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Should Cost Analysis: Reducing Procurement Costs with Transparency & Modeling
"How much potential is lost if your price negotiations rely solely on gut feeling?" Should Costing, beyond comparing alternative offers and market prices, provides insights into cost structures and interdependencies. This method supports cost optimization, product planning, and elevates supplier relationships to a strategic level.
In this article, we address key questions, including:
- What is Should Costing?
- When is Should Costing used?
- How do you calculate Should Cost?
- How to build a Should Cost model?
- How to effectively use Should Cost prices?
- What are the most common mistakes in Should Costing?
- How does Should Costing compare to other procurement optimization methods?
Additionally, we offer practical advice, discuss solutions, and provide a perspective on how modern procurement can leverage this method to build strategic insights, secure long-term competitive advantages, and optimize negotiation positions and supplier collaboration in procurement.
What is Should Costing?
Should Costing is a strategic approach for calculating optimal costs for products or services by modeling a supplier’s actual production or service costs based on all relevant cost components.
Using specific procurement and production conditions, the Should Cost model can establish the cost minimum of a given supplier, as well as the design cost minimum of the specified design or requirements.
Depending on the application, the goal of Should Costing is to create a sound basis for negotiations, foster a collaborative pricing strategy, identify improvement potential, or provide a solid decision-making foundation for product and material choices.
When is Should Costing used?
Should Costing is used when companies seek full control over their cost structure and negotiation processes. A primary use case is creating a well-informed basis for negotiations; by analyzing individual cost elements precisely, buyers can formulate not only fair but also strategically advantageous price expectations. Should Costing also encourages collaborative pricing, allowing suppliers and manufacturers to enter a transparent dialogue on cost drivers and potential savings. The method also helps to reveal improvement potential along the value chain, enhancing efficiency and profitability. For product and material decisions, Should Costing provides a reliable basis that ensures new materials or alternative production processes are evaluated optimally from a cost and performance perspective.
Should Costing is particularly suitable for companies in cost-intensive industries like automotive, electronics, machinery, and consumer goods, where complex products and extensive supply chains make material, production, and logistics costs highly relevant. It is also beneficial for companies aiming to build long-term partnerships with suppliers, improving transparency and efficiency. However, Should Costing is less practical for products and sectors where prices are heavily influenced by external factors like market volatility, scarce resources, or fluctuations in supply and demand. For low-cost, simple mass-produced items, such as standard components, the analysis effort often outweighs potential savings.
How to Calculate Should Cost?
Calculating the Should Cost relies on a thorough analysis of all cost-driving factors of a product or service. The analysis begins with determining material costs, calculating the quantities and expenses for all required raw materials and components (ideally from the BOM). Next, production costs are calculated, considering labor, machine runtimes, and specific production processes. Indirect costs, such as energy consumption, logistics, and potentially administrative expenses, are then added. Ideally, Should Cost analysis data is supported by benchmarking and comparative values to create a realistic cost model. By combining these factors, a detailed, transparent cost structure is established, serving as a basis for informed negotiations and strategic decision-making.
A successful model requires a structured Should Cost analysis that is flexible, adaptable, and robust. Effective Should Cost models are controlled and adjusted through parameters, variables, and entry probabilities or sensitivity analyses to evaluate potential changes.
How to Build a Should Cost Model?
Creating an effective Should Cost model is an iterative process requiring close collaboration between procurement, internal engineers, and, depending on the application, the supplier:
- Engineers play a critical role due to their knowledge of product technical details and production processes, enabling them to make informed assumptions about material use, production steps, and timing.
- Working with procurement, engineers validate each cost element’s plausibility and develop realistic scenarios for various production options.
- Supplier collaboration is equally essential to validate assumptions and unknown variables. Ideally, suppliers provide information about specific production steps, machine use, and material procurement.
Transparent communication among all parties helps to clarify uncertainties and create a shared data foundation. Validating assumptions and production details, supported by benchmarking and comparative values, results in a Should Cost model that reflects realistic cost components and serves as a basis for strategic and fair negotiations.
