Question 1

What is should-cost analysis in procurement?

Accepted Answer

Should-cost analysis is a procurement methodology that builds a bottom-up cost model of what a product or service should cost to produce — independent of what a supplier quotes. It deconstructs cost into components: materials (commodity prices × BOM quantities), direct labor (hours × regional labor rates), manufacturing overhead, tooling and amortization, and supplier profit margin. By knowing the theoretical cost floor, procurement teams can negotiate from an informed position, identify where suppliers have excessive margin, and evaluate whether a quoted price is fair. Should-cost analysis originated in US Department of Defense procurement and is now standard practice in automotive, aerospace, and advanced manufacturing supply chains.

Question 2

How do you build a should-cost model?

Accepted Answer

Build a should-cost model in five steps: (1) Obtain a bill of materials or service breakdown — what are the component inputs?; (2) Research material costs — use commodity price indices (LME for metals, ICIS for chemicals) for current market rates; (3) Estimate labor content — use industry time-and-motion standards or teardown analysis; (4) Apply overhead rates — manufacturing overhead typically runs 100-200% of direct labor cost; (5) Add reasonable supplier margin — industry standard gross margins vary by category (5-15% for contract manufacturing, 20-40% for value-added services). The resulting should-cost becomes your negotiation target and benchmark for evaluating quotes.

Question 3

When should I use should-cost analysis?

Accepted Answer

Use should-cost analysis when: negotiating with sole-source suppliers who have no competitive pressure, evaluating quotes that seem significantly above or below market, challenging a supplier's claim that a price increase is necessary, developing target costs for new product development, comparing make vs buy decisions, and auditing long-standing supplier contracts that haven't been competitively tendered recently. Should-cost is most valuable in direct materials procurement (components, raw materials, manufactured parts) and complex services (IT development, engineering). It requires category expertise and data access — not every procurement team has the resources to build rigorous should-cost models for all categories.

Question 4

How do I use should-cost analysis in negotiations?

Accepted Answer

Use should-cost in negotiations by: presenting your analysis as a collaborative cost-transparency exercise rather than an accusation — 'our analysis suggests the cost structure looks like X, can you help us understand where we're wrong?'; focusing on specific cost elements where your model shows significant gap vs quoted price; asking suppliers to provide their own cost breakdown to validate or challenge your model; using should-cost to establish a fair target price range rather than a single point; and combining should-cost with competitive pricing data for maximum leverage. Suppliers who know you have a cost model negotiate differently than those who don't — even an imperfect model shifts the negotiation dynamic significantly.

Question 5

How accurate are should-cost models?

Accepted Answer

Typical should-cost model accuracy is ±10-25% vs actual supplier cost — even the best models are estimates, not audited financial truth. The goal isn't precision; it's informed understanding to anchor negotiation and identify outliers. Even rough should-cost estimates improve outcomes vs entering negotiation with no internal cost view. Accuracy improves with: better commodity price data, vendor-specific benchmarking, and historical actuals from similar parts. Don't waste effort chasing accuracy beyond what's necessary to support the negotiation.

Question 6

Should I share my should-cost model with vendors?

Accepted Answer

Share should-cost models strategically. Sometimes showing a vendor that you've done detailed homework changes the negotiation dynamic — they're less likely to inflate prices when they know you can challenge specifics. Other times, your should-cost model is a private negotiation tool best kept internal. Never share methodology that vendors can game (e.g., specific overhead assumptions you'll use across the category). Sharing high-level cost structure expectations is usually safe; sharing your full model and assumptions usually isn't.

Question 7

Is should-cost analysis only for manufactured products?

Accepted Answer

No — should-cost analysis applies to services as well as manufactured products. For services: estimate labor hours by activity, apply blended labor rates (mix of senior and junior staff), add overhead allocation (typically 1.5-2x direct labor for professional services), and apply margin expectations for the service category (consulting margins differ from staffing margins differ from outsourcing margins). The methodology applies to anything with definable cost elements. The data sources differ — services use labor benchmarks (Robert Half, Glassdoor) where products use commodity indices.

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%

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

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

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

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

Should-Cost Analysis Guide

What is Should-Cost Analysis?

Why Should-Cost Matters

When to Use Should-Cost

Building a Cost Model

Step 1: Define the Product/Service

Step 2: Identify Cost Elements

Step 3: Gather Cost Data

Example Calculation

Using Should-Cost in Negotiation

✅ Better Approach

Handling Vendor Responses

Model Accuracy Expectations

Know What You Should Pay

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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?

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