MASTER'S THESIS
Total Cost of Ownership in Global
Sourcing
A Case Study at Siemens Industrial Turbomachinery AB
Emma Andersson
Desirée Holmér
2013
Master of Science in Engineering Technology Industrial and Management Engineering
Luleå University of Technology
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Total!Cost!of!Ownership!in!!
Global!Sourcing
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"A!Case!Study!at!Siemens!Industrial!Turbomachinery!AB
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! ! ! ! ! ! ! !Emma!Andersson!&!Desirée!Holmér!
! ! ! ! !Civilingenjörsexamen//
Industriell/Ekonomi/
! ! ! ! ! ! Luleå/Tekniska/Universitet/ Institutionen/för/Ekonomi,/Teknik/och/Samhälle/// !Abstract!
!Today&Global&Sourcing&has&become&a¢ral&part&of&many&companies’&business&strategies.&Given& the& constant& pressure& to& reduce& costs,& many& companies& identify& Global& Sourcing& with& opportunities&to&capitalize&on&lower&cost.&For&this&reason&there&has&been&a&substantial&interest& among&European&companies&to&source&from&China,&previously&known&as&the&country&with&low& labour&costs&and&production&costs.&For&this&reason&Global&Sourcing&has&become&an&integrated& part&of&the&purchasing&strategy&of&many&companies.&Although&due&to&an&increased&awareness&of& the& consequences& of& allowing& the& purchasing& price& to& be& the& dominant& supplier& selection& criteria,&there&has&been&a&growing&concern&for&the&Total&Cost&of&Ownership&(TCO).&Also,&given& that& China& is& becoming& more& equalized& to& Eastern& Europe,& being& highly& comparable& to& the& standards&and&cost&structure&in&Europe,&there&is&an&obvious&tendency&of&companies&changing& their&direction&from&Chinese&to&Eastern&European&suppliers.&&&
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The& purpose& of& this& study& is& to& address& the& differences& in& sourcing& from& China& and& Eastern& Europe&by&adopting&the&concept&of&TCO.&This&comprises&the&mapping&of&the&value&chain&process& of& a& specific& product& and& the& identification& of& the& ingoing& activities& serving& as& significant& and& relevant&cost&drivers.&By&doing&so,&a&comparison&between&the&sourcing&differences&in&the&TCO& between&Eastern&Europe&and&China&will&be&possible.&This&is&by&developing&a&model&capturing&the& most& significant& and& relevant& cost& incurring& activities& within& the& value& chain& of& a& high& importance&component,&by&applying&a&deductive&and&qualitative&research&approach.&&& ! The&study&involves&three&different&cases,&all&aiming&to&contribute&to&the&research&problem&of&the& study.&The&first&case&concerns&the&development&of&a&TCO&model&of&a&high&important&component,& derived&from&interviews&with&employees&at&SIT&AB.&&The&second&and&the&third&case&concerns& supplier&insights&into&the&implications&of&Global&Sourcing&generated&by&interviews&from&two& important&suppliers&of&SIT&AB.&& !
The& study& shows& that& by& applying& a& TCO& perspective& to& the& supplier& evaluation& process,& a& supplier& selection& based& on& a& holistic& valuation& of& the& differences& in& Global& Sourcing& will& be& possible.& Apparently,& the& tendency& of& allowing& the& purchasing& price& to& serve& as& the& major& selection& criteria& is& a& mistake& since& it& only& reflects& a& fragment& of& the& TCO.& Hence,& a& TCO& approach&reveals&that&the&cost&for&transportation,&inspection&of&suppliers,&lacking&information& transferring& routines,& and& cultural& and& communication& barriers& serves& as& major& cost& drivers& contributing& to& the& total& cost& when& purchasing& an& air& intake,& which& is& considered& a& high& importance&component.&Thus&the&supplier&being&favourable&in&terms&of&lowest&price&may¬&be& the&best&alternative&considering&the&TCO.&&&(
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Sammanfattning(
&Global& Sourcing& har& blivit& en& central& del& i& många& företags& affärsstrategier.& Den& konstanta& kostnadspressen&har&gjort&att&många&företag&inför&Global&Sourcing&i&större&utsträckning&för&att& reducera&kostnader.&Detta&har&medfört&att&Europeiska&företag&fått&ett&ökat&intresse&för&att&göra& inköp&från&Kina,&som&tidigare&varit&ett&land&känt&för&låga&löneP&och&produktionskostnader.&Därför& har& Global& Sourcing& blivit& en& integrerad& del& av& företags& inköpsstrategier.& I& samband& med& att& användandet& av& inköpspris& som& den& avgörande& faktorn& vid& leverantörsutvärdering& har& ifrågasatts& så& har& TCO& fått& ett& ökat& fokus.& Dessutom& så& har& Kina& blivit& mer& jämförbart& med& Europa& gällande& standarder& och& kostnadsstrukturer,& vilket& resulterat& i& en& ökad& trend& bland& företag&att&göra&inköp&från&Östeuropa&istället&för&Kina.&
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Syftet&med&studien&är&att&belysa&skillnaderna&mellan&inköp&från&Kina&och&Östeuropa&utifrån&ett& totalkostnadsperspektiv.& Detta& innefattar& kartläggandet& av& en& specifik& produkts& värdekedja& samt&identifieringen&av&de&ingående&aktiviteterna&och&relevanta&kostnadsdrivarna.&Därigenom& är& det& möjligt& att& göra& jämförelser& av& inköp& ur& ett& totalkostnadsperspektiv& mellan& Östeuropa& och&Kina.&Jämförelsen&kommer&att&möjliggöras&genom&att&utveckla&en&modell&som&identifierar& de& mest& signifikanta& och& relevanta& aktiviteter& som& skapar& kostnader& i& en& strategiskt& viktig& produkts&värdekedja,&genom&att&använda&en&deduktiv&och&kvalitativ&forskningsansats.&
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Studien& innefattar& tre& case& som& alla& bidrar& till& studiens& forskningsproblem.& Det& första& caset& innefattar& utvecklingen& av& en& totalkostnadsmodell& för& en& strategiskt& viktig& produkt& utifrån& intervjuer&med&anställda&på&SIT&AB.&Det&andra&och&tredje&caset&omfattar&inköpsinsikter&av&Global& Sourcing&genererade&genom&intervjuer&med&två&av&SIT&ABs&leverantörer.&
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Genom& att& utgå& ifrån& ett& totalkostandsperspektiv& under& leverantörsutvärderingsprocessen& är& det&möjligt&att&välja&en&leverantör&baserat&på&en&holistisk&värdering&av&skillnaderna&mellan&olika& länder.& Uppenbarligen& så& är& trenden& att& låta& inköpspriset& vara& det& avgörande& kriteriet& ett& misstag&eftersom&inköpspriset&bara&speglar&en&del&av&den&totala&kostnaden.&I&studien&har&det& visat& sig& att& den& verkliga& kostnaden& innefattar& förutom& inköpspriset& kostnader& såsom& transportkostnader,& inspektionskostnader,& bristfälliga& informationsöverföringsrutiner& och& kulturella& och& kommunikationsbarriärer& som& alla& driver& den& totala& kostanden.& Således,& den& leverantören&som&erbjuder&det&lägsta&inköpspriset&är&inte&alltid&det&bästa&alternativet&utifrån&ett& totalkostnadsperspektiv.&
