Develop Preliminary Total Cost of Ownership
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
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
• 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
• 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
Life-Cycle Cost Elements
Life-cycle cost elements:
Warehousing and distribution costs
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
• 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
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.
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
The following formula is a simplified approach to calculating TCO:
TCO = P + Present Value of (O + T + M + W + E - S)
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
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