Procurement matters! In many industries the procurement quote (=% of supply costs) is well over 50% of the total costs. Especially in product-related procurement, the supplier contribution to the end products is often crucial. This blog provides an alternative – should costing- to the traditional procurement approach and offers a checklist to determine when it is better to consider switching to should costing.
Traditional procurement uses a three-step-approach: demand bundling, competitive sourcing and quotation comparison. The buying price is determined by negotiating the best bid. When performed well and under the right conditions, this approach often results in savings. However, when performed with the same suppliers year-after-year, savings may decrease. One cannot squeeze juice out of the same lemon, time and again. In addition, the price reference of the buyer is still based on the prices offered by the suppliers and lacks a factual substance. There are good alternatives to quotation comparison: should costing can boost procurement’s contribution to product costing. Should costing is a process, whereby one can determine the cost of the part or product, based on the raw materials used, manufacturing costs and overhead production costs, by identifying major cost drivers. The result of the should cost process – a detailed cost breakdown- can be used during supplier selection and enables “fact based” negotiation.
Main drivers for should costing
There are three drivers that determine if should costing in procurement makes sense:
- Component impact on procurement: consider should costing when the impact is high;
- Supply dependency: consider should costing when the dependency is high;
- Market options: consider should costing when the options are low.
Should costing checklist
Our checklist (see figure) contains eight indicators for you to determine if switching to should costing in procurement will make sense for a particular product category, or list of items:
- Items purchased in large quantities: are the items bought in high volume?
- Big contribution to end product: do the components determine the end product’s total cost and/or value?
- Single source supplier: are you bound to one supplier?
- Fixed design: is there repetitive buying of static, unchangeable components?
- Tailor-made components: is the supplier solution designed-in, only for you?
- Stretched product life-cycle: are supplier contracts long-running, because of a long-running end-product?
- Scarce alternatives/high switching costs: are you locked-in and is competitive sourcing no option?
- Expertise lies with supplier: are you dependent on your supplier expertise?
When answering “yes” more than 3 times, should costing is a good option. Five times, or more “yes”, means should costing is unavoidable. As a specialized consultant, we at Tarlunt can offer you a structured approach to should costing. Our should cost toolbox consists of: product teardown, piece price calculations, cost analysis, should-costing and target costing and fact-based negotiation.
Just consider: what would happen when buyers would know the true price of the goods they purchase?