The ability to consistently get accurate cost estimates for new products and parts is elusive. Cost estimates are inherently imprecise, and the underlying drivers can change daily based on the price of a single material, a new union contract, or a supply-chain disruption. It’s a critical challenge for manufacturers working in tighter product development windows and with increasing pressure on profit margins.
Companies can overcome some of the uncertainty they face in product cost estimation with a practice called “should cost” — and deliver smarter design, strategic sourcing and faster time to market.
A should-cost is a projection of the total cost of a given component if manufactured and distributed efficiently. It accounts for a plethora of factors including labor, materials, overhead and profit margin, and is typically managed by dedicated cost engineers.
A should-cost model is a process and toolset for calculating should-costs. This can range from simple spreadsheets that tally raw material estimates to simulation-driven, physics-based software that analyzes cost drivers at a very granular level.
Done effectively, should-cost can serve as a strategic benchmark for cost engineering and provide a target procurement price to help source components more strategically, anchor supplier negotiations in quantitative data, and estimate procurement costs for new designs without waiting for supplier quotes.
Given the underlying complexity of product cost drivers, should-cost estimates can vary widely vs. actual, but they still provide valuable intelligence as a benchmark for supplier cost optimization efforts — especially since most supplier quotes are wildly imprecise to begin with. Manufacturers often see variances of +/-40% for the same part from three different suppliers.
Manufacturers use many different components, so conducting a thorough should-cost analysis of every item is not practical or worthwhile. Spend analysis is a way of prioritizing cost reduction efforts by analyzing purchases, identifying which functional categories are driving the most spending, finding root causes of cost outliers, and prioritizing corrective action. In these areas, achieving even a small marginal cost reduction via negotiation, resourcing or re-engineering can result in substantial dollar savings.
The following steps provide a high-level overview of conducting a spend analysis:
The more detailed, accurate and actionable a should-cost estimate is, the more value it provides. Should-cost negotiations are closely related to the concept of fact-based negotiation — focusing supplier negotiations on mutually beneficial data rather than gamesmanship. Should-cost is instrumental in developing the “facts” for these negotiations.
Generating actionable facts on suppliers’ product costs requires detailed insight into underlying factors including material costs, manufacturing process costs, labor costs, overhead and tooling/facilities Investments. Calculating how these areas interact to contribute to a component’s ultimate cost can be a complex analytical challenge. A tweaked material selection, for instance, may require a different manufacturing process only available at a different facility with far higher rental and transportation costs.
With these insights in hand, a supplier negotiation can be transformed from “this cost is too high” to, “could you use a laser for this operation instead of stamping?” or “Our manufacturing cost estimation system suggests this part could be over 50% cheaper. What aspect of our design is driving this discrepancy?” or “Our analysis suggests there’s a cheaper production method available for this component. Can we establish a timeline for shifting production/price to this approach?”
The idea is not just to reduce component cost directly but to remove adversarial negotiations in favor of a cost-reduction collaboration with suppliers. Detailed should-cost estimates help move away from “accusing” a supplier of having a price that’s too high and toward investigating why the price is so high. As more supplier relationships become integrated with this approach, components can be sourced from the supplier that has the most efficient production capability as opposed to the supplier who happened to make the most aggressive quote.
Spend analysis is just one valuable use case for a should-cost analysis. Others include:
The right technology tools are an essential enabler for a rigorous should-cost analysis. If it is not founded in detailed, design-level analysis, a should-cost estimate becomes just another arbitrary cost-cutting target. In addition to working far faster than manual, spreadsheet-driven should-costing processes, advanced manufacturing cost estimation tools provide detailed insight into the factors driving costs within the design itself.
Should-cost is being used by different types of manufacturers and procurement leaders to generate cost estimates that help build better products, anchor supplier relationships and accelerate time to market. Apply the steps outlined above to a project in your organization to see the value it can deliver for you.
Stephanie Feraday is CEO of aPriori, a provider of digital manufacturing simulation software.
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