U.S.

General Services Administration

Federal Acquisition Service

The Federal Strategic Sourcing Initiative (FSSI)

Understanding the Elements of Total Cost of Operations (TCO)

Workshop Objectives

Provide a brief overview of strategic sourcing and the Federal Strategic Sourcing Initiative (FSSI) Provide a comprehensive definition of Total Cost of Operations (TCO) Explain the key elements of TCO Clarify the difference between cost elements and cost drivers Present illustrative examples of acquisition decisions based on TCO analysis Share the benefits that can be achieved by incorporating TCO analysis into the procurement process

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Prelude

What is TCO? Total Cost of Ownership The total cost of owning and operating an asset over its expected period of use, i.e., lifecycle cost. Also includes costs to acquire and dispose of the asset Total Cost of Operations Similar to Total Cost of Ownership, but recognizes that certain assets might be leased or provided as part of a contracted operation. Provides a useful cost framework to evaluate:
Policy options Business process alternatives Investment alternatives, e.g., in-house vs contract; own vs lease Acquisition alternatives, e.g., vendor vs vendor; contracting options

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The Federal Strategic Sourcing Initiative is an OMB-initiated program that was established in November of 2005
2005 OMB Mandate
An OMB memo issued May 2005 required agencies to identify no fewer than three commodities to be purchased through strategic sourcing by October 2005 (excluding software purchased through SmartBUY). The memo stated that: Agencies needed to leverage spending to the maximum extent possible Sound business decisions needed to drive spending

Federal Strategic Sourcing Initiative (FSSI)

In November of 2005, as a direct result of the OMB mandate, FSSI was established with a mission to improve the federal government acquisition value chain, increase socio-economic participation and ultimately lower total cost of operations and/or ownership for strategic sourcing vehicles FSSI is governed by OFPP and the Strategic Sourcing Working Group under the Chief Acquisition Officers Council

More than 60 Federal agencies, boards and commissions actively participate in the FSSI Use of FSSI vehicles is non-mandatory, but agencies are encouraged to look at FSSI solutions first
Currently, three FSSI vehicles exist with GSA serving as the Executive Agent: Express and Ground Domestic Delivery Services GSA Schedule 48 BPA Office Supplies GSA Schedule 75 BPAs Wireless Telecommunications Expense Management (TEM) Services IDIQ, multiple award contract
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Strategic sourcing is a process that strives to optimize an organizations supply base while reducing Total Cost of Operations and improving mission delivery

Strategic sourcing is the collaborative and structured process of critically analyzing an organizations spending and using this information to make business decisions about acquiring commodities and services more effectively and efficiently
http://www.whitehouse.gov/omb/procurement/comp_src/implementing_strategic_sourcing.pdf

A group of senior Federal executives participating in the 2006 Public Sector Strategic Sourcing Roundtable defined strategic sourcing in the federal government as:
A Systematic Process for analyzing and developing optimal strategies for buying goods and services

A Data Driven Process that relies on fact-based analysis for decision making rather than hunches
A Holistic Process that addresses customer needs, market conditions, organizational goals and objectives, and other environmental factors Based on Market Intelligence and takes into account small business capabilities Inclusive of Customer Requirements A Cross-Functional Approach that incorporates the perspectives and expertise of acquisition specialists as well as end users About Supporting an Organizations Mission through procured goods and services About Developing Organization-wide Strategies
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The benefits of strategic sourcing and drivers of TCO are numerous and go far beyond simple reductions in unit costs

Primary Benefits of Strategic Sourcing

Reduction in Cost Per Unit

Pricing Improvements Lower unit price Volume rebates Payment term discounts Supply Chain Savings Cost of capital Warehousing costs Shipping costs Reduced Lifecycle Costs Maintenance costs Operating costs Disposition costs

Change in Consumption/ Volume

Demand Management Eliminate demand Reduce consumption Encourage substitution Change product mix Specification Review Eliminate gold-plating Simplify specifications Alternative products

Improved Operating Efficiency

Reduced ProcurementRelated Operating Expense PO Processing Accounts Payable Receipt/Warehousing Standardized procurement process Reduced Non-Procurement Related Operating Expense Other operating efficiencies Performance Monitoring Structured metrics and periodic review of contractor performance

Improved Focus on Socioeconomic Goals

Socio-economic Goals Structured analysis of small/disadvantaged business opportunities

DRIVERS OF TCO

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What is Total Cost of Operations?

