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Cost of Ownership or Product: Which One's the Real Deal?
October 26, 2010 |Estimated reading time: 14 minutes
Perhaps nowhere is the dichotomy between academic theory and empirical evidence more evident than in the application of total cost of ownership (TCO) methodology. Sometimes tactics simply get in the way of sound strategies. A TCO assessment, however, often alleviates serious downstream disappointment.The TCO concept is basic, applying to all business: A financial estimate used to determine direct and indirect costs of a product or system over its useful lifetime (aka: Life-cycle costing). These calculations of the lifetime costs of acquiring, operating and maintaining something often expose quite a difference between the initial price and long-term costs and benefits, ultimately affecting the initial purchasing decision. Unfortunately, however, TCO analyses are sometimes done in hindsight rather than foresight. The BasicsBusiness schools usually tell us to do an ROI, payback analysis or TCO analysis before acquiring capital equipment. That forces us to remember that there are a large number of things to consider other than the initial cost of the product. Unfortunately, in today's economy, many purchasing agents and engineers are tasked with keeping costs at or below a certain level, making them uncomfortable justifying a higher priced item--even if, in the long run, it provides greater value. In addition, a drawback of methods such as payback (the point at which you recoup the dollar amount of the initial purchase) is that they seek a simple "yes" or "no" response to payback within "policy timing," and completely ignore potential gains beyond that time horizon. A TCO assessment, allowing additional costs and benefits over a greater time frame, helps avoid a poor choice based on either the pedestrian "price" assessment or even the more sophisticated ROI or payback assessment. In the electronics industry, for instance, anytime a process improvement can reduce down-time, an ensuing increase in sellable product, and likely profitability, takes place. In the case of profiling equipment there are a number of ways over and above investing in a piece of equipment to cause improvement to the bottom line. In TCO terms, looking at the longer horizon, the benefits derived by use of certain tools far outweigh the initial purchase price. In economic times such as those recently experienced, there is a temptation to drive down expenses. Good concept; however, if one is not looking at TCO, it becomes easy to step over dollars in pursuit of pennies. The often elusive intangibles of TCO apply to usage of most any equipment in any industry and the results of that usage in terms of engineering or management time involved, scrap from bad runs, traceability and confidence, liability, etc. All of these, when positive, are quantifiable benefits, which would allow a company to recognize benefits from both parts of the adage that there are only two ways to increase profit: Increase revenue and cut expenses. That's exactly why a good TCO analysis is vital. TCO becomes even clearer when we put pencil to paper and map out what something really costs, including initial purchase price and ongoing operating costs netted against likely benefits. Particular emphasis is placed on the two words "total cost" of acquisition, however. Especially in the case of larger capital equipment, such as pick-and-place machines or reflow ovens, it is easy to say the cost of acquiring one is several thousand dollars less than another. But is it really? Will special accommodations have to be made to the production floor; special personnel hired to rewire and refit space; additional training on the new equipment undertaken? Will there be a yield difference among the several options, etc.? All these things must be factored in as additional costs; but unfortunately, they are often oversights, or at best, afterthoughts. Such afterthought scenarios sabotage otherwise thorough searches for the best price. They set owners up for bottom-line damage from day one, when perhaps a more thorough evaluation would have shown that one alternative (relative to others, and especially to the lowest purchase price) would reduce these collateral expenses, produce unexpected benefits or both.Structure of the TCO AnalysisA first-pass approach to TCO, at the macro level, might be to assess the basic question: Are we better off doing something or doing nothing? Some operations accept a certain yield loss as a cost of doing business; others have policies that require driving all variance toward zero. To "do nothing" may, in some cases, be the chosen and acceptable strategy.If, however, we have chosen to actively "do something," rather than accept the current or potential problem, the second-pass approach to TCO might then be looking at which is the best of multiple alternative approaches to driving variance to zero. A good TCO Analysis, therefore, shows expected cash flow consequences of each choice over time and includes the rationale used for quantifying benefits and costs. The projected cash flows are analyzed with common financial metrics, such as Discounted Cash flow (NPV), Payback Period and Internal Rate of Return (IRR), or ROI.[1] It also identifies critical success factors and contingencies that must be managed to target-levels to achieve the projected results used to assess the investment in the first place.In talking about these expected cash flow consequences, we must remember also that there are balloon effects that can occur. For instance, the payback (time period) on a piece of equipment can be immediately followed by a sizable increase in profits, inconsistent with the amount achieved in the years leading up to that payback. That balloon effect is overlooked in the simple payback assessment tool, but should be picked up in the more thorough TCO analysis. The same would hold true for an immediate negative effect after payback. Although a quick way to assess an opportunity, the payback method does have this inherent limitation, which the TCO approach helps overcome by including the broader set of benefits and costs.Another important consideration is the Adoption Curve. As the market for a product gets saturated to approximately 50%, you can still quantify against competing manufacturers. As it reaches 75%, or commodity status, however, service and support become a more important issue in TCO. Having an engineer on your staff spending time trying to analyze a problem or result because response from the manufacturer's tech support group is less-than-stellar can add significantly to the true cost of ownership. Including Risks and Other AbstractsA good analysis should also identify and include risks--those factors that cannot be controlled or managed, but