Education — Framework

Should-cost analysis: a step-by-step walkthrough for category managers

Only 4.6% of procurement teams use should-cost analysis. The other 95.4% negotiate from last year's price. Building an independent cost baseline — like getting an appraisal before buying a house — transforms negotiations from "how much more will we pay" to "explain the gap between this number and your quote."

4.6%

Procurement teams actively using should-cost analysis

Fewer than 1 in 20 teams — the widest awareness-to-adoption gap in procurement

14%

Average savings from should-costing

Like getting a 14% discount just by doing the math before walking into the meeting

80%

Of total spend negotiated without a cost baseline

4 out of 5 dollars negotiated blind — with only last year's price as reference

The Five Steps of Should-Cost Analysis

Map cost drivers, not just price history. Identify every input: raw material grade, weight, scrap rate, machine time, labor hours, overhead, and freight. Think of it as itemizing a receipt instead of looking at the total. A cost element is "materials." A cost driver is "3.2 kg of aluminum at $4.15/kg with 12% scrap."

Build the independent cost baseline first. Use published commodity indices, BLS labor data, and industry benchmarks — never supplier quotes. Like checking KBB before negotiating a used car price — you arrive knowing what the number should be. The baseline is only as good as the data that feeds it.

Engage suppliers after the baseline exists. Share your model and ask: "Where does our model differ from your reality?" The conversation shifts from "tell me your costs" to "here's what we think — correct us." This turns interrogation into collaboration.

Reconcile gaps and negotiate from evidence. Every gap over 5% becomes a specific question. If raw material costs are 8% above the commodity index — ask why. A gap that cannot be explained is leverage. A gap explained by a proprietary process that adds value is not.

Maintain the model as a living document. Update raw material indices quarterly, review labor assumptions annually, and rebuild when the category goes to market. A model built in January is obsolete by March without refresh. Extend lighter baselines to mid-tier categories for the next wave of savings.

The Most Common Failure

Risk

Collapsing steps 2 and 3 into one. The single most common failure: asking the supplier for a cost breakdown without building your own model first. The supplier's numbers become the baseline by default — and the buyer arrives at the table with nothing to validate any claim against. This is not should-cost analysis. It is supplier cost validation with a different name.

Two Ways to Approach a Cost Model

Common

Combine the baseline and supplier input into one step. Ask for a cost breakdown, compare it to a rough internal estimate, and call it should-cost. The supplier's quote becomes the baseline by default — there is nothing independent to validate against.

80% of spend negotiated blind

Correct

Build the model independently first using commodity indices and benchmarks. Only then engage the supplier: "Here's what we think. Correct us." Every gap between baseline and quote becomes a specific, evidence-based question.

14% average savings

Jargon Decoder

Should-cost analysis Calculating what a product should cost to make — materials, labor, overhead, margin — independently of any quote. Like getting an independent home appraisal before setting an asking price.

Cost driver A specific, measurable input that drives cost (e.g., "3.2 kg of aluminum at $4.15/kg"). Not a vague category like "materials." Think of an itemized receipt vs. a single total.

Cost baseline An independent reference point built from public data and benchmarks. Like checking KBB before negotiating a used car price — you arrive knowing what the number should be.

Commodity indices Published price benchmarks for raw materials — like stock market tickers but for steel, aluminum, copper, and other industrial inputs.

Overhead multiplier A factor applied to direct costs to cover indirect expenses — facilities, utilities, management. Like adding 30-40% to ingredient costs to cover the restaurant's rent and staff.

Build vs buy Deciding whether to manufacture a component in-house (build) or purchase from a supplier (buy). Should-cost analysis informs both sides of this decision by revealing true production cost.

Sources: Strategy & Business, Art of Procurement, Suplari, McKinsey, Inverto (BCG), Galorath, Deloitte 2025 Global CPO Survey

Rzzro

Procurement, quantified.