What should-costing is: building the target price from the bottom up
Should-costing determines a target price from the bottom up. Instead of taking a supplier's quoted figure as the starting point, you reconstruct the costs a product or service genuinely incurs: raw materials, manufacturing steps, tooling, logistics, overhead and a reasonable margin, each justified on technical and market grounds. The result is a set of should-be costs that stand on facts rather than gut feeling.
This bottom-up view creates cost transparency exactly where it is usually missing. Once the cost structure is visible, it becomes clear where excessive margins, inefficiencies or unjustified mark-ups are hidden — and where they are not. The method is most valuable for complex products and custom-made parts, where no shelf price exists and the buyer would otherwise be arguing from experience alone. A should-cost replaces that with a defensible number and a line of reasoning behind every element of it.
Total cost of ownership and the comparison-price approach
A should-cost tells you what a single bid ought to cost; comparing rival bids needs a second step. The comparison-price approach converts every non-price difference into money, producing one total cost of ownership figure per offer. Adjustments come in two forms:
- Relative factors that scale with total cost and are expressed as a percentage, such as payment terms or maintenance.
- Absolute factors that are fixed amounts, such as set-up, switching or supplier-qualification costs.
Only the differences between bids matter — you price the gaps, not an exhaustive model. The effect is often a reversal: the lowest sticker price can fall behind once switching costs and weaker payment terms are added, while a slightly dearer incumbent proves cheapest on total cost. Because every qualitative judgement is now fixed in money, the comparison becomes fully like-for-like, and the tender can then run on a single variable rather than an argument over offers that were never truly comparable.
Cost transparency in monopolies and oligopolies
Cost transparency matters most where the market gives you least. In a monopoly or a tight oligopoly, genuine comparative offers are missing, so the usual benchmark disappears. A should-cost restores a reference point: from material prices, manufacturing processes and common market parameters you can state what the item ought to cost, independent of the single quote in front of you.
Where only one supplier exists, this lets you argue objectively why a price is excessive, and where savings might sit — through specification changes, alternative materials or economies of scale. It also sharpens a prior question: is this a genuine monopoly at all? Substitutes, adjustable specifications, make-or-buy options and your own demand power often reveal more room than assumed. A frequent error is to overestimate how much the supplier really knows about your dependency; the cost base is one piece of information you control, and can choose to bring to the table.
From the cost base to a solid negotiation
A cost base is only useful if it changes the conversation. Entering a negotiation with a transparent, comprehensible calculation signals that you understand the product and the market and have prepared. That shifts the tone from confrontation to a factual, step-by-step exchange on equal footing: not a blunt claim that the offer is too high, but a line-by-line account of where the quote and the should-cost diverge, and why.
The groundwork can start in the tender phase, by requiring a structured cost breakdown as a condition of bidding. This surfaces early whether an offer is realistic or whether re-negotiations are already pre-programmed. The payoff is best measured through the contribution margin of the incremental business, not the average margin: at a 5% contribution margin on the incremental business, a saving of EUR 100,000 has the same EBIT effect as EUR 2m in additional revenue. Building and defending that cost base rigorously is exactly where specialised procurement consulting comes in.