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Total cost analysis in global supply chains

Total cost analysis is a decision-making approach that considers the minimization of total costs and recognizes the inter-relationships among system variables such as transportation, warehousing, inventory, and customer service.

Purpose of Total Cost of Ownership (TCO) Analysis

Total Cost of Ownership (TCO) analysis provides a comprehensive framework for evaluating supplier performance by looking at the complete cost picture associated with a product or service. Understanding and comparing the TCO of different suppliers enables organizations to make informed decisions regarding supplier selection.

Applying TCO Analysis in Supply Chains

Applying TCO analysis to the supply chain involves identifying all direct, indirect, and associated costs of a product or service:

  • Direct Costs: Include expenses directly related to production, such as raw materials, labor, and manufacturing overhead.
  • Indirect Costs: Cover transportation, warehousing, and administrative fees.
  • Associated Costs: Include elements such as quality assurance, regulatory compliance, and environmental sustainability.

The total cost of ownership is defined as the purchase or acquisition price of goods or services, plus any additional costs incurred before or after delivery. This holistic approach allows businesses to capture the full cost impact over the lifecycle of the product or service.

Supply Chain Cost Drivers

Today’s IoT-led supply chains are complex and interconnected. A cost reduction in one area of operations can lead to cost variations in another, making it crucial for manufacturers to understand these interdependencies.

Key Supply Chain Cost Drivers

  1. Investment Costs: Initial capital investment required for supply chain infrastructure and technology.
  2. Transportation Costs: Expenses related to moving goods from suppliers to customers, including freight and fuel costs.
  3. Procurement Costs: Costs associated with acquiring raw materials or products.
  4. Production Costs: Labor, materials, and overhead costs related to manufacturing.
  5. Inventory Costs: Costs of holding and managing inventory, including warehousing expenses.
  6. Quality Costs: Costs associated with ensuring product quality, such as inspection, testing, and defect resolution.

Approach for Cost Savings in Supply Chains

A three-level approach is used to guide cost-saving strategies in supply chains. Each level offers specific insights to help executives achieve tangible cost reductions.

1. High Level: Where to Focus

At this level, executives identify areas of focus that have a broad impact on business health. Key actions involve prioritizing improvement measures to maximize revenue.

  • Pro-tip: Get a holistic view of the business’s financial health and identify areas for continuous profitability improvements.

2. Mid Level: Key Drivers

Executives expand on critical drivers affecting the selected areas of impact, such as working capital, inventory spending, operational expenses, throughput trends, or cash conversion cycles.

  • Pro-tip: Focus on excess working capital, top inventory spend, operational expenses, throughput trends, and cash conversion cycles.

3. Granular Level: Tactical Plan

This level focuses on creating tactical action plans, such as determining optimal buffer stock, managing demand and supply variability, and setting recommended stock levels.

  • Pro-tip: Emphasize buffer management, supply/demand variability, and appropriate stock levels.

Types of Insights for Cost Savings

This approach translates into three types of insights that help executives streamline and optimize supply chains for cost savings:

  • What to Move: Identify areas for material flow improvement to maximize impact.
  • What to Expedite: Accelerate actions to boost sales and strengthen key product areas.
  • What to Reduce/Remove: Target waste reduction to enable a leaner, more efficient supply chain.
Level Focus Areas Key Activities/Pro-tips
High Level Business Health Get a holistic view of the financial state for continuous profitability.
Mid Level Key Drivers Focus on excess working capital, top inventory spend, operational expense, throughput trends, and cash conversion cycle.
Granular Level Tactical Plan Manage buffer, supply/demand variability, and recommended stock levels.

By applying total cost analysis, understanding cost drivers, and implementing a three-level cost savings approach, organizations can make informed decisions that improve the efficiency and profitability of their global supply chains.

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