Machine Translated by Google

Total Cost of Ownership Models:

An Exploratory Study

AUTHORS
Bruce G. Ferrin
is assistant professor of logistics at Western Michigan University in
Kalamazoo, Michigan.
Richard E. Plank
is professor of marketing at Western Michigan University in Kalamazoo,
Michigan.
This research examines organizational purchasing models
focusing on the use of total cost of owner-ship (TCO) to value
purchasing opportunities. The research presents evidence
that leading-edge companies actually use such models. This
INTRODUCTION The
concepts of total cost (Cavinato 1991, 1992), life cycle
costing (Jackson and Ostrom 1980), product life cycle costs
(Shields and Young 1991), and total cost of ownership (Ellram
and Siferd 1993, 1998; Ellram 1993, 1994, 1995) are all
related. These concepts all suggest that supply managers
adopt a long-term perspective, not a short-term, initial-price
perspective, for the accurate-rate valuation of buying
situations. Three ideas support all of these procurement
valuation constructs. First, cost must be examined from a
long-term perspective and should include elements other
than initial purchase price. Second, supply managers must
consider the impact of other business functions on the
valuation of a specific purchase. Finally, to value a purchase
situation accurately, a supply manager must understand, and

exploratory study provides, for the first time, data on the

nature, and use, of the cost drivers on which organizations base
their TCO computations. The study suggests a generic model of
total cost of ownership is not appropriate. However, the findings
of this research suggest
SUMMARY
a TCO model based on a core set of cost drivers,
along with an auxiliary set of cost drivers, is appropriate. The
core cost drivers would be present in all, or most, TCO
computations. Purchasing managers could use different, specific
cost drivers from the auxiliary set to tailor the TCO computation
for a particular purchase situation. The authors also suggest
that a value-based, multi-firm, or supply chain, TCO computation
model is needed. Such a TCO model should be similar to a single-
firm TCO model.
The Journal of Supply Chain
Management: A Global
Review of Purchasing and
Supply Copyright © August
2002, by the Institute for
™
Supply Management, Inc.
EXAM
measure, the cost impact of all the activities associated
with the purchase.
Ellram and Siferd (1993), in quoting the importance of considering cost
beyond initial purchase price, suggested purchasing management books
dating from 1928 have expressed this notion. Further, Cavinato (1992)
suggested that firms in the 1940s first implemented interfunctional total cost
analysis as they sought to understand the cost influence of one logistics
function on another, transportation and inventory, for example. Ellram and
Siferd (1993) proposed the concept of total cost of ownership (TCO) as an
integrating concept. They defined TCO from the perspective of the flow of
activities related to the purchase of a good or service and the costs associated
with those activities.
The purpose of this article is to report on a study that examines the
nature of total cost of ownership. While still an exploratory study, in
the sense that no hypotheses are tested, this research presents
purchasing managers' updated perceptions of the nature of total cost
of owner-ship and its usage in practice. Further, the research examines
the issue of the nature of TCO models and whether it is feasible to have
a single TCO model for a firm or whether multiple TCO models are
required for specific firms. The research generated, and categorized,
a wide range of TCO cost drivers that supply managers currently use
in TCO evaluations.