Table(of(Contents
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1.0(Introduction(...(1(
1.1&Global&Sourcing!...!1! 1.2&Supplier&Selection!...!2! 1.3&Research&Incentive!...!4! 1.4&Preliminary&Study!...!4! 1.5&Problem&Discussion!...!7! 1.6&Research&Problem!...!8!2.0(Literature(Overview(...(9(
2.1&The&Supplier&Selection&Process!...!9! 2.1.1$Problem$Definition$...$9$ 2.1.2$Formulation$of$Criteria$...$10$ 2.1.3$Qualification$...$13$ 2.1.4$Final$Selection$...$13$ 2.2&Total&Cost&of&Ownership!...!14! 2.2.1$Introduction$to$the$Concept$of$TCO$...$14$ 2.2.2$Application$Areas$...$16$ 2.2.3$Approaches$to$TCO$...$17$ 2.2.4$Cost$Categorization$Approaches$...$20$ 2.2.5$Advantages$of$TCO$...$23$ 2.2.6$Implementation$Barriers$...$23$ 2.3!The!Value!Chain!Process!...!24! 2.4!Discussion!of!the!Literature!Overview!...!26! 2.5!Research!Questions!...!26!3.0(Frame(of(Reference(...(28(
3.1!Identification!of!the!Supply!Chain!Process!and!its!Activities!...!28! 3.2!Identification!of!Cost!Drivers!...!29! 3.3!Cost!Categorization!...!31! 3.4!Design!of!TCO!Model!...!31! 3.5!Summary!of!the!Frame!of!Reference!...!31!4.0(Research(Method(...(33(
4.1&Research&Purpose!...!33!4.2&Research&Approach!...!34! 4.3&Research&Strategy!...!34! 4.4&Sample&Selection!...!36! 4.5!Research!Techniques!and!Analysis!Procedures!...!37! 4.5.1$Data$Collection$Methods$...$37$ 4.5.2$Analysis$Procedures$...$40$ 4.6!Research!Credibility!...!41! 4.6.1$Reliability...$41$ 4.6.2$Validity$...$41$ 4.6.3$Research$Method$Problems$...$41$ 4.7!Research!Procedure!...!42!
5.0(Case(I:(SIT(AB(Air(Intake(...(44(
5.1&Development&of&the&Value&Chain&Process!...!44! 5.1.1$Summary$of$Interview$Responses$...$44$ 5.1.2$Analysis$of$the$Value$Chain$Process$...$51$ 5.1.3$Discussion$of$the$Value$Chain$Process$at$SIT$AB$...$54$ 5.2&Cost&and&Cost&Driver&Identification!...!55! 5.2.1$Summary$of$Interview$Responses$...$55$ 5.2.2$Analysis$of$Costs$and$Cost$Drivers$...$65$ 5.2.3$Discussion$of$Costs$and$Cost$Drivers$...$69$ 5.3&Discussion&of&Qualitative&Implications!...!72! 5.3.1$Strategic$Procurement$...$72$ 5.3.2$Strategic$Project$Procurement$...$72$ 5.3.3$Supplier$Quality$Management$...$73$ 5.3.4$Project$Management$...$73$ 5.3.5$Commodity$Management$...$73$ 5.3.6$Auxiliary$System$Engineering$...$73$ 5.3.7$Operations$Quality$...$74$ 5.3.8$Logistics$&$Packing$...$74$6.0(Case(II:(Donaldson(...(75(
6.1&Cooperation&implications:&Donaldson&–&SIT&AB!...!75! 6.2&Sourcing&Implications&–&Eastern&Europe&vs.&China!...!75! 6.3&Summary&of&Supplier&Insights!...!78!6.4&WithinPcase&Analysis!...!79!
7.0(Case(III:(Camfil(Farr(...(80(
7.1&Cooperation&Implications:&Camfil&Farr&–&SIT&AB!...!80! 7.2&Sourcing&Implications&P&Eastern&Europe&vs.&China&&&Mexico!...!81! 7.3&Summary&of&Supplier&Insights!...!83! 7.4!WithinScase!Analysis!...!84!8.0(CrossNcase(Analysis(of(Case(II(&(Case(III(...(86(
8.1&CrossPcase&Analysis&of&Donaldson&&&Camfil&Farr&–&China!...!86! 8.2&Donaldson&vs.&Camfil&Farr&–&Eastern&Europe!...!88! 8.3&Summary&of&the&CrossPcase&Analysis:&China&vs.&Eastern&Europe!...!89!9.0(Findings(...(91(
10.0(Conclusions(...(97(
11.0(Comparison(of(Major(Quantifiable(Cost(Drivers(...(101(
11.1&Purchasing&Price!...!101! 11.2&Transportation!...!101! 11.3!Inspections!of!Supplier!...!102! 11.4!Total!Cost!...!103!12.0(Implications(for(Management(...(104(
13.0(Implications(for(Theory(&(Further(Research(...(105(
13.1&Implications&for&Theory!...!105! 13.2&Proposals&for&Further&Research!...!105!References(...(107(
Appendix(I(N(Company(Presentation(...(111(
Appendix(II(–(Interview(Guide(at(SIT(AB(...(116(
& ! !Tables(&(Figures(
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Table(2.1:!Summary!of!Criteria!for!Supplier!Selection! 12! Table(2.2:!Summary!of!TCO!Cost!Drivers!! 23! Table(2.3:!Primary!Activities!within!the!Value!Chain! 25! Table(2.4:!Supporting!Activities!within!the!Value!Chain! 25! Table(3.1:&Primary!Activities!within!the!Value!Chain!! 29! Table(3.2:!Supporting!Activities!within!the!Value!Chain!! 29! Table(3.3:!TCO!Cost!Drivers! 30! Table(3.4:!Cost!of!Quality! 30! Table(4.1:!Relevant!Situations!for!Different!Research!Strategies!! 35! Table(4.2:!Summary!of!Research!Strategies! 36! Table(4.3:!Interview!Respondents!at!SIT!AB! 39! Table(5.1:!Summary!of!Cost!Drivers!at!SIT!AB! 63! Table(5.2:!Primary!Activities!within!the!Value!Chain!at!SIT!AB!&!its!Cost!Drivers! 68! Table(5.3:!Supporting!Activities!within!the!Value!Chain!at!SIT!AB!&!its!Cost!Drivers! 69! Table(6.1:!WithinScase!Analysis!of!Supplier!Insights! 80! Table(7.1:!WithinScase!Analysis!of!Supplier!Insights! 85! Table(8.1:!CrossScase!Analysis!of!Sourcing!Implications!in!China! 87! Table(8.2!CrossScase!Analysis!of!Sourcing!Implications!in!Eastern!Europe! 89! Table(9.1:!Emerged!TCO!Model!for!the!purchase!of!an!air!intake!at!SIT!AB!! 96! Table(11.1:!The!purchasing!price!offered!by!Camfil!Farr!&!Donaldson! 102! Table(11.2:!Total!Cost!for!Transportation!of!an!Air!Intake!to!Port!Norrköping! 103! Table(11.3:!Total!Cost!for!Inspection!of!Suppliers! 103! Table(11.4:!The!Total!Cost!for!Inspection,!Transportation!and!Purchasing!Price! 104! ! Figure(3.1:!Cost!Drivers!Integrated!in!the!Value!Chain!Process! 32! Figure(4.1:!Research!Procedure!! 43! Figure(4.2:!Components!of!the!Research!Design! 43! Figure(5.1:!The!Value!Chain!Process!at!SIT!AB!! 53! ! ! ! ! ! ! ! ! !1.0(Introduction(
In#the#initial#chapter,#the#area#of#concern#in#the#study#will#be#introduced.#Commencing#with#the# concept#of#Global#Sourcing#and#its#shifting#characteristics#followed#by#a#discussion#regarding#the# emerged#focus#on#the#Total#Cost#of#Ownership#(hereby#denoted#TCO)#in#the#supplier#selection# process.#Further,#the#research#incentive#of#the#study#will#be#presented#followed#by#a#preliminary# study.#The#chapter#will#conclude#with#a#problem#discussion#regarding#the#presented#areas.##1.1(Global(Sourcing(