which can significantly change outcomes. Risk Management departments should be able to assist in generating specific numbers. Companies without an RM department to provide those figures must estimate what it would cost to recall, replace, repair or scrap affected product, as well as the abstract issues we will discuss, particularly in our automotive example. This task would typically be left to the Process Engineer or Operations Manager to conduct.One example of risk with which we in this industry are familiar is the type of latent field failure that does not show up in production testing/ inspection. Over the last several years, for example, we have seen how passive components (e.g., capacitors) have proven to be as thermally vulnerable as multi-layered and multi-functional active components. This became such a risk that IPC's J-STD-075 was created, suggesting that thermally vulnerable passive components be labeled for protection against "process abuse." The goal: That a single component costing pennies not fail and thus bring down a circuit board costing thousands of dollars. Is there a way to include that into cost analysis? Absolutely. The cost of the type of production equipment or software needs to be balanced by the saving of the estimated product waste, liability exposure, recall costs, lost opportunity, customer ill-will, etc.How can you figure such abstract concepts? Let's look at both Xbox and Toyota. Several months ago, the cost of the Xbox recall, according to several different news sources, stood at 1.5 billion dollars and was still climbing. But that number, huge though it may be, likely reflected only the basic elements of notification, recall and replacement. Does it actually take into account the customer dissatisfaction that will cause a percentage of them to refrain from buying that brand of equipment again? If it doesn't, shouldn't it?In the Toyota case, additional product liability also comes into play. We may have only seen the tip of the iceberg regarding lawsuits filed against the company by drivers or their families who experienced property loss, damage, or worse, fatalities. We will not even attempt to guess the number of zeroes in that field-failure tab.Another abstract cost--the loss of opportunity--must be factored on the risk side. Military, aerospace, medical, and other high-reliability industries will most likely consider past experience to be a predictor of future performance. Those industries need to be able to count on their EMS providers and other vendors to have production traceability and documentation on performance to spec. They must have high confidence that they are not putting their project at risk for possible recall, or worse. In such hi-rel environments, there is not typically an opportunity for a "do-over." Poor performance translates to lost opportunity downstream.As an example, in many equipment-selection processes, the U.S. government is currently looking for a 15-year span to elapse before the "first repair" is necessary. The medical industry is quickly catching up to that requirement, currently looking for at least seven to 10 years or more. In addition, the military is also requesting that all bids for contracts now include risk management plans. Empirical evidence showing degradation has substantiated that hyper-heated passive components on a PCB can reduce expected service life from 12 to 15 years down to 3 to 5 years. Even though solder joints are judged to be shiny, there is no guarantee by gauging the "look" of solder that one has treated passive components "nicely," meaning within spec limits. A person who believes they reduced operating expenses by not thermal profiling, for example, has likely overlooked the TCO of a PCB, such as a server board used in a major telecom system that experiences a field failure.From the benefit of hindsight, if either Microsoft or Toyota could have prevented the problems they now face by purchasing either additional equipment, tools, or software, would they? I'd venture to say the answer would be a resounding "yes." Will other companies performing TCO analyses tomorrow learn from those companies' experiences that risk mitigating equipment might well be worth the investment? We certainly hope so. Avoiding unreasonable risk up front is the best guarantee to protect your bottom line later on; and a TCO that includes risk as part of the equation is most helpful in making a quality decision. Using other organizations' hindsight as your foresight is often a cost-saving strategy in its own right.Actual TCO ExamplesA real and relatable example would be that of preventing costly voltage fluctuations in a critical deposition process, when not doing so has been shown to generate faulty product. Assuming that a fluctuation of 10% would be sufficient to result in scrap produced at a rate of $35,000 per half-hour, then a continuous voltage monitoring solution--even at an equipment purchase cost of, say, $20,000--would pay for itself in less than a half-hour of 10% variation from nominal. Obviously, the up-front investment cost for the continuous voltage monitoring device is far less than posited losses from a single incident. Thus, the prudent decision is to "do something" (provide monitoring).The payback may, however, be somewhat less dramatic and take longer than that simple example when figuring in the TCO, where we fine-tune our comparison of viable alternative approaches. Will the TCO of the $20K invested cost be higher or lower if we consider AC-driven sensors, rather than DC? AC-sensors obviate the ongoing cost of battery replacement and associated labor, over time, of the DC-driven sensing units; yet likely have a higher initial cost of installation. The TCO approach will allow for an accounting of the relative merits of the two approaches over time. What does seem readily apparent in such a case is that the "do something" outweighs the "do nothing" strategy. In summary, we used the TCO approach to both decide whether or not to do something, and then to decide which something is the best of multiple alternatives. Now, let's look at some production examples from real customers.Benefits for Reflow Soldering
How would you gain productivity in reflow soldering through TCO analysis and subsequent investment in equipment with early payback or good ROI? There are several ways. An example is the investment in either products for periodic profiling (of boards) or continuous monitoring (of ovens) that would increase process yield and profitability. The specific savings that would result from either application follow:
- Production time saved;
- Engineering involvement minimized;
- Scrap reduced; and
- Documentation of being in-spec with OEM/EMS requirements characterized in the initial profile:
- To quicken needed troubleshooting;
- To lessen exposure to liability.
