Is the Should Cost Model Obsolete?

Q: Does anybody still use the “should-cost” model?

A: Yes, and if they don’t, they should start.

In my November 4^th weekly procurement update on Blog Talk Radio, I shared an audio excerpt from an A.T. Kearney podcast on how to build a should cost model, a product or industry specific calculation used to estimate suppliers’ costs to build/deliver a product or service.

Traditionally, should cost models have been used to figure out a supplier’s profit margin in advance of a negotiation to gain leverage and contract for competitive pricing. This is hardly in alignment with in today’s more collaborative, relationship-based corporate supply culture. In fact, Procurement Insights blogger and PI Window host Jon Hansen asked the question above: ‘Does anybody still use the “should-cost” model?’

Rather than making should cost models obsolete, I argue that collaborative supply management makes them more important than ever. When supply partners are working arm in arm to address business challenges or develop innovative new solutions, there must be open and honest visibility into costs. In a 2006 post on the topic (Should-Cost Modeling) Sourcing Innovation quoted vendor Akoya from a Spend Matters post as saying “When a purchaser knows what a part should-cost, then she knows what she should pay for it.”

This statement is absolutely true, and there is no reason why the next step needs to be limited to pressuring a supplier to lower prices, looking at alternative sources, or questioning the viability of requirements. A should cost model can (and should – pardon the pun) be completed together by the buyer and supplier. Any prohibitive or unknown costs can be addressed in a 360° approach – examining the supplier’s raw material costs and the buyer’s requirements as well as alternate sources, inventory management and transportation.

If we are to usher in a new era of collaboration in supply management, a better understanding of costs is essential. How can buyers and suppliers work together on common goals if the flow of information remains broken or one-sided? Charles Dominick, President of the Next Level Purchasing Association, said the following of should cost models, “Essentially, you are behaving as if you were responsible for manufacturing the item yourself” (Using a Should Cost Model in Negotiation).

To that point, if our supply management efforts are to result in synergy, there can be no offloading of responsibilities – let alone something as important as working to determine a workable cost model. If the decision is made to invest significant resources in a category, buyers can not be reliant upon suppliers to figure out the cost model, nor should they be secretive about their efforts to determine an efficient cost. Supply partners want everyone in the chain to make an appropriate margin. There is no reason why collaboration needs to preclude profit.

Does your company use should cost models? Do you feel that they are obsolete in the face of relationship-driven supply management strategy? Comment here to continue the discussion or join us on Twitter: @BuyersMeetPoint.