The&business&environment&is&an&everPchanging&phenomenon,&forcing&companies&to&continuously& explore&new&ways&to&compete&(Trent&&&Monczka,&2005).&The&global&competition&multinational& companies& are& being& exposed& to& have& emerged& the& concept& of& Global& Sourcing& (ibid.).& Consequently,&today&Global&Sourcing&has&become&a¢ral&part&of&many&companies’&business& strategies.&Also,&the&constant&pressure&of&reducing&costs&has&resulted&in&a&shift&of&sourcing&from& local&suppliers&to&lowPcost&country&suppliers,&hereby&referred&as&LCCS&(Hultman&et&al.,&2012).&For& this&reason,&Global&Sourcing&has&turned&into&an&inevitable&challenge&for&purchasing&and&supply& chain&managers&in&order&to&keep&up&with&the&growing&competition&cross&boarders&(ibid).& & As&stated&earlier,&the&emerging&competition&between&global&companies&caused&by&the&increased& presence& in& foreign& markets& is& one& of& the& main& strategic& drivers& of& Global& Sourcing& (Trent& && Monczka,&2005).&Moreover,&given&the&reduced&transportation&costs&over&the&past&few&years&in& combination&with&the&increased&access&to&world&markets,&an&interest&among&companies&have& risen&to&explore&the&opportunities&to&source&materials&and&components&globally&(Holweg&et&al.,& 2011).&Other&incentives&for&Global&Sourcing&has&been&identified&as&the&possibility&to&capitalize&on& the&lower&cost&of&wages,&machinery,&production,&and&overhead&costs&(Trent&&&Monczka,&2005;& Nassimbeni,&2007;&Juan&et&al.,&2010&).&Also,&Global&Sourcing&allows&companies&to&take&advantage& of& new& technology,& access& particular& resources,& improve& quality& and& the& benefits& of& being& present&in&a&foreign&market&(ibid).&Thus,&Global&Sourcing&can&be&seen&as&a&possibility&to&contract& suppliers&who&best&fulfill&the&requirements&of&the&sourcing&company&(Akamp&&&Müller,&2012).& Moreover,&in&a&study&conducted&by&Monczka&and&Trent&(2005)&it&was&found&that&73&%&of&173& companies&surveyed&argued&that&the&TCO&declined&after&introducing&Global&Sourcing.&&&&&&&
However,& Global& Sourcing& is& not& a& new& phenomenon& but& has& been& a& target& for& academic& research&since&the&1980s&(Holweg&et&al.,&2011).&The&modernized&definition&refer&Global&Sourcing& to&the&ultimate&stage&in&a&company´s&attempt&to&cooperate&with&international&suppliers,&as&an& integrated&part&of&the&purchasing&strategy&(ibid).&This&is&as&the&purchasing&process&has&become&a&
fundamental& element& in& the& formulation& of& a& company´s& business& strategy& as& it& equals& the& competitive&position&in&the&market&place&(Chen&&&Yang,&2010;&Weber&et&al.,&2010).&Given&that& purchasing& activities& account& for& approximately& 60P70%& of& a& manufacturing& firm´s& total& expenditures,&the&incentives&of&using&Global&Sourcing&to&reduce&costs&have&been&enhanced&(ibid).& This&is&by&exploiting&the&in&general&lower&factor&costs&associated&with&lowPcost&county&sourcing& (Weber& et& al.,& 2010;& Karjalainen& && Salmi& 2013).& For& this& reason& Global& Sourcing& has& been& integrated& in& the& purchasing& strategy& by& serving& as& a& competitive& advantage,& making& use& of& cheaper&material&and&labor&costs&as&well&as&arbitrage&opportunities&(ibid.).&
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For&several&years&China&has&been&attracting&many&western&companies&due&to&its&favorable&cost& situation& (Salmi,& 2006)& and& has& been& considered& as& the& country& with& the& lowest& production& costs& in& the& world.& Although,& along& with& rising& labor& costs,& increasing& transportation& costs,& environmental&issues,&and&new®ulations,&this&is&about&to&change.&Companies&have&therefore& started& questioning& whether& China& is& the& best& sourcing& alternative& in& terms& of& providing& the& lowest&total&cost&and&are&consequently&increasing&their&sourcing&from&suppliers&located&closer&to& their& home& market& (Juan& et& al.,& 2010;& Karjalainen& && Salmi,& 2013).& Today& China& experiences& a& transformation& into& a& country& that& in& many& aspects& is& highly& comparable& to& the& standards& of& manufacturing& firms& in& Europe.& The& development& of& new& infrastructure& and& manufacturing& facilities&is&just&one&part&of&China's&initiative&to&be&associated&with&innovation&rather&than&lowP cost& production& solutions& (Fang& et& al.,& 2010).& Further,& several& studies& reveal& that& suppliers& within&nearby&markets&are&equally&important&to&consider&as&those&in&foreign&markets&(ibid.).& &
Apparently,&there&has&been&a&landscape&shift&in&terms&of&country&to&source&from&as&the&interest& of& adopting& near& sourcing& strategies& is& growing& (Juan& et& al.,& 2010).& Also& in& accordance& to& research& conducted& by& The& Boston& Consulting& Group& (HuttenPCzapski& et& al.,& 2006)& during& the& past&few&years&there&is&an&emerging&interest&among&companies&in&Western&Europe&to&explore& the& opportunities& in& sourcing& from& regions& closer& to& their& serving& markets.& This& is& especially& when&emerging&countries&in&Eastern&Europe&appear&to&be&highly&competitive&to&China&(Juan&et& al.,&2010).&&
1.2(Supplier(Selection(
Given& the& fastPpaced& globalization,& companies& sourcing& products& abroad& are& facing& new& challenging&implications.&This&is&due&to&the&dynamic&nature&of&the&global&business&environment& and&the&emerging&number&of&available&suppliers&in&the&market&(Juan&et&al.,&2010;&Cheraghi&et&al.,& 2004).&As&the&number&of&available&suppliers&increase,&the&number&of&critical&success&criteria&in& the&selection&process&to&consider&has&become&even&more&comprehensive&(ibid.).&To&succeed&in& the& evaluation& and& selection& of& suppliers& the& organization& needs& to& possess& the& ability& to&
conform&to&the&ever&changing&business&climate&and&to&adopt&a&more&holistic&approach&to&the& sourcing&incentives.&Thus,&the&globalization&and&intensified&competition&has&resulted&in&a&change& in&how&the&critical&factors&are&being&ranked&along&with&the&introduction&of&additional&criteria&to& the& selection& process.& For& many& years,& price& has& served& as& the& determinant& factor& in& the& selection& process& (Juan& et& al.,& 2010;& Weber& et& al.,& 2010;& Chen& && Yang,& 2002).& Although,& by& adopting&a&holistic&approach&towards&supplier&evaluations,&companies&will&realize&that&price&is& only&a&small&fragment&of&the&total&cost&of&a&purchase&(Chen&&&Yang,&2002).&Further,&it&will&also& make&companies&aware&of&that&selecting&a&supplier&based&on&the&lowest&purchasing&price&may& be&the&most&costly&alternative&in&the&long&run&(ibid).&This&is&due&to&the&excessive&costs&caused&by& supplier&failure&such&as&late&deliveries&and&recalls&of&quality&problems&resulting&in&high&warranty& costs&(Holweg&et&al.,&2011;&Chen&&&Yang,&2002).This&stresses&the&need&for&a&total&cost&oriented& evaluation&technique&considering&all&the&hidden&costs&incurred&by&the&sourcing&decision&(Salmi,& 2006;&Weber&et&al,&2010).&However,&this&has&resulted&in&firms&moving&their&focus&from&Low&Cost& Country&Sourcing&to&Best&Cost&Country&Sourcing&(BCCS)&(Juan&et&al,&2010;&Hultman&et&al.,&2010).& This& phenomenon& is& also& emphasized& by& Hultman& et& al.,& (2010)& arguing& that& the& ongoing& financial&crisis&gives&no&indication&of&this&trend&soon&coming&to&an&end.&&
