Comment: Using should-cost modelling strategies to absorb rising costs

Should-cost modelling can accelerate cost savings, closing the cost gap that often exists between the business environment of months or even years ago, compared to that of today, say Paul Cooper, director, and Gareth Hall, managing consultant at management consultancy, Vendigital.


While inflation has fallen to 3.2 per cent according to the latest figures, a prevailing climate of rising costs and uncertainty has taken its toll on manufacturers across industry sectors. In some cases, passing rising costs on to customers may no longer be an option, leaving margins squeezed to the bone.    

This seeming perma-crisis has also involved global factors that have disrupted supply chains, leading to delays in receiving raw materials, production bottlenecks and delayed outputs. Faced with this ongoing disruption, it comes as little surprise that businesses have scaled back plans to invest in new equipment or technological innovation. Instead, strategies have focused on survival rather than expansion. 

Despite inflationary cost pressures starting to ease, manufacturers will find it takes time to feel any benefit. With many businesses securing raw materials up to 24 months in advance, the challenges currently facing manufacturers are expected to continue for some time yet. To alleviate pressure on margins in the meantime, manufacturers are looking to make efficiencies wherever possible by reducing costs. 

Should-cost modelling is a technique that helps manufacturers understand cost breakdown at a component, product or even factory level. It is a forensic form of cost analysis that considers all factors such as the cost of raw materials, direct labour, indirect spend, business overheads, manufacturing, transportation, shipping and more. Commonly, around 80 per cent of product costs are baked in during the development phase. By conducting this in-depth analysis and utilising third-party resources where appropriate, a business can gain an accurate understanding of the difference between what it is currently spending versus what it ‘should’ be spending on a particular component, product or process. 

Should-cost modelling allows manufacturers to set benchmarks and targets to inform strategic decisions. It can also help to reset processes and drive improvements that will positively impact margins by facilitating a culture of interrogation that prioritises efficiency and cost-effectiveness. For example, by stripping a product right back to its component parts, businesses can interrogate the design of the product to see where efficiencies can be made, perhaps by changing tolerance specification, raw materials or sourcing locations. 

Should-cost modelling data can also be applied more widely by the procurement function and its supply chain to deliver further efficiencies and savings. A more informed, data-based understanding of what costs should look like can empower manufacturers to re-negotiate contracts based on targets, consider alternative suppliers or even implement large-scale changes such as nearshoring to reduce shipping or other transport costs. Optimising the supply chain network can prove hugely beneficial. 

When applied effectively, should-cost modelling will increase competitiveness. For example, a mining equipment manufacturer found that it was losing market share as a global supplier of a key product-line used to process cement. Should-cost modelling enabled the business to take a 360-degree view of the product, assessing the cost of materials, sourcing, overheads and production processes, as well as profit and margin. A significant gap between the actual cost and the ‘should-cost' of the product was identified, allowing for components to be re-designed and re-negotiated with the supply base. This cost reduction initiative achieved an overall saving of 13 per cent on the product-line, rising to 30 per cent and higher on certain components. 

Manufacturers of any component or product can benefit from should-cost modelling. For example, in the automotive sector, a manufacturer was looking to reduce the cost of in-wheel motor technology and should-cost modelling was used to build a picture of each component’s actual cost. Value Analysis techniques were used to demonstrate which elements of the specification delivered the best value and which could potentially be reduced. A “make versus buy” analysis was also carried out concurrently to determine whether it would be more or less cost-effective to make certain components in-house.   

When considering should-cost modelling for the first time, it might be difficult for some manufacturers to know where to begin. Ideally, they should identify the products or processes that could deliver the biggest cost saving, or those where margins have been squeezed significantly, and break the product or process down into constituent parts to understand how large costs are built up.  

The empirical analysis of should-cost modelling demonstrates benefits quickly by enhancing profit margins on key components or materials. It also creates a cost-conscious culture that can be adopted across all areas of the business, including new product development. To achieve the best results, a business-wide approach should be taken, involving all departments from engineering design to manufacturing, procurement, supply chain and finance.

Once embedded, should-cost modelling can accelerate cost savings, closing the cost gap that often exists between the business environment of months or even years ago, compared to that of today. 

Paul Cooper, director, Vendigital 

Gareth Hall, managing consultant, Vendigital