Module 1

18 The Journal of Supply Chain Management | Summer 2002

Machine Translated by Google
The article begins with a literature review of total cost of ownership and
related constructs. The study procedure is described, findings are
reported in detail, and their significance for practicing supply managers
is discussed. Finally, the limitations of the study are outlined.
LITERATURE REVIEW
As shown above, the total cost concept is not new.
However, as Milligan (1999) noted, accurate total cost measurement is
elusive, because most organizations either don't understand the
calculations or don't have, or won't share, the data necessary for such
calculations.
Meckbach (1998) reported that although
“information technology managers are aware that the annual cost
of administering a [personal com-puter] can exceed its purchase
price … total cost of ownership (TCO) is not a major factor in
purchasing decisions …”
Meckbach's source attributed this to the fact that TCO is hard to measure
and, to date, “TCO estimates [for per-sonal computers] often fail to
account for factors such as user productivity, business benefits, and user
satisfaction.”
Avery (1999) provided a different, more philosophical reason for the
emphasis on price in supply management: she suggested that many
companies concentrate on direct costs, mostly purchase price, because
they feel indirect costs will decline as direct costs decline. However,
Avery noted some organizations have successfully reduced total costs
using project teams focused specifically on total overall cost reductions,
including indirect costs. In other words, she suggested that indirect
costs will not fall by themselves, or because of reduced direct costs, but
because of management's focus on controlling indirect costs.
Academic research defines several cost concepts incorporated-
rating both direct and indirect costs, including total cost (Cavinato 1991),
total cost of ownership (Ellram 1993), product life cycle costs (Shields
and Young 1991), or life cycle costing (Jackson and Ostrom 1980).
However, whatever the name given the total overall cost concept, all of
this research stresses the need for management to concentrate on
reducing indirect costs by design.
Ellram (1995) was very explicit: she clearly stated that effective
implementation of total cost of ownership modeling depends heavily on
the use of activity-based costing methodologies. Porter (1993) made
basically the same argument, explicitly suggesting the need to focus
on cost drivers and activity-based management systems. Tyndall (1988)
also provided examples of total cost measurement, concentrating on
logistics cost management in the distribution chain. Bennett (1996) offered
a similar case study model using activity-based management concepts to
measure and reduce overall costs. Finally, according to Ersten (1998),
a market exists for TCO software systems. Ersten noted that several firms
serve this market with software and systems for either purchasing or
other corporate functions, such as information technology.
Total Cost of Ownership Models: An Exploratory Study
Ellram (1993, 1994, 1995) and Ellram and Siferd (1993,
1998) conducted the primary research examining TCO.
Their work defined the components of TCO in two ways.
Ellram and Siferd (1993) suggested six categories: quality, management,
delivery, service, communications, and price. However, this
categorization examines only those purchasing activities that contribute
directly to total cost of ownership (TCO). Ellram and Siferd did look at
both formal activities and support activities, also suggesting some cost
drivers for these activities.
Ellram (1993) suggested a transaction-sequence cost
component structure, involving pre-transaction cost components,
transaction cost components, and post-transaction cost components.
This typology is more general and considers direct and indirect costs.
Pre-transaction cost components include costs related to activities
such as identifying a need and investigating a source. Transaction
cost components include price, delivery, tariffs, inspection, etc. Post-
transaction cost components include cost categories such as field
quality problems and cost of repair parts. According to Tibben-Lembke
(1998), post-transaction costs include reverse logistics.
However, there is limited empirical research on the use
of total cost of ownership modeling in supply management. Ellram and
Siferd (1993) provided some empirical evidence: 18 percent of their sample
of 103 purchasing personnel reported the use of a formal TCO system,
whereas 25 percent reported no TCO use, with the remaining 58
percent reporting an informal approach to TCO.
Ellram's 1994 research extended the definition of TCO models. She
noted two basic models: the standard model, generally in writing and
repetitively applied to a variety of purchasing situations; and the unique
model, developed for a specific item or purchase situation. Ellram used
a small set of in-depth interviews to collect data. She found evidence
of both types of models and provided examples.
She noted that effective use of TCO is difficult and found in the standard
implementation procedure.
Ellram and Siferd (1998) also conducted case-based research
focusing on 11 companies in 10 industries. They found TCO helped in
supplier selection, communication, ongoing supplier management,
continuous improvement initiatives, and creating organizational
understanding of indirect costs. In addition, Ellram and Siferd reported
most firms that use TCO modeling to focus on important buying activities.
However, they found each firm seems to have its own definition for an
important buying activity. Ellram and Siferd reported several reasons more
firms don't use TCO. Their list includes complexity of TCO measurement,
organizational culture, and arguments regarding the relevance and
proper use of TCO data.
The research by Ellram and Ellram and Siferd suggests
TCO is a little used concept. However, their findings suggest that
when firms use TCO modeling, it may be
The Journal of Supply Chain Management | Summer 2002 19
Machine Translated by Google
Total Cost of Ownership Models: An Exploratory Study
through either formal or informal mechanisms. Further,
Ellram and Siferd's research suggests significant barriers
to the use of TCO modeling, including the nature of a
firm's costing system and data reporting.
Other authors have also examined total cost of ownership-
ship or related concepts. Cavinato (1991, 1992) used the
total cost concept to examine cost structures across the
supply chain. He examined such cost indicators as labor
rate, process effectiveness, capital cost, tax rates, and depreciation.
Cavinato suggested comparing supply chain entities based on
these cost indicators can provide a basis for
assigning specific supply chain processes. He argued that
firms can reduce their total supply chain costs by assigning
specific supply chain processes to those firms in the supply
chain whose cost structures are optimally configured to
support the assigned processes.
Jackson and Ostrom (1980) did an early empirical study
of life cycle costing. In the early 1960s, the Department of
Defense developed life cycle costing to improve its pro-
curement processes (Shields and Young 1991). Jackson
and Ostrom indicated 25 percent of their 107 respondents
used life cycle costing. This is similar to Ellram and Siferd's
1993 finding that 18 percent of their sample used formal
systems for measuring total cost of ownership. The simi-larity in
these results from two projects conducted 13
years apart suggests the field of supply management has
made little progress in addressing the impact of indirect
costs on sourcing decisions.
Degraeve and Roodhooft (1999b) provided a case study
illustration of the application of total cost of ownership
to supplier selection. They divided purchasing activities
into three hierarchical levels. A firm performs supplier-level
activities, eg, a quality audit, only if it uses a specific supplier.
A firm performs ordering-level activities,
eg, receiving, invoicing, transportation, each time it
places in order. A firm performs unit-level activities, e.g.
a production shutdown due to defects in purchased materials,
based on the attributes of the specific items received
in a specific order. Using this activity hierarchy, Degraeve
and Roodhooft developed a mathematical programming
optimization model to select suppliers based on total cost
of ownership minimization. To test the model, they
applied it to supplier selection decisions for heating elements
and ball bearings faced by a “large multinational
Belgian steel producer with annual purchases of over $1.5
billion.” Degraeve and Roodhooft reported expected cost
savings of 8 percent for heating elements and more than
10 percent for ball bearings.
Geiger (1999) discussed the challenges of selecting
appropriate cost drivers for cost management systems.
“
He defined a cost driver as …another measure that is
used to proportionally distribute the cost of activities to
cost objects.” Geiger stated in any situation, typically
there are many possible choices of cost drivers. Each
potential cost driver may differ from others in how it
distributes (or assigns) costs; the cost measurements it
20 The Journal of Supply Chain Management | Summer 2002
requires; the cost to make the measurements; and how
it will affect managers' behavioral response to the cost
management system.
Geiger explained cost driver selection “can generate
powerful managerial responses to reduce drivers because
they appear to be causing” the cost on which the firm
evaluates managers. In other words, effective selection
of cost drivers can focus management attention on the
process attributes that create cost. Geiger also reported
effective cost drivers must be measurable, with reason-
able measurement costs.
In summary, the TCO concept, and the very similar
concept of life cycle costing, has been discussed, and
examined empirically, in the literature, but with limited
scope. The scholarly literature on total cost of ownership
consists mostly of case study and anecdotal data. In particular,
little empirical research has been done at the cost
drivers organizations use for TCO modeling. Cavinato
(1991, 1992) suggested a supply chain, or value chain,
approach to total cost of ownership measurement; Curiously,
little research exists on this approach.
The purpose of this research is to provide empirical
data on this complex topic. Although the investigation
focuses on individual firms, not supply chains, the study
devotes some attention to supply chain implications.
Some data on TCO usage were collected. However, the
main focus of the study was to examine the complexity
of TCO modeling. The research design focused on three
issues: whether standard models are feasible or special-ized
models are required, development of more specific
information on cost drivers, and development of an
improved taxonomy for cost drivers.
THE STUDY
A questionnaire was developed to examine supply man-
agers' perspectives on total cost of ownership; a single-wave
mail survey was used to elicit responses. The
questionnaire was mailed to members of the Institute for
Supply Management™ (ISM) (formerly the National
Association of Purchasing Management (NAPM)). The
data collection instrument included questions on the valuation logic
supply managers use to assess specific purchases and on the use
of total cost of ownership as a value mechanism.
One hundred forty-six respondents, of the 990 who
received the survey, returned the questionnaire, representing a
15 percent response rate. Of these respondents, 122, or 84
percent, reported manufacturing as
their primary business. The remainder of the responders
represent a variety of service businesses and government
agencies. Forty-two percent of the sample
reported total annual revenue between $35 million and
$10 billion. Forty-five percent of the sample reported
annual purchase volume between $10 million and $250
million. Sixty percent of the sample reported total
employment in their firm or division between 100 and
Machine Translated by Google
Total Cost of Ownership Models: An Exploratory Study