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Evidently,& in& Global& Sourcing,& additional& factors& have& to& be& considered& to& reduce& the& risk& of& unexpected&costs&by&thoroughly&analyzing&all&the&costs&associated&with&the&purchase&(Monczka& et&al.,&2005).&The&use&of&a&TCO&model&enables&the&organization&to&quantify&and&summarize&the& total&cost&of&a&purchase&related&to&a&suppler&selection&(Boer,&2001).&According&to&Degraeve&et&al.,& 2000,& a& common& matter& within& many& companies& when& evaluating& suppliers& based& on& factors& other& than& price,& is& that& the& decision& is& influenced& by& the& decision& maker.& Consequently,& resulting&in&a&decision&based&on&subjective&criteria.&Traditionally,&companies&evaluate&suppliers& to&contract,&using&techniques&such&as&a&categorical&system,&a&weighted&point&system&or&a&cost& based&system&(Chen&&&Yang,&2002).&However,&the&advantage&of&using&TCO&is&that&the&technique& allows& no& subjectivity.& Thus,& in& contrast& to& other& evaluation& systems& it& forms& an& objective& framework&for&sourcing&decisions&(Degraeve&et&al.,&2000).&This&also&contributes&to&the&creation& of&a&solid&foundation&for&negotiations&with&potential&foreign&suppliers&(ibid.).&Thus,&the&use&of& totalPcost& based& evaluation& procedures& is& convenient& when& there& is& a& need& to& recognize& the& suppliers’&capability&to&positively&contribute&to&the&organization’s&profitability,&by&providing&the& lowest& total& cost& of& the& purchase& (Chen& && Yang,& 2002).& The& concept& has& been& given& a& lot& of& positive& attention& in& the& literature,& emphasizing& its& effectiveness& and& ability& to& provide& an& objective&vendor&evaluation&(ibid.).&However,&there&is&no&general&model&suitable&to&every&single& organization&since&the&evaluation&criteria&have&to&be&adjusted&to&the&specific&organization&and& purchase&(Ellram,&1994).&In&practice&however,&resistance&towards&the&use&of&TCO&models&exist& due&to&its&complexity&and&the&difficulty&in&quantifying&costPincurring&activities&(Wouters&et&al.,& 2005).&&&&&
1.3(Research(Incentive(
The& initiator& of& this& study& is& Siemens& Industrial& Turbomachinery& (SIT)& AB& located& in& Finspång,& Sweden.&The&company&manufactures&steam&and&gas&turbines&consisting&of&a&large&number&of& different& components,& of& which& the& majority& is& acquired& by& Global& Sourcing.& Today& SIT& AB& source&products&from&all&over&the&world,&resulting&in&a&need&for&a&deep&understanding&for&the& cost& drivers& associated& with& the& purchasing& process& and& how& they& differ& in& sourcing& from& different&countries.&However,&there&is&a&special&interest&within&the&purchasing&department&at&SIT& AB& to& investigate& the& differences& in& sourcing& from& low& cost& countries& such& as& China& and& countries&in&Eastern&Europe&with®ards&to&the&total&costs&of&ownership&as&the&intentions&with& Global&Sourcing,&clearly&is&experiencing&a&shift.&&
&
To&gain&a&prePunderstanding&for&the&use&of&TCO&analysis&at&SIT&AB&today,&a&preliminary&study&was& conducted.& Also,& the& study& aimed& to& explore& the& major& factors& considered& in& the& supplier& evaluation&process&at&SIT&AB.&The&results&of&the&study&are&presented&in&the&following§ion.&&&
1.4(Preliminary(Study(
During&a&workshop&at&SIT&AB&in&Finspång&a&preliminary&study&was&carried&out&by&conducting&semi& structured& interviews& with& four& employees& at& Siemens& AG,& working& with& procurement& and& supply& chain& management& at& locations& in& Russia,& Poland& and& Czech& Republic.& The& responses& from&the&interviews&cannot&provide&a&general&picture&of&the&purchasing&situation&at&Siemens&AG& and&the&use&of&TCO,&although&it&can&be&used&to&get&an&indication.& && The&preliminary&study&will&focus&on&the&following&questions:& ● How#does#Siemens#work#with#TCO#in#the#purchasing#process#today?& ● Is#it#common#to#estimate#the#total#cost#of#purchases?& ● Are#the#total#costs#of#the#entire#procurement#process#studied?& ● What#factors#are#considered#when#evaluating#suppliers?& ● Can#both#quantitative#and#qualitative#costs#be#identified?& ● Are#factors/costs#measured?#Which#are#easier/more#difficult#to#measure?& ● Is#it#possible#to#identify#hidden#costs?& ● Are#the#costs#transparent?& ● What#is#the#intention#of#using#TCO?& #&
The& interviewees& revealed& that& TCO& is& used& very& differently& within& Siemens& AG.& On& the& one& hand,&one&of&the&employees&working&in&Brno,&Czech&Republic&considers&that&they&are&adopting&a& TCO& approach.& During& the& two& past& months& they& have& been& using& an& excel& sheet& model& for& documenting& the& total& costs& of& purchases.& Based& on& the& results& of& the& model,& purchasing&
decisions&are&made.&&On&the&other&hand,&another&purchaser,&working&at&a&smaller&site&in&Poland& argued&that&TCO&is&only&used&from&time&to&time.&He&explained&that&when&evaluating&suppliers&he& selects&between&3P5&suppliers,&where&the&cheapest&and&the&most&expensive&suppliers&are&always& excluded,& as& a& general& rule.& Also,& one& of& the& interviewees,& currently& working& on& a& new& production& plant& in& Russia,& stated& that& the& focus& is& addressed& to& get& the& plant& in& operation& rather& than& considering& TCO& aspects.& The& last& interviewee,& also& working& in& Russia,& but& on& a& different& location,& believes& it& would& make& sense& to& use& TCO.& Although& due& to& the& small& purchasing&volumes&he&does¬&see&any&benefits&with&using&TCO&at&the&site&in&Russia.&
&&
According&to&the&interviewees,&to&make&a&correct&purchase,&the&total&cost&needs&to&be&calculated.& However,&when&purchasing&volumes&are&too&small,&they&don’t&see&any&need&for&using&TCO.&Also,& one& interviewee& mentioned& that& TCO& can& only& be& roughly& estimated& since& some& costs& are& difficult& to& calculate& prior& to& the& purchase,& such& as& transportation& costs.& Further& the& interviewees&agreed&that&it&is&hard&to&calculate&the&total&cost&of&a&products&life&cycle&but&that&is& something&that&needs&to&be&improved.&
&&
