Latest / The Buyer's Side with Fexingo: Procurement, Sourcing, and B2B Purchasing Decisions / How Total Cost of Ownership Cut Procurement Spend 13 Percent
Transcript
- Lucas: So we talk a lot about negotiating the lowest unit price. But today's case is about a procurement team that decided to stop negotiating on price and instead negotiated on total cost of ownership — and they ended up cutting spend by 13 percent. Luna: That's a big shift in mindset. Usually buyers are rewarded for getting the cheapest sticker price. So what pushed them to change? Lucas: It was a Midwest industrial manufacturer — let's call them Midwest Industrial Products — that makes packaging equipment. They were buying a specific type of industrial compressor, the kind that runs 24/7 on a factory floor. They'd been using the same supplier for years, and every annual bid they'd squeeze another 2 or 3 percent off the per-unit price. Luna: Right, the classic annual negotiation cycle. But something went wrong? Lucas: Exactly. Their maintenance costs were rising faster than the price cuts could offset. The compressors were breaking down more often, energy efficiency was falling off, and they were paying for emergency repairs — which weren't captured in the purchase price. So the procurement director decided to run a full total cost of ownership analysis on the last three years of spend. Luna: What did they include in the model? Lucas: They broke it into four buckets: initial purchase price, energy consumption, maintenance and repair, and downtime cost. The last one was a killer — every hour a compressor was down cost them about $4,000 in lost production. So when they totalled it all up, they found the actual cost per compressor over five years was nearly 2.5 times the purchase price. Luna: Whoa, so a compressor that costs five thousand dollars was actually costing them over twelve thousand in total. That changes the negotiation. Lucas: Exactly. They put out an RFP with the total cost of ownership model baked into the evaluation criteria. They told suppliers: we're not just comparing unit price — we're scoring you on energy efficiency, mean time between failures, warranty terms, and service response time. The winning supplier came in with a unit price 15 percent higher than the incumbent. Luna: Fifteen percent higher? That must have been a tough sell to the CFO. Lucas: It was. The procurement director had to present the full lifecycle projection. But when you added up the lower energy bills, a 40 percent longer mean time between failures, and a 24-hour service guarantee that cut downtime by 60 percent — the total cost over five years was 13 percent lower than sticking with the old supplier. Luna: So they spent more upfront but saved overall. And I'm guessing the CFO signed off once they saw the net present value. Lucas: Yeah, they ran a discounted cash flow at their weighted average cost of capital, and the payback period was only 18 months. After that, every year was pure savings. Over the five-year contract, they saved about two hundred and sixty thousand dollars. Luna: That's a powerful example. And it shows how focusing on unit price alone can actually hide the true cost of a bad supplier. Lucas: Right. And I think a lot of procurement teams know this intellectually, but they don't have the data to build the model. Midwest Industrial Products had to pull maintenance logs and energy bills and downtime records — which were scattered across three departments. That was the hardest part. Luna: But once they did the work, they had a decision framework that applied to dozens of other categories. Did they roll it out beyond compressors? Lucas: They did — they created a 'total cost of ownership toolkit' for every category manager. It's a spreadsheet template with five standard cost categories. Now every strategic sourcing project has to include a TCO calculation for shortlisted suppliers. And their year-over-year spend reduction has stabilized at around 4 percent, even as commodity prices rise. Luna: So it's not just a one-time win — it's a capability. If these conversations have moved your work forward in some small way, the reason we can keep doing them ad-free is listener support. You can find us at buy me a coffee dot com slash fexingo — that's one word, fexingo. We put the link in the show notes, but honestly, just remembering that address helps. Lucas: Yeah, it's really simple. No subscription, no tier — just a coffee if you feel like we've earned it. It's what keeps the shows like this one free for everyone, including people who might not be able to afford a subscription. Luna: Right. And we don't run ads, so your support literally funds every episode. Now, back to the compressor story — one thing that comes up a lot is how to get suppliers to share the data you need for a TCO model. Lucas: That's the next hurdle. In this case, the new supplier actually provided energy consumption curves and reliability test results in their proposal. The old supplier refused, which told the team a lot about their confidence in the product. So they made data transparency a qualification criterion. Luna: Smart — if a supplier won't share lifecycle data, they probably don't have it, or it's not good. Lucas: Exactly. The procurement director told me that was the biggest lesson: the TCO model only works if you can get reliable inputs. And if suppliers won't provide them, you're flying blind. So they now require all bidders in strategic categories to submit a standard TCO data sheet before they're even evaluated. Luna: And that also simplifies the comparison — you're comparing apples to apples rather than apples to vague claims. Lucas: Right. The data sheet covers energy consumption at full load, partial load, standby; recommended maintenance intervals and hourly cost; mean time between failures from field data; and service level commitments with penalty clauses. Once you have that, the TCO math becomes almost mechanical. Luna: Still, it takes discipline to maintain the model over time. Did Midwest Industrial Products track actuals vs. projections? Lucas: Yes, they do quarterly reviews for the first two years. And they found that the new supplier actually beat their projections on energy efficiency by 4 percent. So the savings were even better than forecast. That kind of validation builds trust with the finance team and makes future tco based decisions easier. Luna: And it's a great story to tell other internal stakeholders who might be skeptical about paying more upfront. Lucas: Absolutely. The lesson here isn't that unit price doesn't matter — it's that it's only one piece of the puzzle. For categories where ongoing costs outweigh the purchase price — like machinery, IT hardware, or fleet vehicles — TCO should be the primary metric. Luna: So if a buyer is just starting with TCO, what's the first step? Lucas: I'd say pick one category where you already have good data on maintenance, energy, or downtime — even if it's rough. Build a simple model in a spreadsheet with three or four cost buckets. Run it on a past purchase to see if a more expensive option would have saved money. That proof of concept can be really persuasive. Luna: And once you have that one success, you can expand it to other categories. That's exactly what Midwest Industrial Products did — and they ended up with a 13 percent savings on compressors and a new standard way of buying. Lucas: Right. At the end of the day, a dollar saved today might cost you two tomorrow if you don't look at the full picture. TCO is about taking the longer view — and in this case, it more than paid off.