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One of the primary goals of strategic sourcing is the reduction of Total Cost of Operations

WHAT IS TOTAL COST OF OPERATIONS?

Total Cost of Operations (TCO) is a comprehensive, full cost accounting estimate designed to help consumers and commodity managers assess costs TCO consists of costs incurred throughout the life cycle of a service or commodity, including acquisition, deployment, operation, support and retirement TCO identifies costs which are made up of two major components - direct and indirect: Direct costs traditionally are made up of labor and capital costs

Indirect costs are more of the soft costs associated with an acquisition and tend to be more difficult to measure and rationalize

Understanding TCO broadens our baseline understanding of spend and identifies sourcing opportunities beyond purchase price
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TCO of a commodity goes beyond purchase price, it also includes acquisition costs, lifecycle costs, end of life costs and other
ILLUSTRATION TOTAL COST OF OPERATIONS (TCO) ELEMENTS (Conceptual Example)
Management Costs Disposal/ Closeout Costs Disposal / Closeout Costs Management Costs

Costs to Buyer $

Operation Costs Bid & Award Costs

Contract Management Costs

Operation Costs
Bid & Award Costs Contract Management Costs

Supplier's Profit Supplier's Cost

Supplier's Profit Supplier's Cost

Purchase Price

Acquisition Process Costs

Lifecycle Costs

End of Life Costs

Total Cost of Operations

For some commodities, cost elements beyond purchase price may be significant, at times equaling or exceeding initial purchase cost over the commodity lifecycle
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Different commodities can vary significantly in their composition of TCO elements

ILLUSTRATION TOTAL COST OF OPERATIONS (TCO) ELEMENTS (Conceptual Example)

100
End of Life Costs

NOTES
Many buyers will focus on achieving a competitive purchase price and will overlook opportunities to improve other cost elements For some commodities, purchase price is not the largest cost element Therefore, it is important to consider all cost elements, including (but not limited to): Internal procurement, contract management and billing/invoicing processes Internal management of the commodity Operational costs (cost of use, spare parts, maintenance, etc.) Disposal costs

Lifecycle Costs 80 Acquisition Process Costs

End of Life Costs

Lifecycle Costs 60

40

Purchase Price

Acquisition Process Costs

20

Purchase Price

Example A Refrigerator

Example B Laptop Computer

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Key Elements of Total Cost Analysis: Understanding Cost Elements vs. Cost Drivers

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Understanding the total cost of a commodity involves the identification of cost elements and cost drivers

COST ELEMENTS VS COST DRIVERS

What are they?

Examples
Transportation costs Purchasing administration costs Inventory costs Supplier certification costs Distance shipped Number of suppliers Number of purchase orders Number of different SKUs

COST ELEMENTS

Components of total cost of operations (TCO) buckets of cost that can be quantified

COST DRIVERS

Factors or activities that can be changed and have an impact on the magnitude of the cost element

Cost drivers can at times be significant sources of savings for some commodities Drivers of cost within suppliers operations can be very important for commodities where unit price is still likely to be the largest component of our total cost
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When identifying the various cost elements of TCO, it is also important to consider the percentage of TCO that is comprised of each the costs elements
For a common piece of office equipment - a network printer there are multiple TCO components that should be considered when conducting an acquisition. What percentage of the total cost do each of these components make up? NETWORK PRINTER COST COMPONENTS
TCO Element
Description Hardware includes the actual price paid for the product Operations and Maintenance costs include maintenance, repair, help desk, asset management, upgrades, licensing, etc. Consumables (e.g. paper, ink, toner, cartridge) are a significant part of the office imaging cost

Estimated % of TCO

Purchase Price & Acquisition Process Costs - Device Lifecycle Costs Operations and Maintenance Costs Lifecycle CostsConsumables

5%* 50%*

45%*

Source: Prudential Equity Group Research, Oct 2006; Lexmark International; Censeo Analysis * Percentages referenced above are based on an industry report from Lexmark International; this break out will not be true in all scenarios End of Lifecycle Costs are also components that impact the TCO of a network printer, but the estimated percentage was not provided in the referenced industry report

The percentage break out of TCO components does not always align with initial assumptions and can impact the results of a total cost analysis
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As demonstrated in the previous example, consumables, maintenance & IT support, and equipment costs are the key cost elements of desktop printers
RELEVANT TOTAL COST COMPONENTS

