The Adoption of Total Cost of Ownership for Sourcing Decisions – A Structural Equations Analysis

This study investigates the adoption of total cost of ownership (TCO) analysis to improve sourcing decisions. TCO can be seen as an application of activity based costing (ABC) that quantifies the costs that are involved in acquiring and using purchased goods or services. TCO supports purchasing decision-makers in focusing on total value received and not simply price, and it extends ABC concepts and tools to an inter-organizational context. Based on ABC-adoption literature and focus-group discussions with senior purchasing executives, a model is developed to explain relationships among eight constructs hypothesized to explain TCO adoption: competitive pressure in customer markets, strategic purchasing orientation, top management support, functional management commitment, value analysis experience, adequacy of TCO information, success of TCO initiatives, and use of TCO-based review and reward systems. We test this model using multi-sample structural equation modeling on survey data collected from purchasing managers and plant maintenance managers. We find support for most of our hypotheses and, further, that the posited relationships are largely invariant across purchasing manager and plant maintenance manager perspectives. INTRODUCTION This study looks at the adoption of Total Cost of Ownership (TCO) as an application of Activity-Based Costing (ABC) concepts and tools to sourcing strategy. TCO is a cost accounting application that enables purchasing decision-makers to combine value and price in making sourcing decisions. TCO analysis quantifies the costs involved in acquiring and using offerings, such as transaction costs related to purchasing activities (e.g., ordering, freight, quality control), and the costs related to poor quality (e.g., rejection, rework, and warranties) (Carr and Ittner, 1992; Ellram, 1995) Activities that are part of the scope of TCO occur within the purchasing department as well as in other departments. As in activity-based costing, cost drivers can be at various levels, such as unit level