Procurement Intelligence: Should-Cost Modeling Drives Stronger Profitability

Tool provides clear understanding of the specific economics behind manufacturing a particular product or service

Omer Abdullah Color

Over the last 20 to 30 years, the procurement and supply chain space has substantially evolved and the executives running procurement organizations have, in turn, adopted far more progressive and sophisticated tools and approaches for the execution of their strategies. Also, with the increased recognition of procurement’s direct impact on the bottom line – and ultimately shareholder value—it’s no surprise that executives have had to look for more sophisticated ways to reduce total costs, improve quality and obtain value out of every phase of the process.

These changes have driven the need for not only more sophisticated procurement intelligence, but also technical tools that deliver insights that allow for tangible decisions. Should-Cost Modeling is one such tool, providing a clear understanding of the specific economics behind manufacturing a particular product or service. This helps the executive achieve a range of benefits – from improving efficiencies and delivering substantial costs savings, to improved supplier relationships.

Successful Should-Cost Modeling, whether done internally or through a specialist third party, requires the right mix of skills – from a thorough understanding of the industry, sector and commodities involved, to an expertise in financial analysis and cost accounting, to a solid grasp of market variables such as taxation, regulation, tariffs, rebates, and beyond.

If done right, Should-Cost Modeling helps an organization:

  • Understand the nature of individual cost elements for a particular product or service it buys—not just materials, but labor and energy costs, machinery used, shipping, etc. This drives stronger data and fact-based decisions, which lead to benefits including lower total costs and process improvements. 
  • Make critical decisions—from addressing make/buy recommendations, to determining the optimal location to manufacture a product, be it onshore, offshore or nearshore.
  • Negotiate with suppliers—if a supplier claims it needs to raise prices, Should-Cost Modeling can arm the company with a sound, fact-based counter-argument and/or ensure that the cost increase is justified.
  • Structure contracts—ensure a basis for structuring contracts, for example, formula-based pricing structures can be derived using the model’s calculations so that the key cost drivers can be directly linked to product prices.

Most importantly, effective Should-Cost Modeling should fundamentally help buyers and suppliers better understand each other’s businesses by providing a complete understanding of how pricing changes impact the supply chain. This leads to better, more informed decisions and a stronger partnership between an organization and its supplier. 

A Case Study: Should-Cost Modeling for a Vacuum Cleaner

A major consumer goods brand wanted to better understand the economics of manufacturing a vacuum cleaner in Mexico. To achieve this objective, they retained The Smart Cube to break down every aspect of vacuum cleaner manufacturing to understand each component’s contribution to the end price. Key to this process was thorough research involving primary and secondary research as well as technical analysis, allowing the team to understand and analyze the complexity of the product.  For example, while some parts were procured stock from China, others were custom made and hence had alternate implications on total cost.

Building out and vetting the final cost model involved a myriad of elements not only covering component and assembly costs but also energy, workforce, maintenance/repairs, packaging, transportation and customs fees among others.

The final Should-Cost model allowed the company to understand the intricacies of the cost structure for the product, enabled for an apples-to-apples comparison across suppliers and ultimately, achieved the lowest total cost outcome possible (thereby increasing profitability and shareholder value).

A Case Study: Should-Cost Modeling for Preprint Services 

A major consumer brand with significant commercial preprint needs deployed Should-Cost Modeling to better understand potential supply options. The analysis revealed that their vendor’s costs were more than 2x compared to other vendors in the industry. The research, plus the subsequent conversations, also identified that the supplier was not intentionally over charging the client, but rather still relied on manual processes in an area quickly moving towards the digital realm.

These insights enabled the client organization to better understand the supplier situation and offer them the opportunity to retain the business, but only if the supplier was prepared to invest in the technology and systems needed to innovate and remain cost competitive. In the end, effective Cost Modeling allowed the two companies to have an open conversation about costs and the supplier was able to retain the business of a valuable client.

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