Expanding the Scope of Should-Cost Analysis
Spend Matters welcomes a guest post by Joel Johnson of GEP.
“Should-cost analysis” or “clean sheeting” is an advanced procurement technique primarily employed in the direct material space. The approach involves modeling the raw material and conversion costs of a good, allowing for a better understanding of a supplier’s overhead, profit and manufacturing efficiency. Clean sheeting has traditionally enabled negotiations for specialized products with high costs and limited supplier alternatives.
The should-cost method is considered an advanced procurement practice due primarily to the complexities of statistical modeling along with the material and conversion cost databases required to build accurate projections. The margin for error is often high, leading multiple organizations that I have worked with to revert back to competitive sourcing events as the preferred mechanism for obtaining market-competitive prices. Despite these challenges, most large companies recognize that is it a best practice to understand a specific supplier’s cost structure as it relates to major direct material purchases. This same best practice is also increasingly common within the space of indirect materials and services.
A should-cost approach to indirect purchases, particularly those more specialized in nature, informs negotiations and enables supplier development programs. While it certainly does not make sense for an organization to spend time clean-sheeting costs for hundreds of cataloged MRO commodity items, there are certain products and service categories that lend themselves to this approach. The spend profile of an organization along with the degree of specialization of purchases are two primary factors to consider when identifying categories. For example, an organization with an expansive and complex truckload or intermodal transportation network could benefit from a clean-sheet exercise. Factors to be evaluated for each major supplier would include fleet, fuel, maintenance, technology, employee, and overhead assumptions. Done effectively, the visibility into margin levels and operational efficiency on dedicated lanes creates a more dynamic negotiation environment and relationship management framework than solely evaluating the supplier’s quoted cost per mile. It also creates the potential for make-versus-buy- scenario analysis. Specialized categories such as design, engineering, and construction services also lend themselves to this type of approach.
The balance of time to value is much more delicate when evaluating should-cost analysis as a technique within the space of indirect procurement. Increased visibility and transparency into cost structures are always an asset to procurement teams. However, those benefits must be weighed against the time, effort, and accuracy to determine the areas of greatest opportunity.
For more interesting thinking on procurement, visit the GEP Knowledge Bank.