A should cost analysis model is a documented calculation to determine the total cost of constructing a specific product under ideal conditions. The should cost model accounts for every relevant cost factor including labor, materials, overhead, profit margin, manufacturing setup, inspection, etc.
Should cost analysis is a potent internal cost modeling tool widely used within the procurement sector to enhance company profit capability by giving a deeper understanding of each individual cost element. A deeper understanding of the cost elements allows for insights to design your company’s costs better, cut sourced material costs, as well as devise a more efficient pricing strategy.
The information extracted from a should cost analysis model will gain your company an advantage in price negotiations with your vendors and suppliers, as well as enable strategic sourcing for the components/materials/parts of your product(s).
In this article we’ll cover what ‘should costing’ is, how it differs from ‘will costing’, as well as what a should cost analysis is and how you create one.
What’s the difference between Should cost and Will cost?
The should cost refers to what it SHOULD cost when manufacturing a product under ideal circumstances, not what it actually WILL cost. It’s an important distinction to make as to not be surprised when there’s a discrepancy between your should cost model and the actual cost of the product.
You can always expect some sort of margin between the should cost and will cost. Simply because very few, if any, suppliers have been able to fully optimize every single aspect of the entire cost structure of their manufacturing. Regardless, the size of the margin provides you with valuable information that can be used to compare between potential suppliers. The should cost analysis model could also prove to be a long-term goal to argue for supplier cost reduction when in the process of negotiating contracts.
The benefits of a should cost analysis
We’ve covered what should costing is, but what are the benefits of performing a should cost analysis?:
Close the gap between Should and Will cost
Having experience with should cost modeling allows you to hone your negotiation skills, acquiring a deeper understanding of the manufacturing process and costs. This places you in a stronger negotiation position leading to better deals on procurement of goods and services at optimal prices.
Should cast modeling allows you to identify discrepancies and outliers such as overpriced items, or items with a higher profit, meaning that you can sort them out and target materials that fall in under your required price range.
Better cost planning and forecasting
Should cost modeling allow for a better understanding of current and future market trends, improving your ability to carry out strategic decisions aimed towards optimizing costs, better budget planning, and economic forecasting.
Should cost methodology
The should cost methodology generally consists of three steps:
- Data gathering: First step is gathering all product or service data. This includes your current data (if there is any) from your current suppliers, as well as data from other suppliers regarding materials, labor, conversion costs, overheads, logistics, and profit.
- Systematic expansion: Expand upon the key cost drivers mentioned in Step 1.
- Analyzing and identifying cost insights: Analyze the gathered data and information, compare them against each other to identify cost insights and potential cost saving opportunities.
Prognos Should cost analysis tools
Prognos has supported purchasing organisations all the way back to 1983, enabling better negotiations and fact-based decision making. While the should cost methodology might seem like a daunting task, it doesn’t have to be. We offer two types of different should cost analysis tools to help you perform a should cost analysis. Contact us directly for a demo:
Prognos Online is a supporting should cost analysis tool, giving you access to all data you require to perform a should cost analysis on your own. It’s an interactive online tool capable of transforming the data to fit your needs. On it you get access to over 8 000 up-to-date indices on raw materials, components, wages, and currencies.
Should Cost Trackers
We also deliver Should Cost Trackers where we perform the should cost analysis for you. Our experts analyze the cost structure of your product and deliver a tailor-made report with indices for all included cost drivers. Do note this doesn’t result in the should cost for the specific product (the par value), rather a should cost development about how your price SHOULD have progressed until today.
What are the types of costs?
Differents costs for the procurement industry include:
- Raw materials
- Manufacturing costs
- Labour costs
- Transportations rates
- Taxation tariffs
The costs within these areas can be divided further into cost categories including:
- Fixed and variable costs
- Direct and indirect costs
- Product and period costs
- Controllable and uncontrollable costs
- Incremental and opportunity costs
- Out-of-pocket costs and sunk costs
- Imputed costs
What are some Should cost model examples?
A should cost model can be used for any type of product. Regardless if you’re offering cars, manufacturing parts, or food, the process of a should cost model is the same, analyzing the same cost factors applicable to an item:
- Material price
- Labour costs
- Overhead, freight, toll, tax and other costs
- Profit margins
What is a should cost estimate?
The cost estimate from a should cost analysis is simply the cost calculation of what a product/part/service is estimated to cost in regards to different cost drivers including: materials, labor, overhead, and profit margin.