The drivers of raw materials and manufacturing costs are vital to maximizing cost savings. Limited visibility into these factors and the comprehensive production process can impact component pricing significantly, making it more challenging to find ways to reduce costs.Should cost analysis is an effective tool that empowers the procurement team to provide cost forecasts to suppliers and formulate an accurate final cost estimate for negotiations.
Should Cost Analysis
Should cost analysis was developed by the Defense Department to help procurement officers determine fair and reasonable pricing. Now, should cost analysis is required for government procurement processes due to the Federal Acquisition Regulations.In the past few decades, should cost analysiswas adopted by a variety of industries for outsourcing, including Cisco and Apple. This type of analysis determines what a product should cost based on the costs of overhead, labor, materials, and profit margin.A should cost model can help you:
- Estimate the cost of products or components before the Request for Quotation process
- Understand supplier cost structure
- Facilitate in-depth discussions between engineers and suppliers in the beginning phases of design
- Negotiate costs and collaborate with suppliers without negatively impacting the supplier margin
- Develop evidence-based comparisons between technical solutions
- Verify supplier cost quotations
Benefits of Should Cost Analysis
Should cost analysis offers deeper insights into supplier profit margins to gain purchasing power. Once the key cost drivers are identified, the procurement team can choose which components tomanufacture or purchase.Performing an analysis also assists with price comparisons on parts and assembly if they’re outsourced to different locations. For example, the procurement team can evaluate the costs of having a product manufactured in the UnitedStates or overseas and learn how that decision can impact profit margins.
With strategic sourcing, should cost analysis can be a valuable tool to ensure supplier negotiations are favorable and profitable. By evaluating the supplier’s strengths and quality, the procurement team can determine if the supplier can meet the business’s current and future needs.Finally, should cost analysis can help with sourcing the best materials for the budget. Procurement teams can learn how different materials affect the cost and decide if a different material is a better choice. In some cases, cheaper materials may not outweigh concerns of performance or quality.Accurate cost estimations are crucial to a business’s profitability. If the cost of a product or materials vary considerably from the estimate, it can eat into profits and negatively impact bottom-line performance. Depending on the current cash flow, a loss of profits can cause a business to go under.
Strategic Sourcing vs. Should Cost Analysis
Many businesses rely onstrategic sourcing to determine costs, which consists of requestion quotes and comparing prices to find the best deal.Should cost analysis takes an entirely different approach and seeks to understand the underlying material and labor costs that impact the final price. This estimate is then used to negotiate the final prices.Both methods have merit for different businesses. Here are the advantages and disadvantages of each method:
Strategic sourcing, on its basic level, is a comparison of prices. More advanced strategic sourcing gathers spend data and uses it to drive negotiations, which can be complicated in large companies.Despite this shortcoming, strategic sourcing has been a successful and widely implemented method in most US industries. In fact, strategic sourcing is a contributing factor to US-based manufacturing being outsourced to lower-cost global regions.If products and suppliers are abundant and similar, competitive pricing with strategic sourcing can be beneficial. If the products are asymmetrical or rare, price comparisons alone miss a big part of the picture. In this case, strategic sourcing can’t illustrate the differences in performance and quality.
Should Cost Analysis
Should cost analysis examines the materials and labor required to create a product. This is especially useful with asymmetrical or rare materials, components, or suppliers, which can vary widely in quality and performance.In asymmetrical markets, few high-quality manufacturers will lower prices based on competition alone, especially if they know the competitors have inferior products. These contractors are more likely to negotiate with procurement teams that have a direct and informed negotiation that involves true costs and options to lower them.Should cost analysis isn’t appropriate for every product or business, however. Many businesses can get the information they need from strategic sourcing alone. As mentioned, this is true for businesses that source similar products from similar suppliers, all with comparable quality and performance.Another consideration for should cost analysis is that the procurement team must understand the product and the processes necessary to produce it, from raw materials to final quality-control inspections. The accuracy of should cost analysis relies entirely on the knowledge of the team building the model. Failure to properly conduct the analysis can significantly impact the accuracy of the final estimate.
How to Conduct Should Cost Analysis
The first step in should cost analysis is compiling the parts and processes necessary to produce a product. This may include specifications, assembly procedures, models, drawings, and testing protocols. The analysis should take place early in the product life cycle, so that any issues can be identified and corrected before the full production run.
The second step for should cost analysis is analyzing the processes and planning, considering compliance regulations, and compiling material costs. This may include equipment and machinery, labor, manufacturing locations, and overhead.
The third step of should cost analysis is outlining the batch quantities and annual volumes to define cost parameters. At this stage, all aspects of the processes and materials are clearly defined.
The fourth step of should cost analysis is determining outputs, which include:
- Graphs for key cost drivers
- Cost parameters with a full breakdown of the processes and factors
- Processing time for each individual process
- “Breakeven” cost as it relates to production volume
The final step of should cost analysis is reporting, which provides a comprehensive summary of the findings. This includes:
- Piece part cost, or the cost of a single component without other factors
- Itemized breakdown of processes, setup, materials, processing time, and rejects
- Non-recurring engineering cost estimate, or the one-time, upfront costs for product research, design, development, and testing
- Amortizationcost, or accumulated portion of the recorded cost that’s considered an expense through depreciation or amortization
For over 30 years, Galorath has guided organizations in their approach to complex, specialized projects to develop an in-depth understanding of financial decisions. We can take the guesswork out of your projects and provide answers to the most difficult questions, no matter the industry or challenge.Contact ustoday to learn more about our software solutions for cost estimation, projectplanning, and execution!