Why Should-Costing Is Critical for Automotive Buyers in Supplier Negotiations?

Introduction

In the fiercely competitive automotive industry, where global procurement spend reaches hundreds of billions annually, every cost-saving opportunity is vital. Procurement professionals face relentless pressure to optimize costs while ensuring quality and fostering innovation. Increasingly, they are turning to should-costing as a strategic tool to drive value in supplier negotiations. Should-cost analysis involves calculating what a product or part should cost based on its raw materials, manufacturing processes, overheads, and a fair profit margin—rather than passively accepting a supplier’s quoted price. This data-driven approach provides a robust foundation for negotiations, enabling fairer pricing, stronger supplier relationships, and substantial cost reductions.

Industry reports suggest that should-costing can unlock average savings of 10–15% in supplier negotiations, a figure that translates into millions for automotive manufacturers. For example, a procurement leader at a major OEM once remarked, “Understanding costs at a granular level isn’t just about savings—it’s about staying competitive.” This blog post dives into the principles of should-costing, dissects the cost of a typical automotive part, explores its pivotal role in supplier negotiations (with a real-world case study), examines essential tools and techniques, and tackles common challenges with practical solutions tailored for procurement teams.

What is Should-Costing? Definition and Principles

Should-costing is a methodical approach to estimating the optimal cost of a product through a bottom-up analysis of its cost components—materials, labor, overhead, and profit. Unlike traditional costing, which leans on supplier quotes or past pricing, should-costing poses a fundamental question: “What would this part cost if produced efficiently with reasonable inputs and margins?” This shift in perspective helps uncover savings opportunities and supports negotiations grounded in facts, not assumptions.

Originating as a refinement of traditional cost estimation, should-costing gained traction as procurement teams sought greater transparency in supplier pricing. Its principles are particularly relevant in the automotive sector, where cost pressures are constant and margins are slim.

Key Principles and Objectives

Identifying Cost Drivers: This involves dissecting all elements—materials, labor rates, machine hours—that contribute to a part’s cost. For instance, a steel bracket’s cost might hinge on raw material prices, while an electronic module’s cost could be driven by labor-intensive assembly.
Cost Benchmarking: Compare the should-cost estimate against supplier quotes or industry norms. If a supplier quotes $10 for a part that should cost $8, it’s a cue to dig deeper—perhaps into material sourcing or process efficiency.
Fact-Based Negotiations: Armed with a detailed cost breakdown, buyers can challenge inflated quotes. For example, if raw material costs seem high, procurement can ask, “Are you sourcing locally, or is there a premium for imported steel?”
Design Optimization: Should-costing can reveal cost-saving design tweaks. Consider a case where switching from steel to aluminum for a non-critical part cuts material costs by 20% without sacrificing performance.
Predictive Insight: By modeling costs with current data and market trends, procurement can anticipate shifts—like a looming increase in copper prices—and adjust strategies accordingly.

Should-costing empowers procurement professionals with granular insights, balancing the informational advantage suppliers typically hold. It fosters collaborative, value-focused negotiations that benefit both parties.

Breaking Down the Cost of an Automotive Part

Effective should-costing hinges on understanding a part’s cost structure. Whether it’s a simple fastener or a sophisticated sensor, every automotive component comprises material, processing, overhead, and margin costs. Here’s a breakdown, illustrated with a hypothetical example: a brake pad.

