Should Cost Analysis can be termed in one word as a cost estimator. It is a process of determining what a product should cost based on the cost of the input materials, the cost of production and profit margins. It assists the supply chain professionals to seek a fair and reasonable price from the suppliers and enables strategic sourcing for components and parts. A should cost analysis model helps the procurement and finance function to understand the impact of individual elements on the products pricing strategy and helps them to make well-informed decisions based on supply market intelligence. For the procurement leaders, understanding what determines the cost of a product is the pivot around which the entire procurement function revolves.
The concept of should cost analysis was the brain child of the U.S. Department of Defense who continuously strived to improve the government’s ability to monitor pricing and drive cost savings opportunities. It has become an important part of the government procurement process and has been included in the Federal Acquisition Regulation (FAR). Today, should cost analysis can be applied to a variety of industries such as manufacturing industry, automotive industry, retail and consumer packaged goods (CPG) industry. It helps the management to gain knowledge about the pricing strategies and its effect on their supply chain, helps build a strong supplier relationship management and drive profitability. However, organizations often shy away from leveraging this cost modelling technique as they find it too complex and time consuming.
What do organizations follow to determine the product cost?
Business entities have termed the new age should cost analysis as something beyond their understanding. This is because they are accustomed to traditional product costing methods such as cost structure analysis, activity based costing and strategic sourcing. There is no doubt that these are effective cost analysis methods but there’s a flip side to it. These cost methods are often one-dimensional, rigid, costly and difficult to scale across functions or cost elements, and they do not help in building a strong supplier relationship. As a result, the organizations fail to take into consideration the 360-degree view of the supply market, competitive landscape and trends in the industry.
Future trends in procurement: Should cost analysis
Businesses require tools and methodologies, like should cost analysis, that help them to ascertain the price they should actually pay, squeeze supplier margins to the bare minimum and receive the best possible quotes for sourcing materials and parts. In business, organizations don’t get what they deserve, they get what they negotiate. Similarly, the should cost analysis model will enable the organizations to negotiate well with the suppliers, thereby creating a win-win situation for the buyer as well as supplier. It will facilitate collaborative development, improve the product quality by leveraging supplier insights, mitigate potential supply chain risks and have a bigger shot at driving profitability. As against the traditional costing methods in use, should cost model will help organizations to determine the set up cost to ascertain optimum order quantitates and inventory levels.
Organizations can reap several benefits and create a competitive advantage by integrating should cost analysis in their supply chain processes. At SpendEdge, we help our clients to have a first-mover advantage in their specific industry by providing actionable insights to make well informed sourcing and procurement decisions
Types of cost analysis
Marginal Cost Analysis:
Marginal cost is the additional cost incurred by producing one more unit of a good or service. Marginal cost analysis involves examining the impact on total costs when the level of production or output changes by a small amount. This type of analysis is particularly relevant in scenarios where the goal is to determine the most cost-effective level of production. The principle is that if the marginal cost of producing an additional unit is less than the selling price, it is generally considered profitable to increase production.
Life Cycle Cost Analysis (LCCA):
Life Cycle Cost Analysis considers all costs associated with a product, process, or system over its entire life cycle, from design and production to operation, maintenance, and disposal. This comprehensive approach helps decision-makers assess the total cost of ownership rather than just the upfront costs. LCCA takes into account factors such as maintenance expenses, energy costs, and disposal costs, providing a more holistic view of the economic implications of a decision.
Activity-Based Costing (ABC):
Activity-Based Costing is a method that assigns costs to activities based on their use of resources. It involves breaking down the organization’s operations into various activities and allocating costs to those activities based on the resources they consume. ABC provides a more accurate and detailed understanding of how costs are incurred within an organization compared to traditional costing methods. This type of analysis is particularly useful in identifying areas where costs can be reduced or optimized by improving the efficiency of specific activities.