5,000. Forty-nine percent of the sample reported total Table I

purchasing employment between two and 10. Table I
RESPONDENT DEMOGRAPHICS
provides the demographics of the sample.
Clearly, the sample of respondents is concentrated on
A. Purchase Volume
medium-sized, manufacturing organizations with limited
purchasing management staffing. Also, the response rate Respondent Percentage of
Purchase Volume Frequency Respondents
of 15 percent is moderate at best. Non-response bias was
Under $1 million 3 2.4
assured using a procedure suggested by Armstrong and
Overton (1977). Using the variables total employment $1 million to $9.99 million 23 18.3
and total revenue, there were no statistically significant $10 million to $49.99 million 39 30.9
differences between first- and fourth-quartile respondents $50 million to $249.99 million 35 27.8
means. This suggests limited or very low non-response 13 10.3
$250 million to $999.99 million
bias.
$1 billion and over 13 10.3
Data Collection Instrument TOTAL 126 (18 missing) 100
The questionnaire asked respondents to answer a number
of open- and closed-ended questions. The survey form B. Purchase Employment
defined TCO as follows: Respondent Percentage of
“We take a total overall cost, or total cost of owner-ship, Number Purchasing Employees Frequency Respondents
approach (sometimes referred to as value in 1 9 6.3
use) to evaluate the purchase. In other words, we 2-5 49 34.3
examine all the direct and indirect costs over the
6-10 33 23.1
life of the product/service.”
11-20 11 7.7
This operational definition of total cost of ownership 21 14.7
21-50
was used in the questionnaire to provide, for measurement
over 50 20 13.9
purposes, a fundamental and explicit way for
TOTAL 143 (3 missing) 100
respondents to think about TCO without introducing
all the technical nuances presented in the literature. The
term “value in use” was included since it has been used C. Total Revenue

in the marketing literature and there is a possibility this Respondent Percentage of

terminology would be familiar to some of the sample. Company Revenue Frequency Respondents
Under $5 million two 2.1
The questionnaire first asked respondents to report the
percentage of their firm's expenditures on purchased $5 million to $99.99 million 36 37.9
goods and services based on what the respondent considers $100 million to $999.99 million 30 31.6
a total cost of ownership valuation model. In $1 billion to $9.99 billion 19 20.0
addition, the survey asked respondents to check off the 8 8.4
$10 billion and over
categories of goods and services their firm purchases for
TOTAL 95 (51 missing) 100
which there are examples of TCO valuation.
In its second section, the questionnaire asked respondents to
D. Total Employment
evaluate their firm's or division's overall efforts
Respondent Percentage of
concerning TCO purchasing. In answering this question,
Number of employees Frequency Respondents
respondents used one (Very Poor) to five (Excellent)
Under 100 19 13.1
scale. The survey asked respondents to use this same scale
100 to 999 63 43.4
to assess their firm's or division's success in identifying key
TCO cost drivers. The questionnaire asked respondents to 1,000 to 4,999 33 22.8
think about one or more purchase situations with which 5,000 to 9,999 10 6.9
they were familiar that use TCO. Based on their collection, 10,000 to 24,999 7 4.8
respondents listed or described the key cost drivers 13 9.0
25,000 and over
used. This was an open-ended question; respondents used
TOTAL 145 (1 missing) 100
their own words to describe one or more cost drivers their
firm uses in a TCO model.

Following the open-ended question, the survey asked

respondents two questions on cost drivers and TCO
modeling. The first question asked if they thought specific The second question asked respondents whether, if they
TCO drivers vary from commodity to commodity, were to design a TCO model for their purchasing responsibilities,
using a one (no variation) to five (high variation) scale. they would create one model or multiple models.

The Journal of Supply Chain Management | Summer 2002 21

Machine Translated by Google
Total Cost of Ownership Models: An Exploratory Study

The questionnaire's next section focused on the issue model would include some of the same cost drivers.
of standard versus multiple TCO models. Specifically, Based on the TCO experiences of your firm or division,
The survey asked respondents to assess this statement: do you think this is an accurate description of
There is a core set of cost drivers that apply to every the nature of cost drivers and TCO in your firm or
division?
commodity or commodity category. If this statement
is true, a company could have multiple TCO So respondents could indicate their agreement with this
models for different commodities, but every TCO statement, the question included a one (Definitely Yes)
to five (Definitely No) scale.
The survey included a second item dealing with standard
versus multiple TCO models. The instrument again
Table II provided one (Definitely Yes) to five (Definitely No)
SUMMARY STATISTICS FOR SURVEY ITEMS scale for respondents to use to show their opinion with
this statement:
Valid Response Mean ÿof
There are cost drivers (other than those in [the previous
issue Response Range Response Response
question]) that apply only to specific commodity or
Percent of purchases commodity categories. If this statement
made under TCO valuation 137 0 to 100 35.76% 30.7%
is true, a company could develop a modular TCO
Rate firm's overall efforts in model in which, for different commodities or commodity
TCO purchasing 115 1 to 5 3.03 0.94 categories, specific cost drivers could be connected or
Rate firm's efforts at disconnected as required. Based on the

