Your supplier says they’re giving you the best deal. They promise they are saving you tons of money compared to their competitors.
But something in the back of your head tells you otherwise.
The supplier didn’t budge in negotiations during your last RFP. Nothing was gained, and the supplier said they actually had to raise prices, regardless of your business with them. They were the lower bid compared to the other bidders, but you still think that you’re not getting the best pricing.
Enter the Should-Cost Analysis
A should-cost analysis is a detailed breakdown of what a material or service should cost compared to what a supplier wants to charge for it.
Once complete, companies can compare their analysis against the bids of potential suppliers, or the pricing of a current supplier.
While there are some programs out there that enable companies to do this, a spreadsheet can generally fill this need.
Dig Into the Details
Should-costing is an in-depth process, and can take quite some time.
We will use a hammer as an example.
In order to should-cost the hammer, you will need to find out what kind of metal is used to make the hammer head. By weighing it, you can determine how much of that metal is used. Is there a rubber handle? Strip the rubber off and weigh it to determine how much rubber there is.
With these weights you can now search online for the current price of the steel and rubber, and determine the cost of the amount of material used.
Was the hammer made in the U.S.? Or China? Include the base salaries of workers in the country the product is made.
How long does it take to make one hammer? How many people are on the assembly line for the hammer? Machinery is most likely used in the process, too. Using an internet search, you can find videos on how things are made to give you a general idea of cycle times and personnel on the production line. (This “How It’s Made” video is perfect for helping you should-cost hammers: https://youtu.be/7xHVyT5oEL4)
Along with this information, corporate overhead, shipping, and any warranties will need to be factored into your should-cost analysis. Many times you can ask the supplier – in supplier workshops or in the RFP itself – the percentage of overhead they include. Or, for publicly traded companies, they include this in their annual report.
Putting It All Together
Once all of your information is gathered, organize it and add it up in a logical format.
How does your should-cost analysis match the supplier’s pricing? Is the supplier’s margin close, and they actually are giving you the best pricing? Or is there a large delta that you need to discuss with your supplier?
This information is excellent leverage during negotiations. Calling out suppliers on too-high pricing gives your organization a major advantage.
Note: Do not show the suppliers your should-cost analysis! Giving them an idea of the difference in terms of a percentage is enough. If they ask for it – tough! They came up with their pricing, they need to explain it to you.
To give you an idea what this looks like, here is a rough example of a should-cost analysis for a mini-excavator that I did. Again this is very rough, and doesn’t include shipping and warranty data.
A should-cost analysis can be time consuming, but it is a valuable tool to your organization. With a solid should-cost analysis you and your team can gain a great deal of leverage over the suppliers you negotiation with.
Remember, this can be done with services, too. And, the more detailed the material or service analyzed, the more time it will take. But it will be time well spent!