Should-Cost Analysis Guide

Learn should-cost analysis methodology to understand fair market pricing. Build cost models to strengthen negotiation position and validate vendor proposals.

What's a fair price? Not what vendors quote—but what something should actually cost based on its components, labor, overhead, and reasonable margin.

Should-cost analysis builds independent cost estimates before negotiating—shifting power from "take it or leave it" to data-informed negotiation.

What is Should-Cost Analysis?

Component	What It Includes	Typical %
Direct materials	Raw materials, components, packaging	30-60%
Direct labor	Production and assembly time	10-25%
Manufacturing overhead	Facility, equipment, utilities	10-20%
SG&A	Sales, admin, R&D	10-20%
Profit margin	Vendor's reasonable return	5-15%

Why Should-Cost Matters

Without Should-Cost	With Should-Cost
Accept vendor pricing as given	Challenge specific cost elements
Limited negotiation leverage	Data-backed position
Opaque cost structure	Transparent understanding
Hope for "good deal"	Know what "good" means

When to Use Should-Cost

High-Value Uses	Lower Priority
Major purchases, recurring contracts	One-time purchases
Categories bought regularly	Highly differentiated products
Vendor pricing concerns	Small dollar value
Strategic supplier relationships	Spot purchases

Building a Cost Model

Step 1: Define the Product/Service

Document detailed specifications, bill of materials, process steps, volume requirements, and quality requirements.

Step 2: Identify Cost Elements

Direct Materials: Raw materials, purchased components, packaging
Direct Labor: Operations, time per operation, skill level
Overhead: Facility costs, equipment depreciation, utilities
SG&A: Sales costs, administrative overhead
Margin: Industry-typical profit margins

Step 3: Gather Cost Data

Cost Element	Data Sources
Raw materials	Commodity indices (LME, COMEX), supplier quotes
Components	Distributor pricing, manufacturer MSRP
Labor	Bureau of Labor Statistics, industry surveys
Overhead	Industry ratios, public company data
Margin	Public company financials, industry analysis

Example Calculation

Cost Element	Calculation	Amount
Steel (2.5 kg @ $1.20/kg)	2.5 × $1.20	$3.00
Electronics module	Market price	$45.00
Other materials	Various	$12.00
Direct Materials		$60.00
Labor (0.5 hr @ $30/hr)	0.5 × $30	$15.00
Overhead (50% of labor)	$15 × 0.5	$7.50
SG&A (15% of above)	$82.50 × 0.15	$12.38
Profit (10% margin)	$94.88 × 0.10	$9.49
Total Should-Cost		$104.37

Using Should-Cost in Negotiation

✅ Better Approach

Avoid: "Your price is too high."

Use: "Based on current steel prices and standard manufacturing overhead ratios, we estimate production cost at approximately $X. Can you help us understand the gap between that and your quoted price?"

Handling Vendor Responses

Vendor Response	Your Counter
"Our quality is higher"	Help us understand specific quality differences and cost impact
"Materials cost more"	Share your current material costs so we can update our model
"R&D/innovation included"	What's the reasonable R&D allocation for this product?
"Our margins are competitive"	What margin does your pricing reflect vs. industry benchmarks?

Model Accuracy Expectations

Level of Detail	Typical Accuracy
High-level estimate	±25-35%
Detailed model	±15-25%
Engineering estimate	±10-15%
Full breakdown with verification	±5-10%

Key Insight: The goal isn't precision—it's informed understanding of cost structure. Even rough models dramatically improve negotiation positioning.

Frequently Asked Questions

How accurate are should-cost models?

Typical accuracy is ±10-25%. The goal isn't precision—it's informed understanding. Even rough data estimates improve over no analysis.

Should I share my model with vendors?

Strategically. Sometimes showing you've done homework changes dynamics. Other times, keep as internal preparation. Don't share methodology that vendors can game.

Is should-cost only for manufactured products?

No. Services can be analyzed too: labor hours × rates, material consumption, overhead allocation, margin expectations. The methodology applies to anything with definable cost elements.

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Compare Vendor Specifications

Specification differences between vendors should explain price differences. SpecLens helps identify which specs justify premiums—and which don't.

Compare Specifications →

Know What You Should Pay

Should-cost analysis transforms negotiation from guesswork to data-informed discussion. Build your models, understand cost drivers, and negotiate from knowledge.

Calculate TCO → | Hidden Costs Guide →