Should-cost analysis

Should-cost analysis shifts the negotiation dynamic from simply pressing for lower prices to fact-based discussions about cost drivers. When buyers demonstrate understanding of cost structure, suppliers are less able to maintain inflated pricing.

Building credible should-cost models requires understanding of manufacturing processes, access to cost data (material prices, labor rates, equipment costs), and analytical capability to construct models. The quality of analysis depends on input accuracy and understanding of the supplier's actual processes.

Should-cost models have limitations. Every supplier's actual cost structure is different, and models rely on assumptions and averages. Should-costs work best for understood, stable processes where cost drivers are transparent. Novel technologies or unique supplier capabilities may not fit standard models well.

Procurement uses should-cost analysis for supplier negotiation, proposal evaluation, make/buy decisions, and identifying cost reduction opportunities. The discipline of constructing should-cost models also deepens procurement's understanding of what drives costs in their supply base.

Frequently asked questions

What is should-cost analysis?

Should-cost analysis builds up what a product or service should cost from materials, labor, overhead, and a reasonable profit margin. The independent estimate shows what fair pricing looks like and identifies where supplier quotes may contain excess margin or inefficiency.

How does should-cost analysis change negotiations?

A credible should-cost model shifts the conversation from simply pressing for lower prices to fact-based discussion of cost drivers. When buyers demonstrate understanding of the cost structure, suppliers have a harder time maintaining inflated pricing, and unexplained gaps between quote and model become negotiation ground.

What does building a credible should-cost model require?

Building a should-cost model requires understanding of manufacturing processes, access to cost data such as material prices, labor rates, and equipment costs, and the analytical capability to construct the model. For a machined part, that means material cost from weight and material price, machining time estimated from part complexity, regional labor rates, and typical overhead and margin.

What are the limits of should-cost analysis?

Every supplier's actual cost structure is different, and should-cost models rely on assumptions and averages. The approach works best for understood, stable processes with transparent cost drivers, while novel technologies or unique supplier capabilities may not fit standard models well.

What should you do when a quote far exceeds the should-cost estimate?

When a quote lands significantly above the should-cost estimate, the standard move is asking the supplier to explain the variance. Valid reasons might include capabilities the model failed to capture, while unexplained gaps suggest negotiation opportunity. Beyond negotiation, should-cost supports proposal evaluation, make-or-buy decisions, and finding cost reduction opportunities.