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What is Should Cost Analysis?


Should cost analysis ("should costing") was developed by the Defense Department to assist procurement officers in determining fair and reasonable pricing and today is embedded in government procurement practices via the Federal Acquisition Regulations (FAR). It was adopted by industry beginning in the 1980's, and today is the dominant technique used by best in class outsourcing companies like Apple and Cisco. Should cost analysis involves determining what a product should cost based on materials, labor, overhead, and profit margin.

Strategic sourcing: What you're doing today

The most common procurement method is strategic sourcing. Using strategic sourcing, supply chain professionals identify a range of potential suppliers, usually diversifying between size, capabilities, geography, and many other potential factors. The selected suppliers are then given the opportunity to quote. Supply chain analyzes the quotes to make a sourcing decision. This process is referred to as strategic sourcing. It is most appropriate when the suppliers products/services being procured are very similar, i.e. when purchasing catalog off the shelf (COTS) items from distributors.

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But what can you do if the item is custom? The prevailing answer is to use the same techniques used to procure COTS items. Buyers simply treat the custom package as if it were COTS, submit RFQ's to multiple vendors, and compare the quotations. The logic of strategic sourcing has worked well. By comparing quotations from multiple potential suppliers supply chain gains insights that can be used to leverage spend. It is largely responsible for driving offshore procurement as companies search for the lowest possible comparative quotation. Strategic sourcing is particularly useful to organizations that lack the resources to effectively analyze what the product should cost (basically, all of us!).

Should cost: What you'll be doing within 5 years

In contrast to strategic sourcing, should costing begins with an internal assessment of the product's expected cost. Generally, engineering helps assess the necessary labor, procurement gathers the expected material cost, and supply chain assigns expected labor rates and profit margins. Supply chain collects the costs and sums them to determine should cost.

In the case of printed circuit board assemblies (PCBA's), note that should costing still utilizes strategic sourcing. This is because PCBA's cost structure is typically 80% materials and it is not reasonable (even for Apple and Cisco) to fully analyze the fabrication cost of every component, so they must cost material using strategic sourcing techniques.

Most companies do not conduct should costing for PCBA's because they believe the process is to complex for their existing resources. Upon closer inspection, this is probably not true. Remember, materials is likely 80% of your PCBA cost. By simply taking control of your material cost you will have achieved 80% of your should cost goal. You can begin by requiring your suppliers to submit quotations with fully disclosed material costs (they won't like this!), then focusing your resources on negotiating directly with the component suppliers of the highest cost material. This will require a contract manufacturing partner who is willing to provide open book costing.

Should cost resources

There are a number of resources evolving that can assist you with a migration to should costing PCBA's. First, we strongly recommend the seminars conducted by Charlie Barnhart Associates. Charlie and his team conduct periodic seminars that teach you exactly how electronic manufacturing service companies price their services. They show you how to compare landed costs from every region in the country. Additionally, you can receive the results of Charlie Barnhart Associates in depth quarterly survey of detailed cost elements like labor rates, overhead rates, and profit rates from around the globe.

Another outstanding resource for your should cost toolbox is the component benchmarking reports available from Lytica. They are compiling a database of component prices using actual OEM quotations as their data source. They apply a number of statistical techniques to cleanse and normalize the data. 

Yes, should costing can get complex quickly. It's easier to just get a bunch of quotes. But the tools are evolving quickly to ease the task and we believe all OEMs who aspire to best practice sourcing will adopt some elements of should costing in the very near future. 

Next: Quick & Easy Should Cost Analysis