All these elements are vital to maximizing productivity and profits.Example #1: Periodic Profiling TCOAgain, citing that with which we are most familiar, we can examine the benefits of the investment in and periodic use of a twelve-, eighteen- or twenty-channel profiler (versus the repeated use of a five- or six-channel profiler) to both characterize the initial thermal profile, and then verify that the process remains in spec. This example would apply to any manufacturer's profiler with the larger number of T/C's, assuming all have equal reliability and performance records.Let's say you have a PCB destined for a hi-rel user, and the customer indicates 18 points of interest they expect to be "verified" in the process (a very conservative example). You could either run a single board through three times to measure the 18 points, or you could run an 18+ channel profiler through once.In this example, since one cannot defy physics, you'll need two intermediate cool-down periods for the profiler/barrier and a subsequent clerical effort to merge the data or overlay the three profiles for proper analysis. With the larger-count profiler, your single pass eliminates the interim cooling periods and the data merging, saving both engineer time and two periods of interrupted production throughput....the two major components of productivity increase. Other recent technological enhancements allow for even greater productivity increases.The above example, however, focuses only on hard costs; risk and other more abstract factors are not included. True cost of ownership of a "proposed solution" might logically be even more favorable when those additional factors are added, further justifying the investment in a piece of equipment that would solve some of the problems and remove some of the roadblocks. Example #2: Continuous Monitoring TCOFor the second example, we move from investment in periodic profiling equipment for boards, to investing in continuous monitoring equipment for ovens. This approach almost assuredly has a higher upfront investment cost than the prior example. Under certain conditions, that cost can quickly become trivial in the face of even a modest field failure, product recall or consumer liability issue. As we have learned from users, repeated usage, environmental effects, component degradation/failure, etc., can knock even the finest ovens out of spec at some point. When there is not much changeover involved or when jobs require several days to complete, continuous oven monitoring (and associated bar-code capture) may prove to be the best TCO-driven solution. How would continuous monitoring improve productivity and add to the bottom line? Specifically you would see:
- No interruption of production to do set-up;
- Less engineering time required;
- Chance for visual/audible alarms and even line stoppage to be set up for out-of-spec conditions;
- Ability to read bar codes on boards and components, ensuring a fail-safe program to identify wrong boards, devices, etc. and allowing for immediate correction;
- Database retention of profile conditions during reflow of a specific PCB, identified by a serial number and stored for later troubleshooting and/or liability mitigation;
- Same type of customizable reports as in periodic profiling, providing documentation to OEM/EMS, which is particularly useful in high-rel industries, such as medical, aerospace and military, for providing input to risk mitigation plans and for providing less exposure to liability.
ConclusionsIn a nutshell, TCO analysis is, as the name implies, assessment of the complete cost of owning a piece of equipment or pursuing a solution to a problem. That analysis would typically include the basic building blocks: Introduction & Overview, Assumptions & Methods, Business Results, Sensitivity & Risk Analysis, and Conclusions & Recommendations [2]. Following those guidelines for fact, figure and assumption inclusion should produce a viable TCO analysis on which to base decisions and justify investments in tools, equipment, projects, etc. Once the more abstract costs have been included with the hard cost (purchase price and known operating expenses) you can set a course of action which involves pursuit of the true lowest TCO. Our forefathers were quite right when they warned us not to be "penny wise and pound foolish."References: 1. Cost Benefit Analysis, Solution Matrix Ltd. 2004 - 2010.2. The Business Case Guide, 3rd Edition, 2009, Solution Matrix Ltd.
Grant Peterson holds Bachelor of Science in Materials Engineering, and MBA degrees from UCLA and has served in various high-level Operations and Sales positions with the U.S. Navy, Tektronix, TriQuest, Interactive Northwest and BioReaction. Currently, he holds the position of Vice President of Marketing and Sales for ECD, a leading thermal profiling company in Milwaukie, Oregon. He may be reached at grant.peterson@ecd.com.