Raw Materials (e.g., Metals, Plastics, Electronics): Often the biggest slice (40–60% of total cost), this includes base materials like steel or friction compounds. For our brake pad, friction material might cost $2 and the metal backing $1, totaling $3. Prices fluctuate with markets—procurement can cross-check against indexes like the London Metal Exchange.
Manufacturing Process (Fabrication & Assembly): This covers converting raw materials into a finished part, including labor and machine time. For the brake pad, pressing and heat treatment labor might cost $1, with machine operation at $0.50, totaling $1.50. Automation levels and production volume significantly influence this segment.
Overhead and Indirect Costs: Factory utilities, equipment depreciation, and administration typically add 10–15%. For the brake pad, overhead might be $0.50. High overhead could signal inefficiencies—like excessive scrap—ripe for negotiation.
Logistics and Packaging: Shipping and handling costs vary by part size and fragility. For the brake pad, this might be $0.20. For larger items like engines, logistics can be a bigger factor, requiring careful scrutiny.
Supplier’s Profit Margin: A fair margin—often 5–10% in automotive—ensures supplier viability. On a $5.20 brake pad cost, a 10% margin brings the price to $5.72. If quoted at $7, the $1.28 gap prompts questions about cost drivers.

This breakdown reveals where discrepancies lie. Studies show should-costing can yield 10–15% savings by aligning quotes with realistic costs, potentially saving millions across an automotive program.

Why Should-Costing Matters in Supplier Negotiations

Information asymmetry often tilts negotiations toward suppliers, who know their costs intimately. Should-costing levels this field, offering procurement a clear cost picture.

Leveling the Playing Field: A should-cost estimate equips buyers to question quotes confidently. If a part should cost €50 but is quoted at €65, the buyer can probe specific cost elements, shifting the discussion to facts.
Fact-Based, Collaborative Negotiations: Consider this dialogue:
- Buyer: “Our model shows material at $2 per unit, but your quote suggests $3. Why the difference?”
- Supplier: “We’re using a higher-grade alloy for durability.”
- Buyer: “Can we explore a cheaper grade that still meets specs?” This approach fosters collaboration, not confrontation.
Enabling Significant Cost Savings: Savings of 10–40% are possible, with consultancies like Inverto citing an average of 14%. These gains boost profitability or fund innovation, critical in a low-margin industry.
Strengthening Supplier Relationships: Transparent negotiations build trust. By seeking fair pricing, buyers signal respect, encouraging suppliers to address inefficiencies and deepen partnerships.

Should-costing transforms negotiations into strategic dialogues, enhancing resilience amid supply chain volatility.

Case Study: Should-Costing in Action

Nikola Corporation, an electric truck manufacturer, used should-costing to optimize tooling costs for plastic molded parts. Tooling, vital for components like dashboards, often costs millions, with supplier quotes varying widely. Nikola’s team, led by Rich Morabito, employed software to dissect mold costs—steel, machining, labor, and margins—against supplier quotes. They found significant overpricing, negotiating reductions that saved an estimated $20 million annually. This efficiency allowed a lean team of two to handle extensive analysis, proving should-costing’s scalability and impact.

Tools and Techniques for Should-Cost Analysis

Cost Breakdown Templates: Spreadsheets detailing cost elements offer a manual but thorough start.
Specialized Software: Tools like aPriori and Siemens Teamcenter automate cost estimation, integrating with CAD models and cost databases.
Cost Data Libraries: Up-to-date material and labor rates ensure accuracy, supplemented by market research.
Collaboration: Open-book discussions with suppliers refine models and uncover savings.

AI and platforms like VoltBridge enhance these efforts, connecting buyers with competitive suppliers, especially in e-mobility.

Challenges in Should-Costing (and How to Overcome Them)

Data Availability & Accuracy: Use benchmarks and supplier input; update regularly.
Time and Resource Intensity: Prioritize high-value parts; leverage automation.
Supplier Pushback: Frame should-costing as a partnership for mutual gain.
Complexity: Model sub-assemblies first; involve cross-functional teams.
Market Volatility: Incorporate scenario planning and flexible contracts.

Starting small and scaling up builds a cost-transparent culture.

Conclusion and Next Steps

Should-costing is a game-changer for automotive procurement, driving savings and partnerships through cost clarity. Begin with a pilot on a high-spend part, build a model, validate with suppliers, and integrate into processes using digital tools. It’s a mindset of continuous improvement—essential for navigating the industry’s cost pressures and delivering value.