identifying key cost drivers 115 1 to 5 2.95 1.04 TCO experiences of your firm or division, do you
think this is an accurate description of the nature of
Do the specific cost drivers your
cost drivers and TCO models in your firm?
firm uses vary from commodity
to commodity? 115 1 to 5 3.12 1.27 Finally, the questionnaire asked respondents to consider
the involvement of other functions in the development
Is there a set of core costs
and ongoing use of TCO. Respondents could, using a zero
drivers that apply to every
(No Involvement) to five (Heavy Involvement) scale, indicate
commodity or commodity category?
114 1 to 5 2.24 0.92 the involvement, in TCO modeling and cost management, of
Purchasing, Design Engineering, Manufacturing,
Are there cost drivers that
Marketing, Accounting, Information Technology, and
apply only to specific
Logistics.
commodities or commodity
categories? 112 1 to 5 2.32 0.96
RESULTS
In your firm, is purchasing Thirteen of the survey's items required respondents to
involved in the development and provide numerical answers or use a numerical scale. table
ongoing use of TCO? 114 1 to 5 3.92 1.19
II provides summary statistics for these responses.
In your firm, is design
engineering involved in the TCO Usage
development and ongoing use of One hundred thirty-seven of the 146 respondents
TCO? 109 1 to 5 3.05 1.48 answered Question 1, on the percentage of purchases
made with total cost of ownership valuation. As shown
In your firm, is manufacturing involved
by the standard deviation provided in Table II, there
in the development and ongoing use
1 to 5 2.89 1.39 was wide variation in the responses to this item. table
of TCO? 100
III shows the range of responses to this item.
In your firm, is marketing
Table III suggests most respondents' firms do some
involved in the development and
1 to 5 1.99 1.42 TCO valuation. Further, these results indicate some firms
ongoing use of TCO? 106
extensively use TCO concepts in supply management.
In your firm, is accounting
TCO Light vs. Heavy Users. Data on TCO usage were
involved in the development and
ongoing use of TCO? 112 1 to 5 2.18 1.58 examined further to compare characteristics of respondents
reporting minimal use of TCO to respondents
In your firm, is information
reporting extensive use of TCO. A frequency analysis of
technology involved in the
responses to TCO usage was performed. Responses were
development and ongoing use of
TCO? 109 1 to 5 2.42 1.54 divided approximately into equal thirds and categorized
as high, medium, or low TCO. Forty-eight respondents
In your firm, is logistics
reported less than 15 percent of purchases under TCO
involved in the development and
and were classified as minimal users of TCO. Fifty
ongoing use of TCO? 107 1 to 5 2.61 1.59

22 The Journal of Supply Chain Management | Summer 2002

Machine Translated by Google
Total Cost of Ownership Models: An Exploratory Study

respondents reported 15 to 49 percent of purchases under Table III

TCO and were classified as moderate users of TCO.
PERCENT OF PURCHASES UNDER TCO
Fifty respondents reported more than 50 percent of their
purchases under TCO and were classified as extensive
Percent of Purchases Number of Responses % of Responses
users of TCO. Nine surveys did not answer the question
<5% 26 19.0
on TCO usage.
5% - 20% 36 26.3
Using cross-tabulation and chi-square analysis, the three
21% - 40% 23 16.8
groups were examined by product type (capital goods,
packaging, raw materials, services, subassemblies, MRO, 41% - 60% 19 13.9
manufactured parts, others). Statistically significant 61% - 80% 22 16.1
differences in products/services acquired under TCO valuation 81% - 100% 11 7.9
were identified across the three usage categories for three Total 100
137 (9 missing)
types of items: subassemblies (ÿ2 = 9.246, p # 0.01), man-
ufactured parts (ÿ2 = 22.658, p # 0.000), and MRO items
(ÿ2 = 9.732, p # 0.008).
For all three of these items, respondents reporting low Table IV
usage of TCO were much less apt to use TCO for the
TYPES OF PRODUCTS/SERVICES PURCHASED
specified product type. For example, none of the low
UNDER TCO VALUATION
TCO users reported using TCO for valuation in the pur-
chase of subassemblies, manufactured parts, and MRO
Type of Good/Service Number of Responses % of Responses
items. However, 30 percent of the extensive TCO users
reported using TCO valuation for the purchase of sub- Capital Goods 79 28.8
assemblies, manufactured parts, and MRO, while 28 Raw Materials 38 13.9
percent of moderate TCO users reported using TCO valuation Subassemblies 25 9.1
for the purchase of subassemblies, manufactured parts, Manufactured Parts 46 16.8
and MRO items.
Packaging 22 8.0
Conversely, 55 percent of respondents reporting min- Services 29 10.6
imal TCO usage reported using TCO valuation for the
MRO 26 9.5
purchase of capital goods, while 57 percent of extensive
Other 8 3.3
users of TCO and 62 percent of moderate TCO users
reported using TCO valuation for the purchase of capital Total 274 (18 missing) 100
goods. For the purchase of services, similar percentages
of minimal, moderate, and extensive users of TCO all
reported the use of TCO valuation.
Table V
This finding suggests that in employing TCO valuation
logic, purchasing managers are likely to first apply it to RESPONDENTS' RATINGS OF THEIR FIRM'S OR DIVISION'S
nonroutine purchases, such as capital goods. The use of OVERALL EFFORTS IN TCO PURCHASING
TCO valuation logic for routine purchases such as MRO
items, subassemblies, and manufactured parts come, if Respondent Rating Number of Responses % of Responses
at all, much later.
Excellent two 1.7

Items or Services Purchased under TCO Valuation Good 39 33.9

A total of 116 respondents answered Question 2 by Average 42 36.5
indicating the types of items, including services, pur- Somewhat Poor 25 21.7
chased under TCO valuation logic. Table IV shows the Very Poor 7 6.2
range of responses to this item. Many respondents Total 100
115 (31 missing)
indicated more than one category. The “Other” category
included such purchases as “paper/forms,” “fleet,”
“animal tissue,” “specialty manufactured products and
chemicals,” “prototypes for R&D,” “finished goods
(OEM),” “laboratory supplies,” and “computer equipment Respondents' Ratings of Their Firm's or Division's
and software.” The demographic profile of the Efforts in TCO Implementation
sample accounts for purchase categories such as “Capital One hundred fifteen of the 146 respondents gave their
Goods,” “Raw Materials,” and “Manufactured Parts” overall rating of their firm's or division's “efforts in the area
reported most frequently as items purchased with TCO of TCO purchasing.” As indicated in Table II, the standard
valuation. deviation of responses to this item was low. Table V shows
the range of responses to this item.