Regarding& the& selection& of&relevant& factors& to& consider& when& evaluating& suppliers,& the& choice& depends&on&the&situation.&Today,&different&Siemens&locations&measure&and&rank&the&factors&in& different&ways,&which&is&something&that&needs&improvement.&Firstly,&most&of&the&interviewees& agreed& on& that& the& supplier& must& be& able& to& fulfill& the& technical& requirements& requested& by& Siemens&AG.&That&is,&is&the&supplier’s&capability&of&manufacturing&according&to&the&specifications& of& Siemens& AG.& Further,& the& interviewees& mentioned& several& different& factors,& such& as& price,& transportation&costs,&and&costs&for&the&qualification&procedure,&risks,&capacity,&tests,&quality,&the& supplier’s&financial&situation,&and&delivery&time.&One&interviewee&described&that&when&selecting& suppliers&it&is&important&to&make&choices&based&on&the&same&criteria.&In&this&way,&“apples&are& compared&to&apples”,&which&results&in&price&and&delivery&time&being&the&most&important&factors.& &&
The& interviewees& also& mentioned& the& importance& of& other& department’s& opinions,& regarding& production,&quality,&and&safety&for&instance.&Further,&the&factor&quality&is&of&high&importance&in& the&oil&and&gas&industry,&which&is&an&important&customer&segment&for&SIT&AB,&since&a&mistake& could& lead& to& serious& consequences.& Hence,& Siemens& AG& does& not& accept& insufficient& quality.& The&time&aspect&is&important&due&to&the&steam&turbines&long&lead×.&The&costs&caused&by&the& qualification&needs&to&be&considered&since&they&are&often&underestimated.&Also,&when&qualifying& suppliers&in&for&example&China&and&India,&the&travelling&costs&are&very&high.&
&&
Further,& quantitative& factors& are& easiest& to& identify.& Qualitative& factors& or& “soft”& factors& are& seldom& identified.& One& interviewee& said& that& qualitative& factors& are& considered& when& for&
example&two&suppliers&have&almost&the&same&quality&and&price,&resulting&in&the&most&flexible& supplier&being&chosen.&
#&
Generally& regarding& hidden& costs,& the& interviewees& do& not& find& it& hard& to& identify& them.& Although,& one& interviewee& mentioned& that& nonconformance& costs& are& hard& to& identify,& since& they&cannot&be&estimated&prior&to&the&purchase.&One&interviewee&gave&the&example&of&a&hidden& cost&as&the&costs&caused&by&translating&documents&from&a&Russian&supplier.&The&interviewee&also& mentioned& that& hidden& costs& only& appear& with& suppliers& that& are& nonPtransparent.& Also,& the& interviewees&agreed&that&the&costs&are&transparent&since&all&costs&are&documented.&Some&of&the& interviewees&also&mentioned&that&they&often&spend&many&hours&at&the&supplier’s&sites&in&order& to&make&sure&that&the&supplier&manufactures&what&Siemens&AG&want.&This&is&very&costly,&and&it&is& something&that&is¬&often&considered&in&the&total&cost&of&a&purchase.&Also,&some&factors&are& harder&to&measure&than&others.&& #& The&interviewees&agreed&that&TCO&is&suitable&when&changing&a&supplier.&Using&TCO&for¤t& suppliers&is¬&needed&since&Siemens&AG&know&their&supplier&base&and&what&cost&structure&they& have.&Also,&since&the&interviewees&mostly&source&from&LCC&today,&they&claimed&that&they&are¬& in& the& same& need& of& using& TCO& as& for& example& the& site& in& Finspång& is.& Although,& they& must& always&search&for&new&alternatives,&since&for&example&Czech&Republic&might¬&be&a&LCC&in&the& close& future.& So& in& the& future,& when& searching& for& suppliers& in& for& example& Romania,& TCO& is& more&suitable&since&more&factors&needs&to&be&taken&into&consideration.&
&&
To& conclude,& the& interviewees& are& well& aware& of& the& amount& of& information& available& concerning& TCO,& although& the& method& is& not& used& in& the& daily& work.& It& seems& like& the& interviewees& would& like& to& use& TCO& to& a& greater& extent& but& they& need& more& education& and& implementation&work&in&order&to&do&so.&This&supports&the&fact&that&TCO&is&a&philosophy&and&that& it& is& very& theoretical.& Another& issue& is& that& is& seems& as& if& different& organizations& use& the& TCO& concept&very&differently.&Finally,&in&order&to&implement&and&work&with&TCO&there&must&be&some& kind&of&awareness.&Employees&must&be&aware&of&the&benefits&of&using&TCO&and&the&costs&caused& by&a&purchase.& & SIT&AB&is&classified&as&a&company&operating&in&the&assembly&industry&with&a&great&interest&for& high&importance&products.&Given&this,&the&content&of&the&introduction&and&the&results&from&the& preliminary&study,&a&problem&discussion&is&presented&in&the&following§ion.&& & &
1.5(Problem(Discussion(
As&outlined&in&the&introduction,&allowing&the&purchasing&price&to&solely&serve&as&the&foundation& for& supplier& selection& is& not& enough& as& it& indicates& a& lack& of& understanding& for& the& costs& associated& with& the& purchasing& process.& Within& the& academic& literature& there& is& a& mutual& agreement& regarding& the& importance& of& a& multiple& criterion& evaluation& to& award& foreign& suppliers&and&to&determine&the&most&favorable&country&to&source&from&(Maltz&et.al,&2011).&This& is&to&ensure&a&long&term&success&with&suppliers&even&in&occasions&of&downturns&in&the&market& (ibid).&& && Surprisingly,&in&spite&of&the&growing&concern&for&a&holistic&approach&towards&supplier&selection& in&a&global&context,&the&models&and&frameworks&available&for&such&decisions&are&rather&limited& (Holweg& et.& al.,& 2011).& As& sourcing& decisions& is& a& common& occurrence& faced& by& purchasing& managers&every&day&this&is&an&inevitable&problem&comprised&by&various&concerns&impacting&on& the&total&cost&of&Global&Sourcing&and&consequently&the&supplier&selection&(ibid.).&
&&
