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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
Page 1
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
Page 2
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 Officer’s
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
Page 3
Strategic sourcing is a process that strives to optimize an organization’s supply
base while reducing Total Cost of Operations and improving mission delivery
Strategic sourcing is the collaborative and structured process of critically analyzing an
organization’s 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 Organization’s Mission through procured goods and services
 About Developing Organization-wide Strategies
Page 4
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
Change in
Consumption/
Volume
Demand Management
• Eliminate demand
• Reduce consumption
• Encourage substitution
• Change product mix
Specification Review
• Eliminate “gold-plating”
• Simplify specifications
• Alternative products
Reduced Lifecycle Costs
• Maintenance costs
• Operating costs
• Disposition costs
DRIVERS OF TCO
Improved
Operating
Efficiency
Reduced ProcurementRelated Operating Expense
• PO Processing
• Accounts Payable
• Receipt/Warehousing
• Standardized
procurement process
Improved Focus
on Socioeconomic Goals
Socio-economic Goals
• Structured analysis of
small/disadvantaged
business opportunities
Reduced Non-Procurement
Related Operating Expense
• Other operating
efficiencies
Performance Monitoring
• Structured metrics and
periodic review of
contractor performance
Page 5
What is Total Cost of Operations?
Page 6
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
Page 7
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)
Costs to Buyer $
Management
Costs
Disposal/
Closeout
Costs
Operation
Costs
Disposal /
Closeout Costs
Management
Costs
Operation
Costs
Bid & Award
Costs
Bid &
Award Costs
Contract
Management
Costs
Contract
Management
Costs
Supplier's
Profit
Supplier's
Profit
Supplier's
Cost
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
Page 8
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
Lifecycle Costs
80
End of Life Costs
Acquisition Process Costs
Lifecycle Costs
60
40
Purchase Price
20
0
Acquisition Process Costs
Purchase Price
Example A Refrigerator
Example B Laptop Computer
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
Page 9
Key Elements of Total Cost Analysis:
Understanding Cost Elements vs. Cost Drivers
Page 10
Understanding the total cost of a commodity involves the identification of cost
elements and cost drivers
COST ELEMENTS VS COST DRIVERS
What are they?
COST
ELEMENTS
COST
DRIVERS
Components of total cost of operations
(TCO) – “buckets” of cost that can be
quantified
Factors or activities that can be changed
and have an impact on the magnitude of
the cost element
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 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
Page 11
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
Estimated
% of TCO
Purchase Price &
Acquisition Process
Costs - Device
Hardware includes the actual price
paid for the product
5%*
Lifecycle Costs Operations and
Maintenance Costs
Operations and Maintenance
costs include maintenance, repair,
help desk, asset management,
upgrades, licensing, etc.
50%*
Consumables (e.g. paper, ink,
toner, cartridge) are a significant
part of the office imaging cost
45%*
Lifecycle CostsConsumables
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
Page 12
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
Page 13
Key Elements of Total Cost Analysis:
Conducting A Complete TCO Evaluation –
In The Workplace
Page 14
With most acquisitions, unit price is often the only cost component considered
NETWORK PRINTER COST COMPONENTS
Device A
Device B
Device C
Device
B&W Printer –
medium size
B&W Printer –
medium size
B&W Printer –
medium size
Volume
100
100
100
$1,031.00
$783.75
$725.20
$725.20
Unit
Price/Device
Cost
Source: Censeo analysis
Based on the data above,
Device C would be the
best value
Page 15
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 B
Device C
Device
B&W Printer – medium size
B&W Printer – medium size
B&W Printer – medium size
Usage*
4,000 pg/month
4,000 pg/month
4,000 pg/month
Volume
100
100
100
4-Yr Extended Warranty
4-Yr Onsite Warranty
4 Yrs Onsite Product Support
$1,031.00 (34% of total cost)
$783.75 (28% of total cost)
$725.20 (19% of total cost)
$150.00 (5% of total cost)
$150.00 (5% of total cost)
$150.00 (4% of total cost)
$1,425.67 (47% of total cost)
$1,282.50 (46% of total cost)
$2,811.60 (72% of total cost)
$408.00 (13% of total cost)
$538.20 (19% of total cost)
$144.00 (4% of total cost)
$50.00 (2% of total cost)
$50.00 (2% of total cost)
$50.00 (1% of total cost)
Product Support
Purchase Price
Device
Acquisition
Process Costs
Procurement
Est. 4-Yr
Consumables Cost
Lifecycle Costs
End of Life Costs
4-Yr Product Support
Cost
Disposal
Total 4-Yr Estimated TCO
$3,064.67
* 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
$2,804.45
$2,604.45
$3,880.80
A complete analysis of
TCO indicates that Device
B truly is the best value
solution
Page 16
Key Elements of Total Cost Analysis:
Conducting A Complete TCO Evaluation –
In Daily Life
Page 17
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
Sticker Price:
$22,151
Acquisition process and lifecycle
costs*:
 Depreciation
 Taxes and Fees
 Insurance Premiums
 Fuel
 Maintenance
 Repairs
 Interest on Financing
 Stimulus - Auto Assistance
Ownership Amendment
Purchase price after TCO analysis
$9,981
$1,600
$10,216
$10,700
$3,050
$671
$3,840
$1,500
Example B
(Hybrid)
Sticker Price:
$23,650
$10,549
$1,635
$10,216
$5,600
$3,050
$671
$3,953
$1,500
Price: $40,058
Price: $35,658
(cost is 53 cents
per mile to drive)**
(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
Page 18
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,
let’s calculate the cost of a daily commute:
Estimated Daily Cost of Commuting
Total Estimated
Commuting Cost
(per day)
Method of
Commuting
Cost
Components
Estimated Cost (per
day)
Drive
Parking
Gas
$10
$5 (each direction)
$20
Public
Transportation
Fare
Parking
$3.50 (each direction)
$5
$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?