The Journal of Supply Chain Management | Summer 2002 23

Machine Translated by Google
Total Cost of Ownership Models: An Exploratory Study

These results suggest that while a few firms believe they
are successful in applying TCO valuation to strategic
sourcing, many firms believe they are struggling in their
attempts to use TCO valuation logic in supply management,
or at best doing an average job.
These results support existing conceptual research in
total cost of ownership. The literature clearly suggests
the need for different cost drivers to accurately estimate
total cost of ownership for different commodities (Ellram
1994; Degraeve and Roodhooft 1999a).

TCO Cost Drivers Cost Driver Categories

As described above, the data collection instrument The third TCO cost driver question was an open-ended
included three questions dealing with TCO cost drivers. question asking respondents to think about a TCO pur-
One hundred fifteen respondents rated their firm's or chasing situation and identify and describe the key cost
division's identification of its key TCO cost drivers. table drivers. A total of 73 responses generated a list totaling
VI provides the range of responses to this item. 237 cost drivers, with individual respondents providing
between one and six cost drivers.
These results suggest, given the challenging nature of
TCO cost driver identification, firms are unsure of their In an attempt to categorize these cost drivers, content
ability to effectively identify the critical cost drivers for analysis was performed. Based on the 237 cost drivers
estimating total cost of ownership. This finding is consistent respondents listed, the authors created 13 cost driver
with results from similar questions raised in connection with categories. The 13 categories are the authors' best estimation of
activity-based costing (Cokins 1996; Innes the relationships between the 237 cost drivers respondents
andMitchell 1998). identified. One can think of this categorization process as
One hundred fifteen respondents answered the survey's much like naming factors in an exploratory factor analysis.
question on variation in the specific TCO cost drivers their Duplicate elimination reduced to 135 the cost drivers the
firms use for TCO valuation of different commodities. To the respondents named. Table VIII lists these 135 cost drivers,
indicated in Table II, the standard deviation of responses separated into 13 categories.
to this item was somewhat large. Table VII gives the range Operations Cost. The authors categorized 12 cost drivers
of responses to this item. as Operations Cost drivers. In the Operations category, most
respondents mentioned cost, speed, or both.
Quality. The authors categorized 14 cost drivers as
Quality cost drivers, which typically relate to the consequences
Table VI
of poor quality. At least one respondent mentioned a Quality
HOW WELL DID YOUR FIRM OR DIVISION cost driver, customer downtime, related
IDENTIFY ITS KEY TCO COST DRIVERS? directly to quality's impact on the customer and their
operations.
Respondent Rating Number of Responses % of Responses Customer-Related. Three cost drivers were classified
Excellent 7 6.1 as Customer-Related cost drivers, which refer to user
Good 29 25.2 satisfaction, customer perceptions, and customer specifica-
39 33.9 tions. Obviously, these need to be measured from the
Average
customers' point of view and represent respondents from
Somewhat Poor 31 27.0
organizations with very customer-focused strategies.
Very Poor 9 7.8
Logistics. There are 17 Logistics category cost drivers,
Total 115 (31 missing) 100
covering almost the entire logistical process, including
freight (service quality, costs, rate stability), packaging,
materials handling, warehousing, tariffs and duties, availability,
Table VII and logistics customer service.
DO THE SPECIFIC TCO DRIVERS YOUR FIRM Technological Advantage. The authors categorized
USES VARY FROM COMMODITY TO COMMODITY? seven respondent-specified cost drivers as Technological
Advantage cost drivers. These seven cost drivers all
Degree of involves the ability of technology to affect the buyer's cost
Variation Reported Number of Responses % of Responses structure. Some of the Technological Advantage cost drivers
High Variation 15 13.0 report to the supplier's ability to deal with changing

Major Variation 32 27.8 technology.

Moderate Variation 38 33.0 Initial Price. Four respondent-specified cost drivers

Minor Variation 17 14.8 were classified as Initial Price cost drivers. One response
identified long-term price stability as a key TCO cost
Slight Variation 8 7.1
driver. In this context, long-term price stability probably
No Variation 5 4.3
Total 115 (31 missing) 100

24 The Journal of Supply Chain Management | Summer 2002

Machine Translated by Google
Total Cost of Ownership Models: An Exploratory Study

Table VIII

CATEGORIZATION OF IDENTIFIED TOTAL COST OF OWNERSHIP COST DRIVERS

Operations Cost • Quality • Logistics • Technological Advantage • Design

Manufacturing • Durability • Freight • Obsolescence • Suitability for

Machine Efficiency • Replacement • Packaging • Intended Use • Flexibility for New Use
Production to Schedule • Labor Field Failure • Customer Service • • Technology • Changing
Savings • Assembly Customer Downtime • Availability • Technology •
Cost • Operating Inspection • Handling • Long-Term Advantage • Supplier
Supplies • Long-Term Cost of Quality • Instability in Freight Rates • Outbound Ability to Change
Operating Costs • Capacity Utilization • Calibration Cost • Cost • Tariffs • Leadtime
Increase in Production Rework • • On-Time technology
Scrap • Delivery •
Supplier Reliability and
Output • Customer Returns • Supplier-Managed
Capability •
Equipment Speed • Cost Rejection Cost •
in Use • Line Quality Improvement • Inventory • Partnering Costs • Team
Time to Schedule • Costs • Trust •
Speed Unplanned Downtime • Out-of-
Service Costs Supplier
Warehousing •
Duties • Capabilities • Payment Terms