DESKTOP PRINTER TOTAL COST OF OPERATIONS BREAKDOWN

Purchase Price: Hardware: Annual depreciation cost of printers Acquisition Process Costs: Acquisition: Estimated acquisition costs associated with requirements validation & contracting purchasing activity Lifecycle Costs: Operations & Maintenance:
IT Support: Cost estimate of in-house IT help desk support provided to local and network printers User Support: Cost estimate of work effort associated with toner and paper replenishment performed by users Property Mgmt: Estimated property management personnel costs associated with managing printers

Consumables:
Purchase Price Lifecycle & Acquisition Costs Process Costs - Operations & Device Maintenance Lifecycle Total Cost Costs of Consumables Operations

Paper and toner costs Power: Estimated power costs associated with devices

End of Life Costs: Disposal: Cost of product disposal at end of life

Source: Prudential Equity Group Research, Oct 2006; Lexmark International; Censeo Analysis * Percentages referenced above are based on an industry report from Lexmark International; this break out will not be true in all scenarios End of Lifecycle Costs are also components that impact the TCO of a network printer, but the estimated percentage was not provided in the referenced industry report

Understanding internal costs related to purchasing and managing a commodity is important in identifying savings opportunities
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Key Elements of Total Cost Analysis: Conducting A Complete TCO Evaluation In The Workplace

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With most acquisitions, unit price is often the only cost component considered

NETWORK PRINTER COST COMPONENTS Device A Device

B&W Printer medium size

Device B
B&W Printer medium size

Device C
B&W Printer medium size

Volume Unit Price/Device Cost

Source: Censeo analysis

100

100

100

$1,031.00

$783.75

$725.20 $725.20

Based on the data above, Device C would be the best value

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But to truly obtain best value, it is critical to evaluate all TCO cost components before completing an acquisition
NETWORK PRINTER COST COMPONENTS Device A
Device Usage* Volume Product Support
Purchase Price Acquisition Process Costs Device Procurement
B&W Printer medium size 4,000 pg/month 100 4-Yr Extended Warranty $1,031.00 (34% of total cost) $150.00 (5% of total cost) $1,425.67 (47% of total cost) $408.00 (13% of total cost) $50.00 (2% of total cost)

Device B
B&W Printer medium size 4,000 pg/month 100 4-Yr Onsite Warranty $783.75 (28% of total cost) $150.00 (5% of total cost) $1,282.50 (46% of total cost) $538.20 (19% of total cost) $50.00 (2% of total cost)

Device C
B&W Printer medium size 4,000 pg/month 100 4 Yrs Onsite Product Support $725.20 (19% of total cost) $150.00 (4% of total cost) $2,811.60 (72% of total cost) $144.00 (4% of total cost) $50.00 (1% of total cost)

Est. 4-Yr Consumables Cost

Lifecycle Costs 4-Yr Product Support Cost Disposal

End of Life Costs

Total 4-Yr Estimated TCO

$3,064.67

$2,804.45 $2,604.45

$3,880.80

* Usage estimates are based on avg # users per device (8), typical # of pages per user (500) resulting in the estimated total # of monthly pages (4,000). Projected Consumables Costs assume utilization of high-yield cartridges where available. Source: Censeo analysis

A complete analysis of TCO indicates that Device B truly is the best value solution
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Key Elements of Total Cost Analysis: Conducting A Complete TCO Evaluation In Daily Life

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The process of conducting a TCO analysis can be applied in everyday life

TOTAL COST OF OPERATIONS (TCO) EVALUATION
When purchasing a car consumers often consider only one variable sticker price and based on the sticker price in the example to the right, Example A, the non-hybrid is the more economic choice Example A (Non hybrid) Purchase price Acquisition process and lifecycle costs*: Depreciation Taxes and Fees Insurance Premiums Fuel Maintenance Repairs Interest on Financing Stimulus - Auto Assistance Ownership Amendment Sticker Price: $22,151 Example B (Hybrid) Sticker Price: $23,650

$9,981 $1,600 $10,216 $10,700 $3,050 $671 $3,840 $1,500

$10,549 $1,635 $10,216 $5,600 $3,050 $671 $3,953 $1,500

Purchase price after TCO analysis

Price: $40,058
(cost is 53 cents per mile to drive)**

Price: $35,658
(cost is 48 cents per mile to drive)**

*End of Life Costs are not included in this example **Cost of ownership is assumed over a five year period and 15,000 miles a year Source: http://www.edmunds.com/advice/buying/articles/59897/article.html

TCO analysis indicates that the cheaper car to buy is actually the more expensive car to own and operate

