Minimizing expenditure and maximizing profits is the ultimate goal of any successful business. In manufacturing, managing expenses is critical to prevent production costs from exceeding budget. Any miscalculations in the overall production cost nearing or even past the contract amount can be detrimental to the margins and push the entire project into a net loss.
One critical area where manufacturers lose money is maintaining the inventory of raw materials or products. The idle stock will attract maintenance costs and eat up the storage space each day. The part of budgeting that oversees such costs is called Total Cost of Ownership.
Let's explore the Total Cost of Ownership in detail and how manufacturers can leverage nearshoring to bring down costs and maximize profits.
What is the Total Cost of Ownership or TCO in Manufacturing?
An item's initial purchase price does not reflect its total value, and that's where total cost of ownership or TCO comes into play. TCO takes a macro perspective on the product and its value over time. In short, TCO is the sum of an asset's purchase price and its long-term operating costs.
In the mid-eighties, TCO analysis came to the forefront to effectively calculate expenses while acquiring Information Technology (IT) hardware and software. This calculation ended up in an important discovery; that the operating cost of hardware and software is 5 to 8 times higher than the purchase price.
Today, companies in various sectors use TCO calculation in their capital investment decisions such as building, vehicles, manufacturing, and IT infrastructure. TCO analysis also helps decision-makers to make crucial lease vs. purchase comparisons. Besides, considering TCO in the acquisition process positively influences vendor selection, capital acquisition, and corporate budgeting.
Factors to Consider in Total Cost of Ownership
Analyzing the Total Cost of Ownership helps in the manufacturing process of your product. Therefore, you should consider these three key factors, which can positively influence the manufacturing cost of your product.
The cost of acquisition of physical assets includes the money spent on equipment or property excluding taxes but adding discounts, commissions, incentives, and closing costs. Sometimes this may consist of one-time peripheral equipment or upgrades necessary for the installation or usage of the asset.
The operating costs consist of subscriptions or services like utility, direct operator labor, and initial training costs that put the asset into business use.
A skilled workforce is a critical element in every enterprise and essential in analyzing TCO. The cost of manpower includes salaries, incentives, and other monetary benefits given to administrative staff, hardware support personnel, operators in charge of the facility housing the equipment and tools. These expenses also include ongoing training and emergency labor for maintenance activities.
Apart from all these factors, the real total cost of ownership can include expenses and incremental savings or revenue flows from the capital investment. The change in cash flows versus the regular business revenue is a significant factor that mitigates TCO. Those costs must be valued by calculating Net Present Value (NPV) to analyze the change in value over time.
The real Total Cost of Ownership analysis is a critical decision-making tool for enterprises of any size and shape. However, a thorough understanding of an investment and its potential impact on business is necessary to find the correct answer.
How Nearshoring Benefits Your Sourcing
Nearshoring is a business strategy in which a company teams up with a third-party company that provides specific services from a place relatively closer to the company's area. In other words, nearshoring allows a business to transfer work to geographically closer and lesser expensive companies. As a result, nearshoring comes with several benefits. Most notable of which is that traveling to the location doesn't take days. Also, there is no language or cultural barrier between the parties involved.
The immediate benefit of Nearshoring is that manufacturers don't have to burden themselves with the supply, upkeep, and manufacturing of the raw materials. Instead, these activities can be nearshored to an adjacent company.
JEM Electronics is a contract manufacturer of custom cable assemblies, electro-mechanical assemblies, wire harness assemblies, and box builds with over 25 years of experience.
With our manufacturing rooted in the USA, and strict quality controls in place, we work with customers across different industries, including telecom, automotive, military, recreation, consumer electronics, medical, the federal government, and many more.