Area of the Country • Supplier R&D

Customer Must Order Capability • Supplier Ability to
From Grow • Supplier Support • Service

• Import Fees • by Supplier • Stocking at

Entry and Harbor Supplier

Maintenance Fees
(Quantity Availability) •
Familiarity with Supplier

Maintenance Inventory Cost Life Cycle Initial Price

• Supplies • • Safety Stock • • Long-Term Usage • • Unit Cost

Training • Design/Procurement for Projected Life Cycle • Life • Initial Purchase Price
Downtime Inventory Reduction • of Product • Long-Term Price Stability • Initial
• Costs Storage • • Life Cycle Stability • Cost Capital Expenditure
• Labor Perishability • Savings over Life of Customer-Related
• Repair Costs • Turnover Product
Parts • Useful Life • User Satisfaction
Transaction Cost
• Spare Parts • • Redesign Cost • • Customer Perceptions •
• Administration of Post- Customer Specifications
Long-Term Maintenance Life Cycle Obsolescence
Costs Purchase Agreements Cost
Opportunity Cost
• Ease of Transaction
• Repair Frequency •
• Supplier Conversion Cost • Cost of Money •
Reliability •
Overhead
Preventive Maintenance (Cost to Change Supplier) • Small
Schedule Orders
• Procurement
• Transactional Activity • Long-
Term Savings

Miscellaneous • Salary, Benefits • • Installation • Total Installed Price

Indirect Labor • Ease of Operation • • Lease Rate Factors
• Taxes
• Product Use Noise Level • Flexibility of the Supplier • Tooling
• Value Chain
• Depreciation • • Technical Support • and Fixtures • Environmental
• Warranty •
Lease or Buy • Validation/Registration Cost • Overall Issues
Product Design •
Supplier Cost Drivers (From Competition • Service Costs
Availability from a Supplier • Disposal
Requisition to Receipt) •
Costs • Liability and
Safety • • Disposal Value •
Compensation Support Costs • Utility Currency Exchange Rates • Direct
Costs Labor
• Obsolescence Cost

The Journal of Supply Chain Management | Summer 2002 25

Machine Translated by Google
Total Cost of Ownership Models: An Exploratory Study

refers to a supplier's ability to maintain an initial quoted price over a Total Cost of Ownership Models
longer time period. Multiple Models Needed. As described above, the data collection

Opportunity Cost. The authors put two respondent-supplied cost instrument included three questions on development-operation models

drivers in an Opportunity Cost category: the cost of money, for to estimate total cost of ownership. One hundred fourteen

obvious reasons, and overhead. respondents answered the question on the need for multiple models

One can only assume a respondent reported overhead as a cost driver to accurately assess TCO for a variety of commodities. Ninety-six

because of the limiting effect increasing overhead can have on resource respondents, or 65.8 percent of the sample, believed multiple models

availability for other activities. are necessary to accurately estimate total cost of ownership for a
variety of commodities or commodity categories. A total of 12.3
percent of the sample agreed it's possible to derive a general TCO
Supplier Reliability and Capability. The authors put 11 respondent-
model that applies to all commodities or commodity categories.
reported cost drivers in a Supplier Reliability and Capability category.
Such cost drivers obviously include attributes like trust, partnering
costs, and teaming costs; however, respondents often reported factors
such as familiarity, suppliers' ability to grow, supplier service, R&D As expected, most of the cost drivers identified by responders are

capability, and payment terms. quantifiable attributes. In fact, entire categories of cost drivers (see
Table VIII) are given over to indirect costs associated with supplier
relationships and performance.
Maintenance. Twelve respondent-reported cost drivers were
However, respondents identified a number of qualitative drivers of total
categorized as Maintenance cost drivers, related to the preservation
cost of ownership. In the “Technological Advantage” category of cost
of the assets required for operation.
drivers, respondents identified as cost drivers such difficult-to-measure
Inventory Cost. Inventory Cost normally falls in the attributes as “Suitability for Intended Use,” “Flexibility for New Use,”
Logistics category. However, with five respondents all mentioning
different inventory attributes, the authors established a separate
“Changing Technology,” “Long-Term Advantage,” and “Supplier
category. Four of the inventory-related cost drivers are routine,
Ability to Change Technology.” In the “Supplier Reliability and
post-transaction inventory issues. Interestingly, one respondent
Capability” category of cost drivers, respondents identified as cost
reported as a cost driver a supplier's influence on the customer's
drivers such qualitative attributes as “Trust,” “Supplier Capabilities,”
ability to design or procure an item in a way that allows the buyer to
“Supplier R&D Capability,”
meet inventory reduction objectives.
“Supplier Ability to Grow,” “Supplier Support,” and “Familiarity
with Supplier.”
Transaction Cost. The Transaction Cost category of
Clearly, this suggests that effective implementation of TCO valuation
cost drivers reports to the costs involved in the actual
requires procurement managers to look beyond transaction costs
procurement. As shown in Table III, respondents identified a broad
and operating costs in their efforts to identify appropriate cost
range of transaction-related costs as cost drivers for TCO
drivers. In implementing TCO, supply managers must be
valuation. The authors put six of the respondent-supplied cost
prepared to consider the behavioral aspects of supply chain
drivers in a Transaction Cost category.
process performance.