As& mentioned& earlier,& Eastern& Europe& has& become& a& new& target& market& for& many& European& companies&to&source&from,&while&the&interest&for&China&has&started&to&fade.&One&of&the&major& reasons&to&this&is&that&the&geographical&distance&is¬&as&critical&as&before.&This&is&due&to&the& developed& logistics& and& transportation& systems& in& combination& with& the& use& of& effective& electronic&communication&(Stalk,&2006&referred&in&Salmi,&2006).&Instead,&the&physical&distance& induces&greater&challenges,&which&in&many&cases&can&be&even&harder&to&handle&(Nassimbeni&&& Sartor,& 2007;& Salmi& 2006).& To& manage& sourcing& from& Chinese& suppliers,& several& issues& in& addition&to&logistics&and&technological&systems&must&be&considered,&such&as&language,&cultural& differences& and& the& overall& business& praxis,& including& the& ability& to& ensure& quality& at& source& (ibid.).& Thus,& disregarded& cultural& aspects& can& easily& lead& to& misunderstandings& and& result& in& additional&costs&(Meyer,&2007).&Also,&the&fact&that&the&shipment&costs&from&Shanghai&to&the&US& have& tripled& from& year& 2000& to& 2008,& due& to& rising& oil& prices& in& the& world& market,& has& led& to& companies& heading& to& Eastern& Europe& (Gosier& et& al.,& 2008& referred& in& Fang& et& al.,& 2010).& Moreover,&in&many&cases&sourcing&from&low&cost&countries&implicates&the&need&for&tradePoffs&in& terms& of& quality& for& instance.& This& in& turn& may& have& a& negative& impact& on& holding& and& operational&costs&as&well&as&production&capabilities&(Karjalainen&&&Salmi,&2013).&Hence,&Global& Sourcing& is& not& without& risks& and& uncertainties& such& as& exchange& rate& fluctuations,& increased& lead& times,& intellectual& property& theft,& worker& safety& issues,& and& cultural& and& communication& barriers&(Karjalainen&&&Salmi,&2013;&Hemerling&&&Lee,2007.).&A&survey&conducted&by&Accenture& (2004)& revealed& that& to& be& successful& in& LCC’s& companies& constantly& have& to& compromise& between&the&purchasing&price,&logistics&and&risks&(Timmermans,&2005).&&
According& to& a& study& conducted& by& The& Boston& Consulting& Group& (2006),& it& is& clear& that& the& growing& attention& for& Eastern& Europe& originates& from& the& fact& that& the& total& landed& cost& for& products& sourced& in& China& is& rather& similar& to& those& manufactured& in& Eastern& Europe.& This& in& addition& to& the& closer& geographical& distance& to& companies& in& Western& Europe,& along& with& similarities&in&culture&and&customs&make&Eastern&Europe&even&more&attractive&(Meyer,&2007).&&& Given& the& growing& interest& among& Western& companies& to& source& components& and& materials& from&Eastern&Europe,&it&is&highly&attractive&to&study&the&differences&in&sourcing&from&China&with& Eastern& Europe,& by& using& a& TCO& approach.& For& many& companies& assessing& the& total& cost& of& a& procurement&process&present&a&great&challenge,&due&to&the&difficulty&of&identifying&relevant&cost& data&(Weber&et&al.,&2010).&This&is&reinforced&by&the&fact&that&many&companies&still&use&traditional& accounting&systems,&where&it&is&hard&to&identify&the&costs&caused&by&a&specific&sourcing&activity& (ibid.).&Although,&by&adopting&a&total&cost&approach,&costs&can&be&defined&at&various&stages&in& the&purchasing&process&(Weber&et&al.,&2010;&Wouters&et&al.,&2005)&resulting&in&a&sound&model&for& supplier&evaluation.&& &
Given& the& results& from& the& preliminary& study,& it& is& clear& that& SIT& AB& lack& a& general& model& for& calculating& the& TCO& in& supplier& selection.& Also,& the& extent& to& which& a& total& cost& approach& is& accepted&and&practiced&varies&within&the&organization.&The&resistance&towards&the&use&of&the& concepts&as&stated&in&the&introduction,&is&further&supported&and&emphasized&by&the&responses& from&the&interviews,&arguing&a&lack&of&a&solid&and&mutual&TCO&orientation.&There&is&however&a& common& ambition& to& use& TCO& to& a& greater& extent,& why& there& is& an& interest& within& SIT& AB& to& further& explore& the& concept& and& its& contribution& to& the& selection& of& a& supplier& providing& the& lowest&total&cost.&&&
1.6(Research(Problem(
To&summarize,&in&the&process&of&selecting&suppliers&to&contract&there&is&a&need&to&consider&all& the& costPincurring& activities& giving& rise& to& additional& costs& in& a& purchase& decision.& This& is& to& ensure&that&the&ultimate&choice&is&based&on&the&lowest&total&cost&rather&than&the&lowest&unit& price.&For&this&reason,&the&research&problem&is&formulated&as&follows:&
&
How$ can$ a$ TCO$ model,$ for$ a$ high$ importance$ component$ within$ the$ assembly$ industry,$ be$ used$to$compare$the$differences$in$Global$Sourcing?(
&
The& research& questions,& aiming& to& support& the& research& problem& will& be& formulated& and& presented& in& the& literature& review& chapter.& This& is& due& to& the& need& for& conducting& further& research®arding&the&area&of&TCO.&&
2.0 Literature Overview
The#following#chapter#will#present#the#findings#of#the#literature#review#conducted#in#advance#to# the#data#collection.#The#review#aims#to#support#the#study#by#enhancing#the#understanding#for# the#supplier#selection#process#and#the#concept#of#TCO#(TCO).#As#an#introduction,#the#chapter#will# provide#a#description#of#the#supplier#selection#process#and#its#different#phases.#The#chapter#will# then#continue#with#a#TCO#review#emphasizing#the#application#areas,#different#TCO#approaches,# cost#categorization,#implementation#barriers#and#its#advantages.#In#conclusion,#the#chapter#will# present#the#concepts#of#the#value#chain#process#and#the#physical#flow#of#a#product.& & Since&the&major&concern&of&the&study&will&be&TCO,&the&concept&will&be&rather&emphasized&in&the& literature&review.&Given&that&the&concept&of&TCO&aims&to&capture&all&the&costs&associated&to&a& purchase& of& a& component,& it& will& require& an& understanding& for& concepts& regarding& the& value& chains& process& and& the& physical& flow& of& a& product.& For& this& reason& these& concepts& will& be& discussed&in&the&end&of&the&chapter.&Also,&since&TCO&analysis&is&closely&related&to&the&supplier& selection& process,& this& concept& will& also& be& presented.& This& is,& since& TCO& analysis& often& is& an& integrated&part&in&the&supplier&selection&process.&&&
Even& though& Global& Sourcing& is& discussed& in& the& introduction,& thus& serving& as& a& major& component&of&this&study,&the&concept&will¬&be&given&further&emphasize.&This&is&since&Global& Sourcing&only&serves&as&the&arena&in&which&the&area&of&concern&is&taking&place&and¬&the&actual& problem.&&&&&
2.1(The(Supplier(Selection(Process
(
De&Boer&(1998)&suggests&a&framework&for&supplier&selection&consisting&of&four&different&stages& that&comprises&the&complexity&and&importance&of&a&purchasing&decision.&The&supplier&selection& process&does¬&only&involve&the&final&selection&phase&but&recognizes&and&takes&into&account& several&decision&and&evaluation&oriented&steps&prior&to&the&ultimate&selection&(Boer&et&al.,&2001).& Thus,& the& phases& suggested& in& the& framework& are& problem# definition,& formulation# of# criteria,# qualification& and& final# selection& and& will& be& described& in& more& detail& in& the& sections& below.& However,&the&scope&of&the&phases&will&vary&depending&on&the&supplier&selection&situation.&More& specifically&that&is&whether&the&selection&concerns&a&new&task,&a&modified&rebuy,&or&a&straight& rebuy&of&either&routine&items&or&bottleneck&items.&&&2.1.1(Problem(Definition(