How to Use Should Cost Prices Effectively – Practical Approaches & Tips by Use Case
Effectively using Should Cost prices requires more than their calculation. These prices are not always entirely accurate, and due to uncertainties, their exact determination remains challenging. Therefore, the results should not be seen as exact values but rather as a basis for strategic discussions. The true value of Should Costing often lies in the dialogue it generates: through open exchange among buyers, engineers, and suppliers, realistic potential can be uncovered, and joint solutions developed. Different applications of Should Cost prices - whether for negotiations, tenders, supplier collaboration, or as part of cost planning in Product-Lifecycle-Management - each require specific approaches to maximize benefits.
In negotiations, a detailed Should Cost price creates transparency and provides well-founded arguments. The price serves as a foundation for addressing suppliers on realistic cost elements and objectively identifying where savings may be possible. A successful approach is to present the Should Cost price as a reference value, openly addressing differences compared to market prices and incorporating new information into the Should Cost model throughout negotiations. It is advisable to ask targeted questions about product specifications or production processes to jointly review cost elements and achieve a fair agreement.
Tip: Stay flexible and open to the supplier’s perspective to maintain a collaborative and solution-oriented negotiation process.
Should Costing is an effective tool in tenders to objectively evaluate supplier offers and identify hidden cost drivers. This method helps filter out unrealistic offers and establish comparability. Conversely, tenders can also be used to gather relevant information for the Should Cost model and leverage these insights in the negotiation dialogue.
In practice, an existing Should Cost model, or one enhanced with information from the tender, can be successfully implemented by integrating the Should Cost price as a “target calculation” in the tender, inviting suppliers to transparently discuss individual cost positions.
Tip: Use the Should Cost analysis as a benchmark and encourage suppliers to contribute their cost-saving ideas as part of the tender process—this fosters innovation and strengthens competitiveness.
In supplier collaboration, Should Cost analysis serves as a valuable tool for jointly identifying cost optimization opportunities. The transparency Should Costing provides fosters a partnership-based and trustful communication that extends beyond mere costs. The following strategies are recommended in practice:
- Specification Decisions: Open discussions about the need for high-quality materials, such as special alloys or premium leather, can lead to optimized specifications and help assess more cost-effective alternatives.
- Consider Sustainability: Discuss ways to improve sustainability, for example, through reduced material use or waste reduction.
- Transparency and Mutual Benefit Strategy: Emphasize mutual benefits by showing how cost savings can also benefit the supplier, for example, through optimized production processes or more efficient material usage.
- Protection of Confidential Information: Ensure the supplier understands that the goal is general cost transparency, not a detailed disclosure of cost structures or profit margins.
- Early Involvement of the Supplier: Involve the supplier early in the Should Cost analysis process to reduce resistance and foster stronger collaboration.
Tip: Through proactive collaboration, the supplier can contribute valuable insights into production complexity, thus enhancing the model for all parties involved.
Should Costing is a strategic planning tool that provides valuable insights across the entire product lifecycle. In Product Lifecycle Management (PLM) or Enterprise Product Costing (EPC), the Should Cost price is used early in the development phase to create a reliable foundation for cost forecasts and budgets. The recommended approach is to integrate the analysis in the early development phases to identify potential cost pitfalls and proactively adjust design or material choices.
Tip: Use Should Cost analyses to continuously monitor cost efficiency throughout the product lifecycle, securing the product’s long-term profitability.
What Are the Most Common Mistakes in Should Costing?
Several common mistakes in Should Costing can significantly reduce its accuracy and usefulness:
- A solid data foundation is essential, yet outdated or insufficiently accurate data is often used.
- Moreover, indirect costs such as logistics and energy are frequently overlooked, distorting the actual cost picture.
- Companies also tend to overestimate their model’s precision, overlooking the fact that Should Costing primarily serves as a guidance tool - a basis for negotiation, not an absolute price framework.
- Additionally, a common issue is the lack of supplier involvement in the analysis process, leading to resistance and mistrust.
- Another pitfall is failing to account for market fluctuations and supply chain changes, causing the model to quickly lose relevance.
- Lastly, the absence of training and involvement of relevant departments, particularly procurement and engineering, hinders the acceptance and effective application of Should Costing.
Through regular data updates, inclusion of all cost elements and partnership-based collaboration with suppliers, Should Costing can realize its full potential providing precise, value-adding cost control.