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When selecting a means of transportation, it is important to understand how different cost drivers can influence the TCO
Commuting to work is a daily activity for most individuals. In nearly all instances, there are a number of expenses incurred with a daily commute. These expenses will vary based on method of transportation, distance traveled, number of options available, etc. These expenses may also drive us to choose one method of transportation over another. For this exercise, assume that there are only two commuting options available, to drive or to utilize public transportation. Based on the out of pocket expense incurred on a daily basis, lets calculate the cost of a daily commute:

Estimated Daily Cost of Commuting

Method of Commuting Drive Public Transportation Cost Components Parking Gas Fare Parking Estimated Cost (per day) $10 $5 (each direction) $3.50 (each direction) $5 Total Estimated Commuting Cost (per day) $20 $12

Based on an initial assessment, there are multiple cost components that should be considered for both methods of transportation

But are these the only cost drivers?

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In our assessment of the daily cost of commuting, it is important to remember that all costs may not be apparently obvious
In our calculations of the cost of a daily commute, have we considered all costs?
Estimated Daily Cost of Commuting Method of Transportation Drive Parking Fare $10 $0 $5 (each direction) $5.68 $1.69 $5.50 Public Transportation $5 $3.50 (each direction) $3 (each direction) $5.11 $1.69 $4.95

NOTES
There are a number of additional cost drivers that were not immediately apparent in this example

Cost Components

Gas Car Insurance Depreciation of the car Maintenance and repair of the car

These additional costs can have a significant impact on total cost, and only by assessing all drivers can one truly understand the total cost and make an informed decision between the two alternatives
Time is another cost element that was not considered. Time can be assessed as an opportunity cost. Because of limited contracting resources within the government, time is a critical element in any acquisition and cost analysis

TOTAL

$32.87

$29.75

*Figures for drive method assumed for a 2009 Honda Civic over a five year period and 15,000 miles a year Source: http://www.edmunds.com/advice/buying/articles/59897/article.html

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Understanding the Benefits of TCO

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Once we understand cost elements and drivers and identify specific actions we can take to impact total cost, savings estimates can be developed to support recommended changes
SAVINGS CALCULATION FRAMEWORK TOTAL COSTS Examples
Reduced Prices

Price Volume Rebates Payment term discounts Cost of Capital Warehousing Costs Shipping costs Maintenance costs Operating, energy and other costs Disposable costs Elimination Substitution Change in mix

Reduction in Cost per Unit

Reduced Supply Chain Costs

Reduced Lifecycle Costs Total Savings Related to Purchased Goods and Services Change in Consumption/ Volume Reduced Procurement Related Operating Expense Improved Operating Efficiency

Cost of processing purchase orders Cost of processing accounts payable Cost of receipt/warehousing

Reduced NonProcurement Operating Expense

Other Operating efficiencies

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Understanding TCO and how to apply the concept to acquisition decisions can result in significant savings opportunities, specifically unit cost reduction and planned changes in consumption and volume

NOTES
Unit price reductions can be achieved by: Negotiating payment terms to gain pricing improvements and discounts Optimize the supply chain Reducing lifecycle costs through the management of maintenance costs, operating costs, and disposal costs Planned changes in consumption and volume can be achieved through: Demand management, eliminating demand and reducing consumption Specification review, simplifying specifications and suggesting alternative products

The following slide provides an example of how unit price reductions and changes in consumption/volume can result in reduced lifecycle costs and efficiencies
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In the example below, understanding the TCO elements of lifecycle costs and specification requirements can result in significant cost savings when making an acquisition decision
EXAMPLE ROOFING SCENARIOS 20-YEAR LIFETIME COST COMPARISON ($ per SF)
$50K
Disposal of Roof (End of Life Costs)
Acquisition (Acquisition Costs)

NOTES
Reduction in Cost per Unit and Lifecycle Costs:
Investing in higher quality materials, workmanship, and warranty coverage upfront will cost more in year one, but will provide the lowest lifetime TCO

Disposal of Roof (End of Life Costs) Acquisition (Acquisition Costs)

Disposal of Roof (End of Life Costs) Acquisition (Acquisition Costs)

$40K

Minor Repairs (Lifecycle Costs)

Minor Repairs (Lifecycle Costs)

Major Repair (Lifecycle Costs)

Minor Repairs (Lifecycle Costs)

$30K

Roof Replacement (Lifecycle Costs)

Roof Replacement (Lifecycle Costs)

Major Repair (Lifecycle Costs) Initial Roof (Purchase Price)

