Gauging the total cost of ownership requires a sophisticated framework. Here’s one.
By Alejandro Gusis
Total cost of ownership (TCO) is one of the most overused, and usually misused, terms that procurement professionals hear, and sometimes say. Most of the time, TCO means “we-are-not-considering-only-price-in-our-decision.” Although that significance is directionally correct, it is advisable to understand the different components of TCO in each procurement situation (e.g., TCO for IT consulting will be completely different from TCO for machinery spare parts). Failing to assess TCO from different points of view usually results in unexpected future cost and undesirable situations that could have been prevented, or at least considered, during the planning phase of the project.
In constructing any framework for new talent acquisition, a procurement professional must first deconstruct the life cycle of that process and analyze which factors should be considered in each phase. (Note: All the opinions and definitions are exclusively mine and do not represent the views of my previous or current employers.)
Three main phases of cost need to be considered.
1. Acquisition Phase Cost. This is defined as the sum of all expenses necessary to put the new talent in ready/producing mode. It is worth noting that all the work related to this phase can be achieved with internal resources (e.g., W2 employees) or external (e.g., outsourced services either domestic or offshore, or independent contractors). In both cases, companies should try to quantify (more difficult in the case of internal since it is based on arbitrary allocation calculations) what the total expense incurred will be.
Within acquisition, the first component is the selection cost. If an internal staffing department is used, it is necessary to assess and quantify, to the extent possible, the items below:
• Internal staffing. This includes not only how many man hours of internal staffing resources were used to identify the selected person but also the average cost per hour of those resources. A common mistake is neglecting to include the total number of hours spent on reviewing all potential candidates and not just the ones for the selected candidate.
• Hiring manager time. How many hours are dedicated to the selection process, and what is the average cost per hour? Again, a common mistake is neglecting to include the number of hours spent on reviewing all potential candidates. At minimum, HR and procurement departments should implement processes and tools to minimize hiring managers required time.
• Software licenses and systems. What such tools were used during the selection process, and what was the per unit or proportional cost of all software tools used in the search?
If, on the other hand, external parties are engaged for the candidate sourcing and selection processes (e.g., recruitment process outsourcing (RPO), managed services program (MSP), vendor management system (VMS), agencies fees, background verifications) the item below needs to be added to your analysis:
• Partner/vendor costs. These fees are paid during the selection of the preferred candidate. Depending on contractual terms, these cash outflows can be per occurrence, fixed fee, or any other negotiated agreement. Common mistakes are neglecting to consider all contracted expenses including cost of technology, bonuses, penalties, etc., and not excluding implementation cost from the calculations. (This cash outflow was already incurred and should not be part of the analysis).
The second component of acquisition costs is onboarding expenses. Again, all activities related to these cash outflows can be performed internally or by third parties (comments and principles discussed above apply here). We can categorize the onboarding expenses into:
• Physical and hardware costs. These include all work and expenses to produce and provide the candidate a working place, personal computer, mobile telephone, security badge, relocation services, and travel and logistics expenses.
• Virtual and software costs. These include all work and expenses to provide the candidate the digital tools needed to perform his/her responsibilities (e.g., access and permissions, software licenses, network access, etc.).
2. Execution Phase Costs. After acquisition, these are defined as the sum of all ongoing—direct and administrative—expenses incurred once the resource starts producing.
These expenses are mostly internal by nature, and they can be classified as direct- or opportunity-cost related.
• Direct cost. This includes the variable and fixed expenditures paid to the resource as compensation for her/his work (e.g., total salary through a W2 including bonuses and other cash payouts, or bill rate through a staffing agency or payrolling company), as well as the internal administrative cost of maintaining this resource (e.g., benefits, invoicing, accounts payable process, etc.) Please note the latter administrative cost—excluding benefits—could be insignificant in most cases if done internally or might already be included in the VMS, MSP, and/or RPO services fees.