The&initial&phase&of&the&supplier&selection&process&aims&to&clarify&the&intention&with&selecting&a& supplier.& That& is& to& determine& the& purpose& of& using& additional& or& the& same& supplier& by& appreciating&the&need&for&an&extended&supplier&base&by&defining&and&formulating&the&problem&
related&to&the&given&situation&(Boer&et.&al.,&2001).&Thus,&the&problem&definition&will&be&expressed& differently&depending&on&the&specific&situation&and&whether&the&problem&relates&to&a&completely& new& supplier& or& an& already& existing& supplier.& The& problem& definition& can& be& supported& by& methods& questioning& the& problem& and& motivate& the& selection& of& one& or& more& suppliers& to& overcome&the&problem&(ibid.).&&
2.1.2(Formulation(of(Criteria(
The&second&step&of&the&supplier&selection&process&involves&the&determination&of&relevant&criteria& for& the& supplier& selection& (Boer& et& al.,& 2001).& Thus,& the& criteria& should& comprise& the& buying& organization's& requirements& on& the& supplier& (ibid.).& Depending& on& the& buying& situation,& the& determination&of&relevant&criteria&will&vary.&In&a&study&conducted&by&Dickson&(1966)&referred&in& Cheraghi&(2011),&the&most&important&criteria&for&supplier&evaluation&and&selection&in&the&mid& 1960s&were&recognized&as&price,&delivery,&and&quality&(in&descending&order).&Likewise,&a&more& recent&study&carried&out&by&Bevilacqua&&&Petroni&(2002),&showed&that&exactly&the&same&criteria& are&those&of&highest&importance&in&the&selection&of&a&supplier.&Although,&price&and&quality&has& switched&positions.&Also,&a&study&conducted&by&Cheraghi&et&al.&(2001)&based&on&more&than&110& research&papers&reexamined&the&criteria&which&was&first&developed&by&Dickson&(1966).&The&study& revealed&the&fifteen&most&commonly&used&selection&criteria&to&be;&quality,&delivery,&price,&repair& service,&technical&capability,&production&facilities&and&capacity,&financial&position,&management& and& organization,& reliability,& flexibility,& attitude,& communication& system,& performance& history,& geographical&location,&and&consistency&(Cheraghi&et&al.,&2001).&For&a&comparison&between&the& ranking&of&the&criteria&developed&by&Cheraghi&et&al.&(2001)&and&Dickson&(1966),&see&Table#2.1# below.&
&&
According&to&Omurca&(2013),&the&most&important&decision&criteria&in&a&supplier&selection&model& are& the& following;& quality& management& practices& and& systems,& selfPaudit,& process/manufacturing& capability,& management& of& the& firm,& design& and& development& capabilities,& cost& reduction& capability,& quality& performance,& price& performance,& delivery& performance,& and& cost& reduction& performance.& On& the& other& hand,& Crow,& Olshavsky,& and& Summers&(1980),&suggest&using&supplier&selection&criteria&in&two&stages.&Firstly,&the&suppliers&are& evaluated&on&the&criteria&quality,&delivery,&and&technical&assistance.&The&qualified&suppliers&then& present& how& their& products& are& priced& and& when& they& can& deliver& the& products& (Crow& et& al.,& 1980).&&&
&&
Ho,& Xu& and& Dey& (2010)& have& investigated& the& most& popular& supplier& evaluation& and& selection& criteria& which& resulted& in& the& following& fifteen& criteria:& quality,& delivery,& price/cost,& manufacturing& capability,& service,& management,& technology,& research& and& development,& finance,& flexibility,& reputation,& risk,& relationship,& safety,& and& environment.& Comparatively,&
Vonderembse& and& Tracey& (1999)& identified& the& supplier& selection& criteria& to& be& as& follows;& product&quality,&product&availability,&delivery&reliability,&and&product&performance.&
&&
A& study& was& conducted& on& five& Brazilian& companies& in& order& to& examine& whether& Brazilian& companies&consider&environmental&criteria&when&selecting&suppliers&(Jabbour&&&Jabbour,&2009).& The& study& revealed& that& this& was& not& the& case& (ibid.).& The& most& important& criteria& were& identified&as&underscored&quality,&cost,&and&delivery&performance&history.&Although,&the&study& resulted& in& a& purpose& of& 5& qualitative& environmental& criteria;& environmental& management& competencies,& environmental& image& of& suppliers,& development& of& products& with& high& environmental& performance,& environmental& management& systems,& and& environmental& competencies&(ibid.).&&&
&
Table# 2.1& summarizes& the& identified& costs& emphasized& by& all& researchers& mentioned.& The& summary& indicates& that& the& most& important& supplier& selection& criteria& are& price,& quality,& and& delivery.& Other& frequently& mentioned& factors& are& management& and& organization,& finance,& flexibility,&service,&and&technical&capability.&
Table&2.3:&Summary&of&Criteria&for&Supplier&Selection& !
Dickson&&
(1966)& Cheraghi&et&al.&&(2001)& Ho&et&al.&&(2010)& Omurca&&(2012)& Crow&et&al.&(1980)& Vonderembse&&&Tracey&(1999)& Jabbour&&&Jabbour&(2009)&
Price!! Price!! Price/cost! Price!performance! 2.!Pricing! !! Cost!
Delivery! Delivery! Delivery! Delivery!
performance! 1.!Delivery!! Delivery!reliability! Delivery!performance!history!
Quality! Quality! Quality! Quality!
performance!
1.!Quality! Product!quality! Quality! Management!&!! Organization! Management!&!! Organization! Management! Management!of!the! firm! !! !! !!
Financial!position! Financial!position! Finance! !! !! !! !!
Flexibility! Flexibility! Flexibility! !! !! !! !!
Repair!service! Repair!service! Service! !! !! !! !!
Technical!!
Capability! Technical!capability! Technology! !! 1.Technical!assistance! !! !! Reliability! Attitude! CommunicationI!! system!performance!! History! Geographical!! location! Production!facilities! &!Capacity! Reliability! Attitude! CommunicationI! system!performance! History! Geographical! location! Production!facilities! &!Capacity! ! R&D! Reputation! Risk! Relationship! Safety! Environment! Manufacturing! capability! Process! /Manufacturing! capability! Design!&! Development! capabilities! Cost!reduction! performance! SelfIaudit! Cost!reduction! capability! !! Product!performance! Product!availability! !! ! ! ! ! !! !! !! !! ! ! !! !! !! !! !! !! !! ! ! !! ! !! !! !! ! ! ! ! !
