What Is Should-Cost Analysis?

Definition

Should-cost analysis estimates what a product or service should cost under specified assumptions about materials, components, processes, and overhead. Its purpose is to make the economics behind a supplier offer understandable rather than treating the quoted price as an unexplained number.

A should-cost model is an estimate, not a supplier's audited cost record. Formal modeling guidance emphasizes making cost scope, assumptions, uncertainty, and limitations visible to decision-makers.

How to build a useful should-cost model

The UK Cabinet Office's guidance, written for public procurement, recommends proportionate model complexity, relevant data, testing, and comparison of assumptions and scenarios. VPP applies the general discipline of transparent cost modeling without treating UK public-sector requirements as rules for private companies.

• Define the requirement: Fix the specification, quality standard, volume, delivery conditions, and time period being modeled.
• Identify the cost drivers: Separate material consumption, process time, labor, overhead, packaging, and other relevant inputs.
• Document the evidence: Record which inputs come from supplier data, market references, engineering estimates, or assumptions.
• State the commercial allowance: Show how profit, risk, or other market factors are treated rather than hiding them within operating costs.
• Test sensitivity: Identify which changes could materially alter the result.
• Use the model in dialogue: Ask the supplier to explain material differences and revise the model when better evidence becomes available.

For a first analysis, prioritize the inputs most likely to change the decision. More decimal places are not a substitute for stronger evidence.

Example: Turning a price gap into specific questions

Consider a hypothetical purchased component with the following unit economics. Assume the model and quotation cover the same specification, order volume, freight scope, and commercial conditions.

The $0.52 difference is an analytical question, not automatically recoverable savings. In this example, VPP would investigate whether the model understates material loss, setup frequency, capacity constraints, warranty exposure, or another requirement included in the quote.

The assumed 10% is a markup on cost, not a 10% margin on selling price. Keeping that distinction explicit prevents the example from embedding an inconsistent profit calculation.

Should-cost versus target cost

Should-cost analysis builds an estimate from the economics of the requirement, while target-cost analysis works from market price, volume, and profit objectives to determine an allowable cost. A business's desired cost is therefore not, by itself, proof of what a supplier can sustainably deliver.

VPP recommends using the difference between the target and the modeled cost to frame options. Those options may include specification changes, process improvements, volume commitments, or a different supply arrangement rather than a price demand alone.

Frequently asked questions

• Is an open-book supplier required? Not necessarily; should-cost models can use relevant data and explicit assumptions, with uncertainty made visible. VPP recommends identifying unsupported inputs and testing them rather than presenting assumptions as facts.
• Does the model establish the correct market price? It establishes an estimated cost under defined circumstances, not a guarantee of the price available in the market. Use qualified supplier engagement to test commercial feasibility.

Make negotiations more specific

VPP connects category intelligence with operating knowledge to turn broad price discussions into questions about actual cost drivers. Start with the assumptions that matter most to the sourcing decision.