What’s the cost of your Bill of Materials (BOM)? That’s a tough question to answer, isn’t it? From material prices to supplier margins, different aspects of a product’s cost exist. Then, there are taxes, labor costs, and industry standards. It might seem simple, but calculating product cost is complex. However, it is important to make informed financial decisions and guide your strategy. After all, product cost can significantly impact profitability.
That’s why selecting the right cost analysis method is so important. While many businesses traditionally depended on partner and supplier quotes, top organizations now rely more heavily on should-cost analysis for greater accuracy. Using a should-cost analysis tool or should-cost analysis software streamlines this process, offering detailed insights into your supplier cost breakdown analysis. If you’re wondering how to do should cost analysis, adopting a should costing methodology ensures consistency and reliability in your calculations.
What is Should-Cost Analysis?
Should cost analysis is a strategic approach used in manufacturing and procurement to determine a product or service’s expected or “should-be” cost. It breaks down every aspect of a product’s design, materials, manufacturing process, and supply chain to understand the true cost of production. At its core, should-cost analysis is about gaining visibility into the cost structure of a product.
Why is Should Cost Analysis Important?
Should cost analysis is one of the best cost analysis methods used by various industries for outsourcing because it helps in
- Estimating costs of products or components early before requesting supplier quotes.
- Gaining visibility into supplier cost structures.
- Having meaningful discussions between cost engineers and suppliers during early design phases.
- Negotiating effectively without compromising supplier profitability.
- Creating evidence-based comparisons between different technical solutions.
- Validating supplier quotes with detailed cost verification.
In short, this approach ensures that manufacturers aren’t overpaying for goods or services while maintaining high-quality standards.
Also Read: The Limitations of Excel in Modern Cost Estimation: Why It’s Time to Upgrade
Is Should-Cost Same as Sourcing Cost Analysis?
Sourcing cost analysis is often used instead of should-cost analysis, but both differ. Should cost analysis software and should-cost analysis tools focus on calculating the theoretical cost of a product based on materials, labor, overhead, and profit margins.
On the other hand, sourcing cost analysis evaluates the total cost of acquiring goods, including supplier costs, shipping, taxes, and other external factors.
Both the cost analysis methods are important for businesses to identify gaps between actual costs and the ideal costs. How? Should cost analysis pinpoint factors that impact pricing, such as raw material costs or production inefficiencies. It also helps in performing a supplier cost breakdown analysis to compare suppliers and determine the best value options using a structured should costing methodology.
Benefits of Should Cost Analysis
- Cost Reduction: Highlights unnecessary expenses and inefficiencies.
- Improved Decision-Making: Provides data-driven insights for procurement and production choices.
- Greater Efficiency: Streamlines production processes by eliminating waste.
- Supplier Accountability: Ensures suppliers give fair pricing.
- Innovation Opportunities: Identifies areas for redesign or alternative materials to reduce costs.
The Role of Should Cost Models in Analysis
To accurately analyze the should-cost of a product, certain frameworks are used that typically consider:
- Material Costs: The cost of raw materials is included in the production.
- Labor Costs: Time and wages involved in production.
- Overhead Costs: Indirect expenses like utilities and maintenance.
- Profit Margins: Expected profit for the supplier or manufacturer.
These calculations can typically take weeks. Modern tools, such as AI-driven platforms or cost estimation software, can perform these calculations faster and more accurately.
How to Do Should Cost Analysis
Step 1. Gather Data
There is one most important factor in should cost analysis and that is product knowledge. Before doing the analysis, get a deep understanding of the product and its production process. Having this knowledge puts businesses in the upper position during the procurement and negotiation stage.
To begin, collaborate with the design, engineering, and procurement team. Also, engage with the suppliers for better understanding of different components and how quality impacts the cost. Market research is also important at the beginning stage of analysis to get a picture of the current market price of materials to be used in the product. It is also the first step of doing cost analysis which we will discuss in the following points.
- Design Specifications: View blueprints, CAD models, or design documents to understand the product’s dimensions, features, and tolerances. These details are critical for understanding material usage and production methods.
- Material Requirements: Identify all the materials used for production, including their types, grades, and quantities. Knowing these details helps you choose more affordable materials.
- Production Processes: Understand how the product is made. This includes details about machining, assembly, surface treatments, and packaging.
- Supply Chain Data: Gather information on the cost of transportation, storage, and supplier terms.
Step 2. Break Down Costs of Each Component
To get an ideal estimate, break down the costs into materials, labor, overhead, and logistics categories. This will also give you an idea which category is consuming the most resources and help you explore ways to optimize them using a should-cost analysis tool or should-cost analysis software.
Step 3. Compare with Industry Standards
Look at data from similar companies or industries to understand typical cost structures. For example, the average labor cost for your region’s widget manufacturing. Study the prices of comparable products to gauge competitiveness. Use past internal data from similar projects as a reference point.
Benchmarking helps you identify if your costs align with expectations or if there are opportunities for improvement.
Step 4. Analyze Gaps
With benchmarks in hand, analyze the differences between the actual costs (what you’re currently paying) and should-be costs (what the costs ideally should be).
- Cost Discrepancies: Highlight areas with costs higher than expected.
- Root Cause Analysis: Identify the reasons behind these gaps. It could be due to inefficiencies, outdated processes, or a lack of supplier competition.
Step 5. Collaborate with Suppliers
The next step is to engage with suppliers in constructive discussions. The goal is to achieve mutual benefits without affecting the manufacturer-supplier relationship.
Industry Applications of Should Cost Analysis
- Automotive: Evaluating component costs and supplier pricing for vehicles.
- Aerospace: Ensuring cost-efficiency in high-value, complex parts.
- Electronics: Managing pricing for rapidly changing technology components.
- Consumer Goods: Optimizing costs for large-scale production of everyday items.
- Healthcare: Reducing expenses for medical devices and equipment.
Each application tailors the analysis to meet specific industry challenges and opportunities.
Conclusion
Should cost analysis be for every industry, from core manufacturing, such as aerospace, to new industries, like retail and CPG. It gives a true overview of the actual cost these industries will spend on product manufacturing. However, estimating a diverse and large product catalog is difficult with traditional should-cost analysis. Automation and modern software for cost optimization are, thus, important for implementing this cost analysis method without heavy expense.
