Latest / The Buyer's Side with Fexingo: Procurement, Sourcing, and B2B Purchasing Decisions / How Procurement Teams Use Total Cost of Ownership
Transcript
- Lucas: You're negotiating a supplier contract. They offer you a unit price that's ten percent below the next bidder. Looks like a win. Luna: Standard procurement play — go with the lowest price. But I'm guessing you're about to tell us why that's a trap. Lucas: Exactly. The lowest unit price can cost you more in the long run. The concept is Total Cost of Ownership, or TCO. And most procurement teams still don't calculate it systematically. Luna: Define TCO for someone who thinks it's just purchase price plus shipping. Lucas: TCO includes everything — acquisition cost, installation, training, maintenance, energy consumption, downtime risk, spare parts, even disposal at end of life. A study by the Institute for Supply Management found that ignoring TCO can inflate actual costs by twenty to forty percent over the asset's life. Luna: That's huge. So a supplier that looks cheap on paper can end up being the most expensive. Lucas: Right. Let me give you a concrete example. A mid-sized manufacturer I spoke with — they make industrial pumps — they used to source electric motors based purely on unit price. They switched to a TCO model two years ago. They now include energy efficiency ratings, warranty length, and average repair frequency. Luna: And what happened? Lucas: They shifted from a low-cost supplier in Southeast Asia to a slightly more expensive European supplier. Unit price went up twelve percent. But energy costs dropped eighteen percent, maintenance calls fell by half, and unscheduled downtime — which they valued at four thousand dollars per hour — almost disappeared. Net savings: about two million dollars annually. Luna: So the cheaper motor would have cost them more in electricity and lost production. That's the classic TCO story. Lucas: It is. And it's not just machinery. TCO applies to services, software, raw materials. For example, cloud computing contracts — the base compute price is often the smallest line item. Data egress fees, support tiers, integration costs — those can double the bill. Luna: Which is why some procurement teams now demand a TCO breakdown in every RFP response. Lucas: Exactly. But here's the challenge: TCO is hard to calculate well. It requires data you might not have — like historical failure rates, energy usage, or disposal costs. And suppliers don't always volunteer it. Luna: Do you have a simple framework for listeners who want to start? Lucas: Start with five categories. One: acquisition — the invoice price, taxes, shipping, installation. Two: operation — energy, consumables, labor to run it. Three: maintenance — spare parts, repair labor, predictive maintenance tools. Four: downtime — how often will it fail, and what does that cost per hour. Five: end of life — removal, disposal, environmental compliance. Luna: If you can estimate those five, you're ahead of most procurement teams. Lucas: And you don't need perfect data. Use ranges. A low-end and high-end estimate. Even a rough TCO model beats comparing unit prices alone. The pump manufacturer started with spreadsheet estimates and refined over two years. Luna: Speaking of things that need refining — there's an interesting behavioral angle too. Procurement teams often get evaluated on unit price savings. So they're incentivized to choose the cheapest supplier, even if TCO is worse. Lucas: That's a real structural issue. If your bonus depends on beating last year's unit cost, you'll optimize for that metric. Some companies are now adding TCO savings to procurement KPIs. It changes behavior. Luna: And suppliers know this. Some will even help you build a TCO model — if they know their total cost is lower, they want you to see it. Lucas: That happened with the pump manufacturer. The European supplier came in with a TCO analysis showing their motor paid for itself in energy savings within eighteen months. The buyer didn't have to crunch the numbers — the supplier did it for them. Luna: That's a sign of a mature supplier relationship too. Lucas: It is. Now, a quick honest thing — we keep this show ad-free, and it's entirely listener-supported. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what makes it possible to produce episodes like this. If these conversations have helped you make better purchasing decisions, that's the reason we do it. Luna: Yeah, it's a small community, but it keeps us going. We're grateful. Lucas: Back to TCO — I want to talk about a common mistake. People include everything but the cost of capital. If you prepay for a three-year service contract, that's money tied up. Your finance team could have used that cash elsewhere. The true cost includes the opportunity cost. Luna: So TCO should factor in payment terms and working capital impact. Lucas: Exactly. A supplier that offers net-60 might have a higher unit price but lower TCO than one demanding net-15, because you keep your cash longer. That's a subtle point many buyers miss. Luna: Any other categories people forget? Lucas: Training and onboarding. If a new machine requires two weeks of operator training and the alternative doesn't, that's a real cost. Also regulatory compliance — if one supplier's material requires special handling or reporting, that adds overhead. Luna: So the TCO list keeps growing. But you have to draw the line somewhere. Lucas: You do. The rule of thumb is: include anything that varies significantly between options and matters to your business. If all suppliers have similar energy efficiency, don't model it. Focus on the big differentiators. Luna: Let's talk about tools. Are there software platforms that help? Lucas: Yes — there are TCO modules in most procurement suites like SAP Ariba, Coupa, and Jaggaer. But honestly, a well-structured spreadsheet works too. The pump manufacturer used Excel for the first year. The key is having a repeatable template, not fancy software. Luna: And once you have the model, do you share it with suppliers? Lucas: Some do. It can be a negotiating tool. If you show a supplier that their TCO is twenty percent higher than a competitor's because of poor reliability data, they may offer a better service contract. Or they may challenge your assumptions — which is good, because it forces you to validate your data. Luna: TCO also helps with internal buy-in. If you're a procurement manager trying to convince engineering to accept a higher-priced supplier, showing a TCO analysis makes the case objective. Lucas: Absolutely. It turns a subjective preference into a data-driven decision. And that's really the core of modern procurement — moving from transaction-focused to value-focused. Luna: So the takeaway for today: unit price is just the starting point. The real cost is everything that happens after the invoice. Lucas: Right. And the next time you see a supplier offering a ten percent discount, ask yourself: what am I not seeing? Because if TCO were the same, they'd be showing you that too.