The Devil is in the details

The Devil is in the details –One of the greatest resources to the US consumer is Consumers Union, the publishers of Consumers Report. Consumers Report puts Total Cost of Ownership (TCO) data into the hands of the consumer. I’ve been a life long reader and recommend it highly. They are a non profit organization that accepts no advertising – a one of a kind. They collect enormous amounts of objective comparison data on a wide array of products. Over time, one of the many things I have learned from the data they collect is that, in fact, it is simply a fallacy to believe low price saves money.A Lexus will likely cost substantially less over it’s life than the Volvo which has a purchase price $4000 less. Maybe it doesn’t matter that an $80 pair of running shoes will last 3 times longer than a $35 pair of running shoes. But I bet it really does matter to a lot of people who just never give it a second thought and simply buy that “low price all the time.

”One of the greatest feats of marketing that I have witnessed in my lifetime is Walmart’s success at convincing the US consumer that low price is the most important thing. As millions of US consumers bought into that and as Walmart moved their purchasing headquarters to Shanghai, millions of US jobs went with it to China. Walmart lead this charge and survival dictated that many other US companies do the same thing with devastating effects on the US economy and peoples lives. What is so ironic about this is that the very people who bought into the simplicity of “buy cheap” participated in eliminating their own jobs. Why do so many people believe that buying low price is the most important thing? If they simply stopped, looked at the economy and gave it a little thought the consequences would be apparent. As Mark Felt said “Follow the money.” But the loss of American jobs isn’t the only penalty to be paid, as devastating as that penalty has been.

Purchases for personal use are one thing but what about the purchase of manufacturing equipment for your business? Is purchasing based on lowest price the smart thing to do? In fact, lots of industry data confirms that, in general, it is not the smart thing to do. There is a great deal of research that demonstrates how small a role purchase price plays in the total cost associated with a manufacturing asset. So, how do you decide what to buy? Are you compelled to go for that “low low” purchase price? Or, do you take the time to ask questions and really understanding if price is the only difference, or if there are other costs that need to be considered?

The concept of TCO has been around for a long time and is used widely by industrial purchasing professions to get to the root of what an item really costs over the life of the asset. For this reason, TCO is sometimes called life cycle cost analysis. TCO is an analysis meant to uncover all the lifetime ownership costs that follow from owning certain kinds of assets. These costs include purchase costs, of course, but ownership also brings costs for installing, deploying, operating, upgrading, maintaining and disposing of the asset or the materials used by the asset. For many kinds of acquisitions, and particularly manufacturing systems, TCO analysis finds a very large difference between purchase price and total long term cost. Many studies and lots of data have been collected demonstrating the importance of looking deeper than just the purchase price of an item. One recent industry study published by ITT found –

“Though many plants shop for equipment based on price, industry data shows that purchase costs represent only 10 percent of the total cost of ownership”.

Another example of the relevance of TCO can be found at the Edmund’s.com car valuation guide. Edmunds has developed their own proprietary method of calculating what they call the “True Cost to Own” (TCO, clever) each vehicle. With their system you can find out if “saving” $1000 on purchase price really saves you money or if that car will actually cost more to own than the car thathas a $1000 higher price tag. Like Consumer Reports, Edmund’s is following the lead of industrial purchasing pros in giving greater consideration to the costs you will pay after you buy the asset. The Kelly Blue Book has just started doing the very same thing. It makes sense because while cheap purchase price is easy to find the best economics can only be found with some further investigation. Edmund’s, Kelly Blue Book, Consumer Reports and others are helping to bring TCO thinking to the mass market.So, back to the question, how do you decide what to buy and is the long term cost of ownership part of your thinking? For many of us the hard part is knowing what questions to ask. So, here is a list of some of the questions industrial buyers ask.

Is the manufacturing process for each option the same or, is there a process technology or efficiency advantage to one vs. the other?
Who developed the technology? Am I buying from them or a “fast follower” who may have an incomplete or only empirical understanding?
How does the cost of waste disposal/clean up, environmental impact or pollution control
compare?
Are there operating cost advantages – labor, energy, speed etc?
Are there potential employee hazards created by one of the options?
Are repair and spare parts costs the same?
Are future upgrades possible?
Are there any supplier experience and capability advantages?
Does one option give improved operational capability ie. – higher quality, manufacturing
flexibility etc?
What do their customers say about them?

The list of hidden cost categories above could be extended for many kinds of purchases and you could make it shorter as well. But if you ask questions about some of these areas you may find real differences between the options you are considering; differences that over the useful life the purchase could save far more money than any price difference between them.

Price is important, of course. And it’s easy to know, which makes it useful as a decision criteria. But next time you are gearing up to strike that hard bargain and negotiate that excellent price, keep in mind that the assumption price is most important in choosing one option over another is, in many cases, simply wrong and a potentially expensive error in thinking. Invest that effort uncovering some of the hidden costs and you will likely save more money and make a wiser choice of supplier. Companies who place great emphasis on the low price of the products they sell often have little else to differentiate what they are selling.

So, next time you’re trying to decide between several options, do what the pros do and use a little TCO thinking. Ask some of the questions above. With just a little extra effort, you should be able to find out if that low price is really a good deal or a way for the supplier to capitalize on what you don’t know and the questions most people don’t ask.

As Will Rogers once said – “It’s not what you pay but what it costs you that counts.”

Until next time … best of health and happiness

Ron