Supply Chain

What is Should Cost Modeling?

The purpose of Should Cost Modeling is to ensure that your organization can minimize the difference between Should Cost and Actual Cost. Learn how you can effectively manage the difference between "Should Cost" and "Could Cost."

What is Should Cost Modeling and how you can understand the difference between "Should Cost" & "Could Cost."

The purpose of Should Cost Modeling is to ensure that your organization is best positioned to minimize the variance between Should Cost and Actual Cost(s). Products, equipment, raw materials, and services always have an ideal or target cost, entire programs can be based on this data. As a procurement professional or team, your role is to minimize unforeseen costs by purchasing the right materials for the best price possible. This responsibility is overlayed with consideration of factors such as commercial negotiation position and transactional costs such as logistics. I would be remiss not to mention the responsibility for ensuring everything is available on time too. How can we ground ourselves in this data and become more effective in the procurement space? 

Effective Should Cost Modeling:

Positioning ourselves to separate the Should Cost from Could Cost in order to find true cost savings and security in the strategic approach.

Many procurement teams take a penny-wise and pound-foolish approach by misinterpreting the Should Cost for “Could Cost” while analyzing Should Cost Modeling data. The raw data within the model is still valuable. However, the approach or interpretation of your analysis is most optimal when you take into account the entirety of the lifecycle costs and note the relationship or interdependencies that are occurring. If we choose to leverage the qualitative burden against the quantitative (raw data), a distinct competitive edge can emerge. There are endless opportunities to pursue to drive down costs, but we need to be grounded in the reality that one solution likely won't fit all. Prioritizing the reduction in cost drivers against your procurement team and organization's overall goals provides better insight into the initiative that suits your needs best while still maintaining an account of the actual cost. 

An Everyday Example of Should Cost Modeling

Let’s start with an everyday example that most of us face due to rising commodity prices: gas purchases. Say for our hypothesis, a gas station on the other side of town averages $.10-.15 cheaper per gallon. It’s about 10 miles away from your home. If your tank contains 12 gallons of gasoline and assuming a fuel consumption of 20mpg it averages 1 gallon to get there and back, you would spend an additional $4-5 just to fill up there. Does that negate the $1.20-$1.80 savings to fill your tank? Now, if your tank holds 25 gallons, it looks a little bit more reasonable, but have you considered your time as a commodity or the wear and tear on your vehicle?

Should Cost Modeling Mistakes

Often when organizations perform Should Cost Modeling, they make similar mistakes to our fuel purchase example: not all variables are considered. It’s important to understand the difference between what things could cost under absolutely ideal circumstances compared with what they should cost when you consider your unique business conditions. Common examples include:

  1. Organizations paying extra for shipping to order cheaper commodities or not considering total logistics costs when examining on-site and off-site labor rates.

  2. Direct purchases to remove markup without an assessment of the indirect, internal resources responsible for assuring a usable purchase, for example, technical requirements are met, coordination of the set down and storage is agreed upon, reallocation of purchase costs to the project budget, etc.

  3. Negotiating Supplier discounts without a comprehensive understanding of the buying power you do or do not hold due to lack of transparency into 3rd and 4th tier purchases.

Should Cost Modeling has the potential to deepen your understanding of the cascading implications of a chosen procurement strategy on the construction project's ecosystem. To provide the most optimal tool for your team or organization, as you collect data, first ask yourself:

"What could these products or services cost” 

Then be critical with your analysis from a frame of:

“But should it cost this?"

The goal of this modified approach should bolster your confidence (qualitative) in existing commercial strategies through the interpretation of raw data. Simultaneously providing yourself a data-driven view highlighting specific opportunities to bring confidence back into existing decisions and where a change of strategy would equate to quantitative savings.

Should Cost Modeling on easy mode

So how can you determine whether your organization utilizes Should Cost Modeling to get the best final price? My suggestion is to start by avoiding the most common mistakes. The biggest mistakes I see organizations take:

  1. Misunderstanding labor burdens:
    Time is valuable. In order to save money on procurement costs, organizations may impose additional administrative burdens on highly skilled employees.

  2. Under-valuing existing suppliers:
    Your suppliers are integral to the success of your business. Their experience in helping you optimize your overall spend is invaluable. Approach them as a partner and build trust through transparency.

  3. Qualitative vs. Quantitative:
    There are trade-offs to all decisions. The best overall procurement strategy for your organization must be able to show the incorporation of qualitative and quantitative costs. 

  4. Disregarding existing conditions:
    There is an ideal price for everything. However, it’s just that: ideal. You wouldn’t drive 2 states away to save a few pennies. The gas alone would cost more.

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