• Opportunity costs. These are by nature not easy to identify, even less to quantify. Their impact varies from minimum to extremely significant depending on the situation. Although most of these potential additional expenditures materialize during the execution phase, they originate during the acquisition phase, more precisely during the hiring process decision. They directly impact quality of the work product or deliverable, productivity, or delays. Decision makers should answer the following questions and act accordingly during the Acquisition Phase to avoid the additional expenses:
a. Should I hire a more experienced resource (veteran) or an equally capable, though less experienced and potentially cheaper resource (a newbie), that I can “form” to match the company needs?
b. If I bring in new talent from outside the company, how steep is the learning curve? What proportion of the hiring manager’s time will be necessary to train the new resource?
c. And in the unfortunate case when things do not go according to plan, what is the true cost of rework and delays? Although some cases can result in additional time and materials (T&M) fees or change orders, it is my experience that in most cases the impact is not as bad as is initially feared (e.g., moving the go-live date, which might have been arbitrarily set nine months before during the design phase of the project, does not significantly modify the operational or financial results expected). The takeaway: do not overreact to bad news. Instead, objectively assess the situation, quantify the operational and financial impact of the issues, and take appropriate corrective actions.
3. Conclusion Phase Costs. These are defined as the sum of all one-time expenditures necessary to discontinue the relationship between the resource and the company. They include both direct cash outflows as well as business continuity and risk management items.
• Offboarding expenses. These include the costs and efforts necessary to collect back all the physical and virtual tools, equipment, permissions, and software licenses given to the resource during the onboarding process or the additional ones given later on during the engagement. As in the case of the onboarding expenses, these cash outflows can be performed internally or by third parties.
• Severance and outplacement services costs. For company employees whose positions have been eliminated, these expenses should not be overlooked. They deserve special attention since it is easy to underestimate the financial impact of them, especially in the case of mass layoffs or during the discontinuation of senior leadership.
• Early engagement termination. For third party employees, this can put the organization in a significant financial burden, especially in cases not clearly addressed by contracts.
• Loss of know-how. This is another expenditure easier to identify than to quantify or address during the transition. Employees, both internal and third parties, leave the organization with deep knowledge of the operations and processes that not only need to be re-taught to their potential replacements but also can be used by the competition. Companies need to identify these “pockets of knowledge” and make reasonable commercial efforts through their employee retention programs and contractual non-compete clauses.
Finally, some costs are present during the entire process. I am not going to go in depth into any of them since there is a lot of literature that covers the topic in better detail. I am presenting them as part of the “to-be-considered” category.
• Disgruntled employees might threaten or engage in legal activity against the company for a variety of reasons (e.g., co-employment, discrimination, harassment, etc.). It is highly advisable to have formal policies and both internal and external processes in place to minimize and hedge against these types of risks.
• Big and broad organizations constantly assess the centralization/standardization dilemma (e.g., does your company prefer to design and implement a formalized and centralized program to procure temporary talent, or does it prefer to leave this procurement activity to the hiring manager’s discretion?) A business case scenario needs to be performed for each one of the HR services under discussion to achieve a deep understanding of the costs and benefits.
• Related to the topic above: Which of these activities should be performed in house vs. outsourced? Again, a business case analysis, including strategic considerations, is in order for these decisions.
• And last but not least, always bring aboard your HR legal counsel for these discussions. They can be an invaluable source for addressing regulatory, compliance, discrimination, and other legal risks and issues.
In summary, TCO is more than “we-are-not-considering-only-price-in-our-decision.” During the entire life cycle of the project or engagement, procurement and HR professionals should consider and try to quantify the expenditures and efforts discussed above in order to have a comprehensive picture of the total potential cost. Although external costs are usually the easier to quantify since we can rely on invoices paid, taking the extra time and effort to consider all the “hidden” internal expenditures and the usually ”sneaky” opportunity costs can bring significant benefits to your organization while minimizing and addressing both short and long term risks and financial burdens.
Alejandro Gusis is director of strategic sourcing and operations for Wolters Kluwer.