How Does Should Costing Compare to Other Procurement Optimization Methods?
Should Costing is a strategic procurement optimization method that complements or contrasts with other common approaches. Compared to tenders, supplier partnerships, insourcing, or offshoring, Should Costing offers distinct advantages in cost control and transparency, but also presents specific challenges. Below, the connections and distinctions among these methods are discussed.
1) Tenders or Competitive Negotiations
Tenders and competitive negotiations rely on competition, often resulting in rapid cost reductions as providers present their best offers. Should Costing, however, focuses on a deeper analysis of the cost elements behind a product or service, providing a foundation for realistic pricing independent of market offerings. Combining both approaches can be beneficial: while tenders strengthen price competition, Should Costing offers an objective basis for negotiations, identifying unrealistic offers or hidden cost drivers early. However, relying solely on tenders may impair long-term supplier relationships, as short-term price cuts are the main focus.
2) Supplier Partnerships & Collaborative Development
Should Costing and supplier partnerships complement each other well. While the cost analysis provides transparency and in-depth insights into cost drivers, collaborative development fosters close cooperation for sustainable cost optimization. This mutual understanding of production processes and cost elements leads to joint optimizations, such as selecting more cost-effective materials or implementing efficient manufacturing methods. The advantage of partnerships lies in shared innovation and long-term relationship stability. However, building such partnerships can be time-intensive and requires a strong foundation of trust - an area where Should Costing adds value by establishing cost transparency.
3) Insourcing
Insourcing, or in-house production of goods and services, allows full control over manufacturing costs and quality. While Should Costing is used externally to better assess supplier prices, it can also be applied to evaluate the cost efficiency of potential in-house production. If Should Cost analysis reveals that external production costs exceed internal production costs, insourcing might be a viable alternative. Insourcing provides cost control and quality assurance, though it requires significant resource investment and can reduce flexibility in fluctuating demand scenarios.
4) Offshoring
Offshoring seeks to achieve cost savings by shifting production processes to low-cost countries. Unlike Should Costing, which provides transparency based on cost elements, offshoring primarily leverages location advantages, such as lower labor costs. Should Costing can support offshoring decisions by calculating realistic target costs for international suppliers and helping substantiate relocation decisions through transparent comparative costs. Offshoring’s advantage lies in direct cost reduction, yet it entails risks like quality issues, longer lead times, and complex supply chains, which can reduce its long-term effectiveness.
While methods like tenders and offshoring focus on direct cost reduction, Should Costing provides an in-depth approach to analyzing and optimizing cost structures. Especially in combination with strategic partnerships and as a basis for make-or-buy decisions, Should Costing is a valuable tool that contributes to more sustainable and transparent procurement decisions.
Outlook: Strategic Knowledge and Competitive Advantages through Should Costing in Modern Procurement
Should Costing provides a methodological foundation for modern procurement departments that goes beyond mere cost calculation. By analyzing the real cost structures and cost drivers of products and services in detail, companies build a reliable basis for negotiations founded on a deep understanding of manufacturing processes and their associated costs. This method’s advantage lies in its flexibility and applicability across various procurement strategies - whether for supporting tenders and negotiations, optimizing costs through collaborative supplier projects, or serving as a tool for decisions between in-house production and outsourcing.
In combination with other procurement strategies, such as tenders, supplier partnerships, insourcing, or offshoring, Should Costing provides companies with precise cost control and a data-driven decision-making foundation. This methodological clarity strengthens procurement’s negotiation position and supports the development of a resilient supply chain that is both flexible and cost-efficient. Consequently, modern procurement gains a future-oriented alignment that enables companies to anticipate market changes early and proactively pursue cost optimizations - an essential advantage in an increasingly dynamic competitive landscape.
OCM supports you with consulting, implementation, or coaching in our Should Costing advisory module.
As discussed above, integration into the following modules or expertise areas is often beneficial:
Additional modules can be found in our comprehensive procurement consulting offering.
We would be pleased to present our approaches and modules on this topic or discuss specific solutions and integration approaches for Should Costing tailored to your individual challenges.
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- Should Costing als Methode der Einkaufsoptimierung
- Der Weg zu Should Cost Analyse & Should Cost Modell
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