Life Cycle. Life Cycle costs suggest a longer-term guideline

Core Drivers. One hundred fourteen respondents answered
tation in supply management. Many respondents suggested they
the survey item on the existence of a core set of cost drivers that could
used life cycle costing procedures to examine cost over time. Whatever
be applied in every TCO model for any commodity or commodity
terminology the respondent used — life of the product, cost
category. Table IX provides the range of responses to this item.
savings over the life of the product, or life cycle stability — the
issue is the same: computing costs over time. The authors categorized
These results suggest that respondents agree with the proposition
nine respondents-supplied cost drivers as Life Cycle cost drivers.
that while supply managers need multiple TCO models to accurately
estimate the total cost of owned-ership for a variety of commodities,
Miscellaneous. Thirty-two of the 135 respondent-specified cost
they would use some cost drivers for most, or all, of the TCO models.
drivers did not seem to fit any of the other 12 established categories.
Therefore, the authors created a Miscellaneous category. These
Modular Drivers. One hundred twelve respondents answered
Miscellaneous cost drivers provide considerable support for the
the question on the existence of a set of cost drivers, other than the
argument that there will be situations in which accurate TCO estimates.
core drivers that apply to all commodities, that only apply to some
specific commodities.
tion will depend on the identification of unique cost drivers. For
Table X gives the range of responses to this item.
example, disposal costs are relevant only for items that require
disposal. Further, environmental issues are less important in many These findings suggest the validity of a modular structure for TCO

procurement situations, but more important in others. models. In this modular structure, supply managers would use the
core drivers for every TCO model for any commodity or
commodity category.

26 The Journal of Supply Chain Management | Summer 2002

Machine Translated by Google
Total Cost of Ownership Models: An Exploratory Study

However, supply managers would also create a set of Table IX

modular drivers for specific TCO models related to a
CORE SET OF COST DRIVERS THAT APPLY TO EVERY
commodity or commodity category. This set of modular
COMMODITY OR COMMODITY CATEGORY
drivers would consist of all the additional cost drivers
necessary to tailor the core cost drivers to accurately estimate
the total cost of ownership for any commodity or
Respondent Opinion Number of Responses % of Responses
set of commodities. Definitely Yes 23 20.2
Mostly Yes 54 47.4
Functional Involvement in Total Cost of Ownership Neither Yes nor No 26 22.8
Valuation Mechanisms
Mostly No 9 7.9
As described above, the survey asked respondents to
indicates the involvement of other functional areas in the Definitely No two 1.7
development and ongoing use of total cost of ownership Total 114 (32 missing) 100
valuation in supply management. Table II provides the
average response, on the zero (No Involvement) to five
(Heavy Involvement) scale, and the standard deviation
Table X
of responses for each functional area. Table XI provides
the range of responses to this item for each corporate SET OF COST DRIVERS RELEVANT ONLY TO SPECIFIC
function. However, since for each business function different COMMODITIES OR COMMODITY CATEGORIES
numbers of respondents answered this question,
the percentages are not directly comparable. Respondent Opinion Number of Responses % of Responses
As expected, and with solid justification, respondents Definitely Yes 24 21.4
perceived purchasing managers as having a major role in 41 36.6
Mostly Yes
TCO valuation. Respondents also indicated, again not sur-
Neither Yes nor No 36 32.1
prisingly, that design engineering has an important role in
Mostly No 9 8.1
TCO. However, nearly 63 percent of respondents indicated
their perception that the contribution logistics managers Definitely No two 1.8
make to TCO valuation is “Moderate,” “Minor,” “Slight,” Total 112 (34 missing)
or “None.” Further, 84 percent of respondents indicated
that marketing makes only a “Moderate,” “Minor,”
“Slight,” or no contribution to TCO valuation; 75 percent
of respondents indicated accounting plays little role in
TCO valuation; and nearly 72 percent of respondents market-responsive supply chains, boundary-spanning
indicated information technology managers play only a functions such as logistics and information technology
minor role in TCO valuation.
must also make a significant contribution to TCO valuation,
Clearly, as firms attempt to make their supply chains especially given the impact that supplier performance can
market-responsive, marketing managers must assume the have on the buying firm's costs in areas such
larger role in TCO valuation. Further, the firms pursue as logistics, manufacturing, and information technology.

Table XI
INVOLVEMENT OF DIFFERENT BUSINESS
FUNCTIONS IN TCO VALUATION

Information Design
Purchasing Manufacturing Logistics Marketing Accounting Tech. Engineering
#% # % #% #% #% #% #%

heavy 46 40.4 8 8.0 10 9.3 5 4.7 9 8.0 8 7.3 20 18.3

Major 35 30.7 31 31.0 30 28.0 12 11.3 19 17.0 23 21.1 28 25.7
Moderate 19 16.7 30 30.0 22 20.6 22 20.8 18 16.1 26 23.9 25 22.9
Minor 6 5.3 13 13.0 13 12.1 22 20.8 24 21.4 19 17.4 15 13.8
Slight 8 7.0 9 9.0 17 15.9 28 26.4 21 18.8 16 14.7 15 13.8
None 0 0.0 9 9.0 15 14.0 17 16.0 21 18.8 17 15.6 6 5.5
Total 114 100 100 100 107 100 106 100 112 100 109 100 109 100

The Journal of Supply Chain Management | Summer 2002 27

Machine Translated by Google
Total Cost of Ownership Models: An Exploratory Study

CONCLUSIONS bias, that procedure is not above criticism. Therefore, confirmation of

This research supports the notion that total cost of own- these findings on different samples is necessary before projecting
ership valuation is a difficult process, but is likely to be worthwhile for these results to the general corporate population.
firms that apply it well. The data, while not necessarily an outstanding
sample of the population from which it was drawn, indicates firms are
making significant efforts at TCO valuation.

An important finding is the staggering number of cost drivers that

companies can and do use when attempting to implement TCO. This
research suggests that a standard TCO model will not exist, but that
some cost drivers are more universal than others and will appear in
many TCO valuation models. This is, however, consistent with the work
of Ellram (1994) who found support for both standard and unique TCO
models. It is suspected, as companies continue to refine their TCO
models, these will evolve into various sets of models, some of which
will be standardized, some slightly modified, and some unique.

This research also suggests that a completely precise categorization

scheme for TCO cost drivers is likely to be elusive. The three-category
scheme developed by Ellram (1994) is a good start. However, the large
number of cost drivers identified by respondents, and the subjective
nature of many of these cost drivers, suggests a more complex
categorization taxonomy may be useful.

Further case-based research is probably necessary as TCO

valuation continues to grow. An examination of many cases will
provide the reader with insight into how the process is developing over
time and the nature of the cost drivers firms use in different situations.

