Should Cost Model
Build a bottom-up cost model from first principles to establish what a product or service should cost — before supplier negotiations begin. Should costing gives you a defensible target price based on materials, labour, overhead, and a fair margin, rather than accepting whatever a supplier quotes.
Should costing is a bottom-up cost estimation method. Rather than anchoring to the supplier’s price, you independently construct a fair cost from its constituent elements and add only a reasonable margin. The resulting figure becomes your negotiation target — and the gap between it and the quoted price quantifies the negotiation opportunity.
Overhead covers factory fixed costs allocated per unit: rent, utilities, equipment depreciation, and quality control. Industry norms range from 15% (lean, high-volume manufacturers) to 45% (complex, low-volume production). Benchmarking supplier overhead rates is one of the most valuable intelligence activities in strategic sourcing.
Target margin should reflect a fair return for the supplier’s risk and capital. Setting it too low is unsustainable and damages supplier relationships; setting it at a competitor-validated rate gives you a defensible position in negotiation.
History of Should Cost Analysis
Should cost analysis was pioneered by the United States Department of Defense in the 1960s as a method for evaluating defence contractor pricing. The DoD found that contractors often priced bids based on what the government could afford or had historically paid, rather than actual production costs. Should cost audits — detailed independent cost estimates — became a formal requirement under the Truth in Negotiations Act (TINA) of 1962, later codified in the Federal Acquisition Regulation (FAR).
The methodology was subsequently adopted by the automotive industry in the 1970s and 1980s. General Motors and Ford developed internal should cost departments to benchmark component pricing against their own cost models, enabling supplier negotiations anchored to manufacturing economics rather than market price. Japanese manufacturers, particularly Toyota, developed parallel approaches as part of target costing — working backwards from a market price to set allowable cost targets for suppliers.
Today, should costing is a core competency in direct materials procurement across automotive, aerospace, electronics, and FMCG sectors. Software tools for detailed should cost modelling — capable of accounting for machine rates, country-specific labour rates, and material commodity pricing — are standard in leading procurement organisations.
How the Calculator Works
The calculator builds cost from the ground up in three layers. The first layer is direct cost: material + labour. The second applies the overhead rate to this base. The third adds logistics, tooling amortisation, and finally the margin multiplier to arrive at the should cost price.
The variance section compares your should cost to the supplier’s quoted price. A positive gap (quoted > should cost) quantifies the negotiation opportunity — this is the amount by which the supplier is pricing above a fair, bottom-up cost. A negative gap may indicate that your cost inputs are too high, that the supplier is cross-subsidising, or that there are costs you have not accounted for.
How to Use This Tool
Step 1. Gather commodity prices for raw materials. Use market price data from trade publications, commodity exchanges (MCX, LME), or supplier-provided material cost breakdowns if disclosed. Apply the volume-adjusted rate relevant to the supplier’s purchase scale.
Step 2. Estimate labour cost by researching prevailing wages in the supplier’s manufacturing region. For India, the Ministry of Labour publishes sector-specific minimum wages; actual rates in organised manufacturing typically run 1.5–3× minimum wage.
Step 3. Validate your overhead assumption. Overhead rates are industry-specific: 15–20% for high-volume electronics assembly, 25–35% for precision machining, 35–50% for low-volume complex fabrication. Use industry benchmarks or request an open-book cost disclosure from the supplier.
Step 4. Enter the supplier’s quoted price in the final field to calculate the price gap. Use this gap as the opening anchor for your negotiation, supported by your cost model as evidence. Even if you don’t share the model, having it increases your negotiating confidence and precision.