Page 19
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?
NOTES
Estimated Daily Cost of Commuting
Method of Transportation
Cost Components
Drive
Public
Transportation
Parking
$10
$5
Fare
$0
$3.50 (each
direction)
Gas
$5 (each
direction)
$3 (each
direction)
Car Insurance
$5.68
$5.11
Depreciation of the car
$1.69
$1.69
Maintenance and repair of the
car
$5.50
$4.95
TOTAL
$32.87
$29.75
• There are a number of additional
cost drivers that were not
immediately apparent in this
example
• 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
*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
Page 20
Understanding the Benefits of TCO
Page 21
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
Reduction in
Cost per Unit
Reduced Prices
 Price
 Volume Rebates
 Payment term discounts
Reduced Supply
Chain Costs
 Cost of Capital
 Warehousing Costs
 Shipping costs
Reduced Lifecycle
Costs
Total
Savings
Related to
Purchased
Goods and
Services
 Elimination
 Substitution
 Change in mix
Change in
Consumption/
Volume
Reduced
Procurement
Related Operating
Expense
Improved
Operating
Efficiency
 Maintenance costs
 Operating, energy and other costs
 Disposable costs
Reduced NonProcurement
Operating
Expense
 Cost of processing purchase orders
 Cost of processing accounts payable
 Cost of receipt/warehousing
 Other Operating efficiencies
Page 22
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
Page 23
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)
$40K
$30K
Minor Repairs
(Lifecycle Costs)
Roof
Replacement
(Lifecycle
Costs)
Disposal of Roof
(End of Life Costs)
Acquisition
(Acquisition Costs)
Minor Repairs
(Lifecycle
Costs)
Major Repair
(Lifecycle Costs)
Roof
Replacement
(Lifecycle
Costs)
Disposal of Roof
(End of Life Costs)
Acquisition (Acquisition Costs)
Minor Repairs
(Lifecycle
Costs)
Major
Repair
(Lifecycle
Costs)
$20K
$10K
Initial
Roof
(Purchase
Price)
Initial
Roof
(Purchase
Price)
Initial
Roof
(Purchase
Price)
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
2
3
1
Disposal of Roof
(End of Life Costs)
Acquisition
(Acquisition Costs)
Minor Repairs
(Lifecycle Costs)
Initial
Roof
(Purchase
Price)
High Quality Roof
20 - year
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
 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)
4
Source: Censeo Analysis
Page 24
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
Page 25
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
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
6) In the mailroom the mailroom employee keys into a FedEx
system the destination address
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
7) The mailroom employee records the tracking number on the
requisition form
6) FedEx then picks up all outbound shipments
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
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
Page 26
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
Savings Calculations
1
• 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.
2
• 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.
3
• 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
Page 27
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
2)
Identify the cost drivers for this commodity – which of these can we
control/influence?
3)
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
4)
Identify the appropriate timeline to measure the total cost of this acquisition
5)
With a revised, prioritized list of TCO components, assess the true cost of the
commodity
6)
Compare and save!
Page 28
Points of Contact:
GSA FAS - FSSI Program Management Office
Michel Kareis, PMP
FSSI Program Manager
[email protected]
(703) 605-3669
FSSI website: www.gsa.gov/fssi
FSSI email address: [email protected]
Office of Federal Procurement Policy (OFPP)
Jack Kelly
[email protected]
(202) 395-6106
Page 29
Questions?
Page 30