The Reshoring Initiative, a nonprofit organization
dedicated to helping companies determine the feasibility of manufacturing in their home country (
primarily the United States, but the group’s approach
applies to any country), has developed a method for
calculating the total cost of ownership. (For more
information, see the sidebar “About the Reshoring
Initiative.”)
The Reshoring Initiative’s trademarked Total Cost of
Ownership Estimator software is based in part on the factors that motivated dozens of U.S. companies to successfully reshore products ranging from
small consumer electronics such as
earphones to larger, more labor-intensive items like water heaters and
automotive components.
To determine the total cost of
ownership, the user assigns a value
to each factor that is relevant to the
specific case, and then accumulates
a single cost value for a product
sourced from a particular supplier.
The user then repeats the process, substituting other
vendors. In this way, it is possible to readily and objectively compare the TCO for the same product from
multiple vendors, whether local or offshore.
What kind of costs should a TCO calculation
include? It will vary depending on the specific circumstances, but the following list, grouped by category, is
a useful guide. The list begins with easily quantified,
“hard cash” costs and progresses to more subjective
measures. Each item also includes some observations
and recommendations for comparing the costs of local
and offshore sourcing. Figure 1 shows the calculations
for a hypothetical example.
receipt of the goods. U.S. suppliers typically are paid
two to three months after the shipment date, which
essentially is the same as the receipt date. In such cases,
the customer’s cash will be tied up for three to four
months longer with an offshore source. An appropri-
ate measure for calculating the carrying cost for this
period, therefore, is the customer’s cost of capital.
b. Carrying cost of inventory on-site. At the simplest
level, the amount of safety stock is proportional to the
square root of the lead time. If the lead time for product
sourced in Asia is nine weeks and the local lead time is
one week, then the safety stock for Asian-made goods
will be three times higher than for
locally sourced products. In addi-
tion, the amount of on-site invento-
ry will be dramatically higher for
product shipped by ocean freight
from offshore than for shipments
from a local, ideally just-in-time
(JIT), supplier. One reason why is
that offshore shipments will arrive
in container loads to minimize ship-
ping costs. If the product arrives
monthly, then the cycle inventory will be one-half of a
month. Additionally, extra inventory must be held to
compensate for arrivals of late or defective shipments.
c. Prototype cost. Many companies prefer to source
prototypes locally so their engineers and marketing
organizations can work intensively with the suppliers
during product development. Local suppliers typically
charge less for the prototype if they also receive the
production orders.
d. End-of-life or obsolete inventory. When demand dies
down or a product is revised or replaced, a company
will end up holding some obsolete inventory. With an
offshore source, the amount of inventory in-house, en
route, and on order will be higher than it would be with
a local source. Thus, companies that source offshore are
likely to end up with more obsolete inventory.
e. Travel costs. The cost of travel associated with the
startup of the sourcing relationship as well as for
ongoing auditing and problem solving is often overlooked when companies calculate sourcing costs. Yet it
can have a notable impact on a product’s total cost.
Most customers visit a supplier several times year.
For a local supplier, this might require a few hours or
a day or two. For an Asian supplier, each trip can take
a week or two and might cost US $10,000, including
time and travel expenses. Offshore sources also may
require more face-to-face meetings because of time-zone and language differences. Alternatively, larger
1Cost of goods sold or landed cost: This includes price, packaging, duty, and planned freight, such as
surface transportation, fees, and insurance. This data
should be readily available, especially for items that are
large or valuable enough that the various costs usually
are aggregated.
2Other “hard” costs: These include factors that affect other costs that have an immediate effect on
cash flow or are calculable and highly likely to occur.
a. Carrying cost for in-transit product. Foreign and
local suppliers often are paid on different schedules.
For example, Chinese suppliers generally are paid
prior to shipment, typically three to six weeks prior to
