TCO Defined Part 2 (1/4) – Breaking Down Purchase Cost
This is a follow up to our most recent post (“TCO Defined, Why You Should Care, and How It Will Save You Money”, October 19th) that introduced the topic of total cost of ownership, or “TCO”, applied to medical equipment. TCO is a holistic approach to managing equipment costs across the entire equipment lifecycle that applies to many different categories of assets. In the case of medical equipment it can take a little bit of work to define and understand what costs should be included in TCO, and more important – why it is an increasingly valuable (and thus important) way for hospitals to save money and reduce costs.
Our previous blog offered a simple formula to help readers understand how to calculate TCO: the purchase price of equipment, plus all non-labor direct costs of operating, servicing, and maintaining the equipment for its entire anticipated life, less any value recovered from the disposition (whether re-use, trade-in, resale or donation) of equipment once it is no longer being used. While implementing a systematic TCO strategy to reduce medical equipment costs can be challenging, and the processes and inputs differ for each hospital, the benefits can be both immediate, and sustainable. In response to our last post, we’ve received several questions about the “how” of TCO, and the validity of TCO as a viable cost saving strategy. In this post, we’ll address a couple of these questions, and provide examples of the many different costs that need to be considered in an effective TCO strategy.
Q: TCO is great in theory, but I don’t control all the costs you say are part of TCO. Doesn’t that limit how much value we can get from a TCO approach?
Managing TCO doesn’t fall on just one person or department. It is an enterprise-wide approach to managing equipment costs that requires buy-in from the many different departments and functions responsible for planning, budgeting and managing all the costs associated with the medical equipment lifecycle. The path to implementing TCO and realizing the many benefits of a successful TCO strategy starts with making sure everyone has good information about the various costs that you are paying for medical equipment, a clear definition of how your hospital will measure and track TCO, and most important – an understanding of how, and commitment to, fully leveraging every cost within the medical equipment lifecycle as an opportunity to save and contribute to lowering the total cost of ownership.
In order to help show just how many different costs can contribute to total cost of ownership (and how many opportunities there are to save), we’ll provide more detail in response to the question below. This post will break out the various costs included in the “purchase cost” to acquire equipment, and will address similar examples for the remaining 2 phases of the equipment lifecycle – service and disposition – in subsequent blog posts.
Q: Purchase cost, purchase price – they are the same thing, aren’t they?
This is a great question, but the answer is no. Traditionally, hospitals have treated purchase cost as being equal to the purchase price of the base system, but for purposes of calculating TCO, there are many other costs associated with the purchase of equipment that should be included in the total cost of ownership. Think of the many different decisions when buying equipment that can represent incremental costs – whether the accessories you select, specialty software options for different types of procedures, installation, training and more. These costs are all real, and can quickly add up to much more than just the “purchase price” as noted above.
Trying to identify and figure out all the additional costs to include in the TCO for specific equipment can be daunting, but it may help to instead of thinking about these items as just costs, consider instead that each of these additional costs also represents another potential opportunity to save.
Every different modality, make and model of medical equipment can have costs uniquely associated with them, and different hospitals will account for these costs in different ways. That doesn’t matter. What does matter is that you can see, measure and influence these costs, and contribute to an effective TCO strategy. Beyond just purchase price, consider the many line items listed below – and associated costs – that your hospital may be paying when buying equipment:
- Base System
- Hardware Options
- Operating Software
- Application Software
- Shipping and Delivery
- Facility Preparation/Construction
- Technical Training
- User Training
Hopefully these examples of the many different costs that are part of an equipment purchase, and should be taken into account when planning and implementing a TCO strategy, are useful for your hospital. One final item to add to the list of purchase-related costs above is the Trade-in of existing equipment. You may be thinking “trade-in, I get a financial credit for value of my existing equipment so why on earth should I treat it as a cost?”
The answer is pretty straightforward, and an expression we often use is that “the trade-in is often the most expensive decision hospitals make when buying new equipment” – because if you don’t know what your trade-in is truly worth, then how do you know you are not losing money, or paying more than you need to for new equipment, by trading it in for less than it is worth?
Now, consider the fact that purchase cost represents less than 30% of total annual equipment costs for most hospitals. When one applies the same logic of breaking down individual costs that count towards the TCO for the equipment service and disposition phases of the lifecycle, there is an even bigger opportunity to save. We’ll address these other phases of the medical equipment lifecycle in future blog posts, and we hope you’ll come back and read.Tweet