LIMITATIONS OF THE RESEARCH

As with any research, the limitations of this investigation must be
considered. This is a cross-sectional study, based on a single
respondent in each firm. Thus, the responses are based on the
memories and perceptions of a single individual and may not represent
all TCO purchasing activity in a given firm.

The sample frame was drawn from the membership of

ISM and may not represent the total population of pur-chasing
professionals. For example, in this sample, only 12.8 percent of
respondents are employed in firms with fewer than 101 employees;
whereas the ISM 1999 Profile of Purchasing and Supply Management
Professionals shows 20 percent of ISM membership is employed in firms
of this size, and the 1992 Economic Census of the US

Department of Commerce shows 38.3 percent of the general

economy is employed in firms of this size. Thus, a typical survey
respondent is employed by a larger firm.

The moderate response rate of 15 percent is another limitation of this

research. This response rate is attributed to the difficulty of the
questionnaire; that begs the question of non-response bias. While a
procedure (Armstrong and Overton 1976) indicated limited potential
non-response

28 The Journal of Supply Chain Management | Summer 2002

Machine Translated by Google
REFERENCES
Armstrong, JS and TS Overton. “Estimating Nonresponse Bias in
Mail Surveys,” Journal of Marketing Research, (15:8), 1977, pp.
396-402.
Avery, S. “MRO Costs Have BIG Impact on Profits!” Purchasing,
(126:10), 1999, pp. 95-96.
Bennett, P. “ABM and the Procurement Cost Model,” Management
Accounting, (77:9), 1996, pp. 28-32.
Cavinato, J. “A Total Cost/Value Model for Supply Chain
Competitiveness,” Journal of Business Logistics, (13:2), 1992, pp.
285-301.
Cavinato, J. “Identifying Interfirm Total Cost Advantages for Supply
Chain Effectiveness,” International Journal of Purchasing and Materials
Management, (27:4), 1991, pp. 10-15.
Cokins, G. Activity-Based Cost Management, Making It Work: A
Manager's Guide to Implementing and Sustaining an Effective
ABC System, Irwin Professional Publications, Burr Ridge, IL,
1996.
Degraeve, Z. and F. Roodhooft. “Improving the Efficiency of the
Purchasing Process Using Total Cost of Ownership Information: The
Case of Heating Electrodes at Cockerill Sambre SA,”
European Journal of Operations Research, (112:1), 1999a, pp. 42-53.
Degraeve, Z. and F. Roodhooft. “Effectively Selecting Suppliers Using
Total Cost of Ownership,” The Journal of Supply Chain Management,
(35:1), 1999b, pp. 5-10.
Ellram, L.M. “A Taxonomy of Total Cost of Ownership Models,”
Journal of Business Logistics, (15:1), 1994, pp. 171-191.
Ellram, L. M. “Activity Based Costing and Total Cost of
Ownership: A Critical Linkage,” Journal of Cost Management, (9:1),
1995, pp. 22-30.
Ellram, L. M. “Total Cost of Ownership: Elements and
Implementation,” International Journal of Purchasing and
Materials Management, (29:4), 1993, pp. 3-10.
Ellram, LM and SP Siferd. “Purchasing: The Cornerstone of the
Total Cost of Ownership Concept,” Journal of Business Logistics,
(14:1), 1993, pp. 163-185.
Ellram, LM and SP Siferd. “Total Cost of Ownership: A Key Concept
in Strategic Cost Management Decisions,” Journal of Business
Logistics, (19:1), 1998, pp. 55-76.
Ersten, D. “TCO Finds the Strike Zone,” Datamation, (44:1), 1998,
pp. 97-98.
Total Cost of Ownership Models: An Exploratory Study
Geiger, D. R. “Practical Issues in Cost Driver Selection for
Managerial Costing Systems,” The Government Accountants
Journal, (48:3), 1999, pp. 32-39.
Gunasekaran, A., H. B. Marri, and R. J. Grieve. “Activity-Based
Costing in Small and Medium Companies,” Computers and
Industrial Engineering, (37:2), 1999, pp. 407-411.
Innes, J. and F. Mitchell. A Practical Guide to Activity-Based
Costing, Institute of Chartered Accountants, London, 1998.
Jackson, D. W. and L. L. Ostrom. “Life Cycle Costing in Industrial
Purchasing,” Journal of Purchasing and Materials Management,
(16:1), 1980, pp. 8-12.
Malmi, T. “Towards Explaining Activity-Based Costing Failure:
Accounting and Control in a Decentralized Organization,”
Management Accounting Research, (8:4), 1987, pp. 459-480.
Meckbach, G. (1998) “Study Reveals Organizations Blame about
TCO,” Computing Canada, (24:43), 1998, pp. 15-17.
Milligan, B. “Tracking Total Cost of Ownership Proves Elusive,”
Purchasing, (127:3), 1999, pp. 22-23.
Plevniak, D. “$3M Savings Projected in TCO Review,” Health
Technology Management, (19:13), 1998, p. 28.
Porter, AM “Tying Down Total Cost,” Purchasing, (115:6), 1993, pp.
38-42.
Samid, G. “Activity-Based Cost Management: Making It Work,”
Cost Engineering, (39:10), 1997, p. 8.
Shields, MD and SM Young. “Effective Long-Term Cost
Reduction: A Strategic Perspective,” Journal of Cost Management,
(6:2), 1992, pp. 16-30.
Shields, MD and SM Young. “Managing Product Life Cycle Costs: An
Organizational Model,” Journal of Cost Management, (5:3), 1991, pp.
39-52.
Tibben-Lembke, RS “The Impact of Reverse Logistics on the Total
Cost of Ownership,” Journal of Marketing Theory and Practice,
(6:4), 1998, pp. 51-60.
Tyndall, G.R. “Analyzing the Costs and Value of the Product
Distribution Chain,” Journal of Cost Management, (2:2), 1988, pp.
45-51.
The Journal of Supply Chain Management | Summer 2002 29