2.1.3%Qualification%
The$ third$ step$ involves$ the$ prequalification$ process$ of$ potential$ suppliers$ that$ meet$ the$ criteria$formulated$in$the$previous$phase$and$can$therefore$be$classified$as$approved.$Thus,$ this$stage$is$not$to$be$regarded$as$the$final$stage$in$which$the$ultimate$selection$is$made,$but$ rather$ a$ process$ of$ reducing$ the$ available$ suppliers$ to$ a$ manageable$ number$ of$ qualified$ suppliers$(Boer$et.$al.,$2001).$Depending$on$the$supplier$situation$the$qualification$process$ can$be$based$on$either$existing$data$from$previous$experience$with$the$supplier$or$new$data$ collected$for$the$specific$purpose.$Also,$the$qualification$procedure$may$vary$by$using$either$ ranking$or$sorting$techniques$to$distinguish$potential$suppliers$from$those$who$fail$to$meet$ the$criteria.$Some$of$the$methods$used$for$qualifying$suppliers$are$the$categorical$method,$ Data$ Envelopment$ Analysis$ (DEA),$ Cluster$ Analysis$ (CA),$ and$ CaseHBasedHReasoning$ (CBR)$ systems$(Boer$et$al.,$2001).$$$
2.1.4%Final%Selection%
The$final$phase$of$the$selection$process$involves,$as$indicated,$the$ultimate$selection$of$one$ or$more$suppliers$to$award$and$contract.$The$selection$is$based$on$the$qualification$process$ in$the$previous$stage$resulting$in$the$evaluation$of$one$or$more$suppliers$being$most$capable$ of$facing$the$problem$formulated$in$the$initial$phase$(Boer$et$al.,$2001).$ $$In$ the$ final$ selection$ phase$ there$ are$ several$ techniques$ and$ tools$ that$ can$ be$ used$ to$ support$ the$ ultimate$ choice$ (Boer$ et$ al.,$ 2001;$ Bhutta$ &$ Huq,$ 2002).$ These$ tools$ are$ recognized$ as$ linear$ weighting$ models,$ TCO$ models,$ mathematical$ programming$ models,$ statistical$models,$and$artificial$intelligence$(AI)Hbased$models.$In$the$following$section$the$ characteristics$of$each$model$will$be$further$described.$$
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When$embracing$a$linear'weighting'model$weights$are$given$to$each$criterion.$Small$weights$ indicate$relatively$low$importance$whereas$big$weights$indicate$the$highest$importance$of$ those$ criteria$ (ibid.).$ To$ obtain$ a$ total$ score$ for$ each$ supplier,$ ratings$ on$ the$ criteria$ are$ multiplied$by$their$given$weights$and$then$added.$Thus,$the$linear$weighting$model$suggests$ the$selection$of$the$supplier$with$the$highest$overall$score.$ $
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According$ to$ Boer$ et$ al.,$ (2001)$ a$ mathematical' programming' model$ is$ characterized$ by$ “allowing$the$decisionHmaker$to$formulate$the$decision$problem$in$terms$of$a$mathematical$ objective$ function”.$ The$ function$ is$ then$ either$ maximized$ (maximize$ profit)$ or$ minimized$ (minimize$ costs)$ by$ regulating$ the$ values$ of$ the$ variables$ in$ the$ designed$ function$ (ibid.).$ More$specifically$that$is$the$amount$of$ordered$products$from$the$supplier.$However,$the$ objectivity$ of$ the$ model$ is$ somewhat$ discussed.$ Even$ though$ mathematical$ programming$ models$ are$ argued$ as$ more$ objective$ than$ rating$ models,$ it$ only$ considers$ criteria$ of$ quantitative$nature$(ibid.).$
Statistical' models' on$ the$ other$ hand$ can$ be$ described$ as$ a$ tool$ handling$ the$ stochastic$ uncertainty$ associated$ with$ the$ supplier$ selection.$ This$ uncertainty$ concerns$ the$ lack$ of$ knowledge$regarding$the$internal$demand$for$the$products$purchased,$although$the$model$ does$only$consider$one$criterion$at$a$time$(ibid.).$
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Artificial'intelligence'based'models'involves$the$use$of$computerHaided$systems$that$can$be$ developed$ by$ a$ purchasing$ expert$ or$ historic$ data.$ The$ system$ is$ based$ on$ artificial$ intelligence$ technology$ and$ is$ designed$ to$ equal$ the$ human$ judgment$ to$ a$ greater$ extent$ than$traditional$models$(Boer$et$al.,$2001).$
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TCO'models$aims$to$address$all$the$costs$related$to$a$purchase$in$the$supplier$selection$by$ considering$ the$ costs$ throughout$ the$ entire$ lifecycle$ of$ the$ item.$ Yet,$ the$ model$ is$ characterized$by$the$quantification$and$summarization$of$all$the$costs$or$at$least$several$of$ the$costHincurred$activities$related$to$the$supplier$choice$(Boer$et$al.,$2001).$ $$ As$the$focus$of$this$research$is$addressed$to$the$use$of$TCO$models$when$evaluating$new$ suppliers,$the$following$section$aims$to$present$an$extended$review$of$the$literature$related$ to$the$use$and$implications$of$the$concept.$$The$chapter$will$also$include$a$presentation$of$ the$concept$of$physical$flow.$The$identification$of$the$physical$flow$of$a$product$is$needed$in$ order$to$map$the$total$cost$of$a$purchase.$$$
2.2%Total%Cost%of%Ownership%
2.2.1%Introduction%to%the%Concept%of%TCO%
TCO$is$a$concept$referred$to$as$a$creative$philosophy$as$well$as$a$model$aiming$to$capture$all$ the$costs$incurred$by$a$purchase$(Ellram,$1994).$The$concept$has$been$a$subject$of$interest$ for$many$researchers$and$has$been$given$remarkable$attention$in$the$literature$ever$since$its$ introduction$in$1987$(Weber$et$al.,$2010).$For$this$reason$there$are$several$definitions$of$the$ concept$available$in$the$literature,$some$of$which$are$presented$below:$ $“TCO' is' an' attempt' to' quantify' all' the' costs' related' to' the' purchase' of' a' given' quantity”' (Degraeve'&'Roodhoft,'1999).$
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“TCO'is'an'innovative'philosophy'aimed'at'developing'an'understanding'of'the'true'cost'of' doing'business'with'a'particular'supplier'for'a'particular'good'or'service”'(Ellram,'1994).$ $
“To' evaluate' a' sourcing' decision,' all' costs' associated' with' the' acquisition,' use' and' maintenance'of'a'product'are'taken'into'consideration”'(Ellram'&'Siferd,'1994).$
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TCO$can$therefore$be$classified$as$a$concept$closely$related$to$the$purchasing$process$of$an$ organization.$In$many$companies,$the$purchasing$price$serves$as$the$determinant$factor$in$
