In the early 1990s, a procurement executive at Ford Motor Company arrived at a supplier negotiation with something unusual: a cost model showing, to within a few percent, exactly what it cost the supplier to make the component in question. The supplier’s initial position collapsed within minutes. The technique — should-cost modelling — has been standard practice in automotive procurement ever since.

What Is Should-Cost?

Should-cost is a bottom-up cost estimate built from first principles: raw materials at market rates, direct labour at local wage rates adjusted for productivity, factory overhead as a multiple of labour cost, selling and administrative expenses, and a reasonable target margin for the supplier category. The result is a defensible, auditable estimate of what the product ought to cost — independent of what the supplier chooses to quote.

The gap between the should-cost figure and the supplier’s quotation is your negotiation room. It is not a guess or an aspiration. It is a mathematically grounded target supported by cost engineering data.

“Walk into every negotiation with a number, not a feeling. The supplier who knows you’ve done the cost build-up negotiates differently — and so do you.”

The Origins: Defence and Aerospace

Should-cost modelling has its roots in US defence procurement. By the 1960s, the Pentagon was using detailed cost models to challenge defence contractors’ quotes on systems where no competitive market existed. The methodology was formalised in FAR (Federal Acquisition Regulation) Part 15, which requires cost or pricing data from sole-source suppliers above defined thresholds — a legal recognition that quoted price and actual cost are different things requiring independent verification.

Toyota’s adaptation of the technique as part of their supplier development system in the 1970s brought it into commercial manufacturing. By requiring suppliers to open their cost structures and working jointly to reduce them, Toyota built supply chains that were simultaneously lower cost and higher quality — a combination that conventional price negotiation never achieves.

The Four Cost Buckets

Every manufactured product’s cost decomposes into four elements: materials (typically 40–60% of total cost), direct labour (10–25%), factory overhead (15–30%), and SG&A plus margin (10–20%). The proportions vary by industry, automation level, and geography, but the structure is universal. Should-cost modelling is the discipline of estimating each bucket from external data rather than accepting the supplier’s internal allocation.

The Labour Efficiency Problem

The most commonly miscalculated element in cost models is labour. Direct labour rate is not direct labour cost. A worker paid ₹180/hour who is 85% productive in a facility with 12% absenteeism has a true labour cost of approximately ₹250/effective hour. The difference between the rate and the cost is what suppliers exploit when buyers focus only on wage benchmarks.

Using Should-Cost in Negotiation

The should-cost figure is not your opening position. It is your anchor. Present it as a model, not a demand: “Based on our analysis of material costs at current market rates, typical labour productivity for this process, and a reasonable margin for your category, we estimate this product should cost approximately ₹X. We’d like to understand where your cost structure differs from our model.”

This approach does three things: it establishes that you have done serious analysis, it invites the supplier to explain legitimate cost differences rather than defend a number, and it positions any gap as a shared problem to solve rather than an adversarial position to win.

The result is not just a better price. It is a better supplier relationship — one built on cost transparency rather than information asymmetry.