Disposal of Roof (End of Life Costs) Acquisition (Acquisition Costs) Minor Repairs (Lifecycle Costs)

Change in Consumption/Volume:
For major facility capital investments like HVAC equipment or roofing, clearly identifying and assessing specifications can result in cost savings by reducing consumption (and limiting replacements of parts or full structures)

$20K Initial Roof (Purchase Price) Initial Roof (Purchase Price) Initial Roof (Purchase Price)

$10K

Status Quo Scenario 1 Low quality with full replacement

Status Quo Scenario 2 Low quality with partial replacement

Status Quo Scenario 3 Low quality with partial overlay

High Quality Roof 20 - year

1
Source: Censeo Analysis

4
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TCO can also help evaluate the benefits of operational decisions such as changes in consumption/volume and improved operating efficiency

NOTES
Change in consumption/volume and improved operating efficiency can be achieved in a number of ways:

Through the implementation of an online ordering system to reduce paper and manual transactions and improve invoice processing and auditing
Business Process re-engineering

The following slides provide an example of how to calculate savings gained through improved operational efficiencies
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Reducing processing times improves operational efficiency

IMPROVED OPERATIONAL EFFICIENCY PROCESSING TIME Shipment of FedEx Packages
PREVIOUS SHIPPING STEPS
1) Employee walks to copier room to obtain FedEx letter and requisition form 2) Employee walks back to their desk to complete the form 3) Employee secures requisition form to the letter with tape 4) Employee walks back to the copy room to place the outgoing letter in a designated place 5) At a designated time a mailroom employee walks the halls and picks up all out going FedEx packages and mail and returns all to the mailroom 6) In the mailroom the mailroom employee keys into a FedEx system the destination address 7) The mailroom employee records the tracking number on the requisition form 8) The form is returned to the original sender 9) The form is secured in a file cabinet 10) FedEx then picks up all outbound shipments

REVISED SHIPPING STEPS

1) Employee walks to copier room to obtain a FedEx letter 2) Employee returns to their desk and clicks on FedEx Online 3) After 3 clicks the label prints out on the employees printer 4) Employee walks back to the copy room to place the outgoing letter in a designated place

5) At a designated time a mailroom employee walks the halls and picks up all out going FedEx packages and mail and returns all to the mailroom
6) FedEx then picks up all outbound shipments

All time was studied and this took on average 1 minutes and 22 seconds to complete

All time was studied and this took on average 14 minutes and 42 seconds to complete
Source: This example is provided courtesy of Federal Express Corporation

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Reduced labor costs is an example of the savings that can be achieved through improved operational efficiency
SAVINGS CALCULATION IMPROVED OPERATIONAL EFFICIENCY PROCESSING TIME Reduced Labor Costs Associated With Shipment of FedEx Packages 1

Savings Calculations
STEP 1: Divide the hourly labor rate of the individual conducting the procurement (based on GS level and pay grade) by 60 min in an hour to generate the estimated labor rate per minute. STEP 2: Next, work with subject matter experts to estimate the current and future processing time of the given transaction and subtract the current time from the future processing time. Then, multiply the variance by the labor rate per minute identified in Step 1. STEP 3: Identify the total number of transactions that are processed per year. Multiply this number by the labor cost savings per unit identified in Step 2.

These calculations result in the annual estimated labor rate savings achieved through improved processing time
Source: This example is provided courtesy of Federal Express Corporation

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There are a number of key steps that should be completed as part of any acquisition to ensure a thorough TCO evaluation has been conducted and best value achieved

STEPS TO CONDUCT A TCO EVALUATION

1)

Before beginning any acquisition, through market research or product analysis, identify the key cost elements that comprise the total cost of operations for this commodity beyond just price Identify the cost drivers for this commodity which of these can we control/influence? Once the cost elements and drivers have been identified, assess each of these components and assign an estimate percentage of total cost if the assigned percentage is not significant (falls below 5%) eliminate it from your evaluation Identify the appropriate timeline to measure the total cost of this acquisition With a revised, prioritized list of TCO components, assess the true cost of the commodity Compare and save!

2) 3)

4) 5) 6)

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Points of Contact:
GSA FAS - FSSI Program Management Office
Michel Kareis, PMP FSSI Program Manager michel.kareis@gsa.gov (703) 605-3669 FSSI website: www.gsa.gov/fssi FSSI email address: fssi@gsa.gov

Office of Federal Procurement Policy (OFPP)

Jack Kelly jkelly@omb.eop.gov (202) 395-6106

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Questions?

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