Should-cost modelling: a practical guide for buyers

When should-cost is worth the effort

• High-volume, high-spend components where a few percent moves the number
• Bespoke items with no market benchmark
• Categories with a small supplier base and limited competitive tension
• Any sole-source or single-source renegotiation
• New product introduction where target costing is required

The cost driver tree

Every should-cost model breaks price into five buckets:

• Direct material: specification, grade, yield, scrap and indexed input prices.
• Direct labour: cycle time, labour rate for the geography, indirect labour ratio. EU hourly labour costs range from around EUR 11 to EUR 55 depending on the country, with wages and salaries making up roughly three-quarters of total labour cost ^[2], so geography is a first-order variable, not a rounding error.
• Machine / process: machine rate, setup time, tooling amortisation.
• Overhead: factory overhead, SG&A, freight, packaging, duty.
• Margin: a defensible profit assumption for the supplier's segment.

Where the data comes from

Those PBL and Eurostat ranges are also the reason a should-cost model has to be built bottom-up per category: input-cost structure varies far too much across geographies and sectors to apply a single benchmark ^{[1, 2]}.

• Public commodity indices (LME, ICIS, Argus, Eurostat) for raw materials
• Regional labour rate databases and manufacturing benchmarks
• Reverse-engineered bills of materials and teardown analysis
• Supplier RFI data, filed accounts and analyst reports
• Internal engineering estimates: the most under-used source

From model to lower price

The model does not negotiate for you. Three moves make it pay:

• Anchor: open with a target price grounded in the model, not the current price minus 5%.
• Decompose: discuss line items (material, labour, overhead) not the total. It changes what "reasonable" looks like.
• Index: agree pass-through mechanics tied to public indices so future moves are automatic, not negotiated.

Should-cost model example

The table below is an illustrative example with hypothetical numbers. It is not a client case. It shows a moulded plastic housing bought at 10,000 units a year, quoted by the incumbent at £1.45 per unit.

In this hypothetical case the gap between the quote and the model is £0.35 per unit, or £3,500 a year at 10,000 units. The gap is a question to put to the supplier, not a saving yet: the supplier may have costs the model has missed.

Should-cost analysis in a negotiation

Share the structure of the model, not every number. Ask the supplier to explain the largest gaps line by line, starting with material and cycle time, where the evidence is strongest. Where the supplier shows a real cost the model missed, update the model and move on; where it cannot, the gap becomes the basis for a lower price.

Keep a credible alternative in view. A should-cost analysis carries most weight when the supplier knows other suppliers have been asked to quote, and when price changes are tied to public indices rather than annual requests.

Common failure modes

• Model built once, never refreshed as indices move
• Engineering builds the model, procurement does not use it in the room
• Margin assumption too aggressive: supplier walks or quality slips
• No fallback if the supplier refuses to open the books

Related reading

Should-cost is one lever in a wider set. See the seven-lever cost reduction playbook and the sequenced strategy guide for how to combine it with demand and specification work.

We apply should-cost models inside our cost reduction consulting and procurement consultancy work, using classified data from a spend analytics baseline and applying the same logic to sourced goods under product sourcing.

If you want help applying should-cost to your own contracts, our cost reduction consultants use it in every renegotiation, and an independent product sourcing agent can test it against quotes from other suppliers.