ownership (TCO) often drives the maintenance and engineering department. That difference is the conflict: Minimizing the TCO might not involve purchasing the lowest-cost materials. In fact, it can even help managers make the case for purchasing products with higher initial costs.
After considering each department's perspective, I'll offer guidance on reconciling this potential conflict to help each party succeed.
First, consider the procurement view. The procurement department bases its decisions mostly on such factors as delivery, handling, marginal benefit and price fluctuations. The group's financial objectives are based on reducing single-item costs or costs per stock-keeping unit (SKU).
The bottom line for the department is having functional materials available for users and achieving that goal at the lowest cost to the organization. If the department achieves those goals, it often receives recognition.
Now consider the view of the maintenance and engineering department. Managers try to extend the life of the organization's assets and minimize TCO. Managers use factors such as mean time between failures (MTBF) and mean time to repair (MTTR) to identify opportunities and determine the success of their efforts.
Formally, TCO involves determining the costs associated with buying and using a product or service. Calculating TCO takes an item's purchase cost into account, but it also considers related costs, such as ordering, delivery, subsequent use and maintenance, supplier costs, and post-delivery costs.
Consider the case of pump specification. A manager might find a pump that meets the expected specifications on paper, but its actual performance might differ. Pumped materials might attack or create greater wear than anticipated in components, causing premature failure.
When looking at the reasons for failure, the purchase cost of a lower-quality pump could be insignificant — maybe 5-10 percent less — but the costs to operate and maintain that pump might be substantially higher — sometimes 10-15 times.
The performance characteristics of lower-cost materials also can create risks or other problems for the business that managers must consider in determining TCO, including:
- Environmental risks, including spills and releases
- Injury risks, due to the increased need for technicians to intervene
- Regulatory risks involving fines and business interruptions
- Performance risks, including shorter MTBF or longer MTTR
- Higher maintenance costs
- Lost revenue. Downtime associated with poor performance of a low-cost component decreases productivity.
Clearly, it is important to incorporate TCO principles when creating metrics for the procurement department's performance.
Focus on TCO
Now that managers understand the struggles between procurement and maintenance that create risks and cost implications for their organizations, how can they overcome this unhealthy situation and keep the focus on TCO? I recommend the following steps:
Set a vision and direction. Leadership, from the top of the organization down to department-level managers, needs to set expectations and make it important to manage both parties in the purchasing equation. Leadership needs to set the expectations across the organizational silos to prevent any disparity. This process starts with establishing vision, alignment and clear direction, as well as recognizing results.
Establish a team approach and collaborated metrics. To effectively control both elements in the procurement equation — obtaining the lowest cost to purchase while also minimizing TCO — different groups must collaborate. I have seen the word team defined as "together everyone achieves more." That definition best summarizes this collaborative approach. Managers need to establish cross-functional metrics, make sure everyone clearly understands expectations, and tie accountability for metrics into the performance-management system.
A great example of the team approach occurred recently at a client site. We performed a study of equipment bearings and discovered the total cost of replacement for the lowest-cost bearings — the sum of bearing costs, labor costs, asset downtime, and number of replacements within a two-year period — was at least 10 times higher than the cost of purchasing high-quality bearings at a 30-50 percent higher price. Using the higher-quality bearings resulted in no failures after two years.
This is an example of applying TCO principles to the decision-making process to arrive at a budget-savvy specification decision.
Remain diligent. The final step in obtaining the lowest TCO is to create a culture that maintains focus and sustains expectations. To foster a proactive and positive environment, managers must keep the focus on identifying issues, applying effective root-cause analysis, and eliminating the causes of asset-reliability problems.
Organizations also can create a structure and systems that promote a proactive approach to maintenance and engineering activities by:
- developing staff competencies
- defining roles and responsibilities clearly
- measuring performance
- providing feedback and counseling
- promoting a focus on quality and precision
- ensuring adequate facilities and resources.
Often, obtaining the lowest TCO requires paying a higher initial price. But as long as managers minimize the TCO, it does not matter if the initial cost is higher than desired. The alignment of goals comes from having all parties judged by the same criterion, which is lowest TCO.
Managers who act on these recommendations can help address the ongoing struggle to lower TCO, regardless of the product in question. By setting a vision and direction, creating a collaborative team environment focused on the right metrics, and remaining diligent, managers can succeed in minimizing TCO.
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Bruce Wesner is a managing principal with Life Cycle Engineering, www.lce.com. He has more than 25 years of maintenance and engineering management experience.