During any new packaging development process, business often asks Procurement: "How much should this product cost?" Unless the Procurement resource has expertise in "should-cost" modeling, the most common "solution" is to check similar product prices or ask for a quick supplier quotation.

This lack of price understanding creates multiple points of value leakage across the packaging life-cycle, including price creep and lack of continuous improvement. In some cases, buyers have been hit with double-digit cost escalation over the course of a two- to three-year contract due to inefficient price management. 

Using should-cost price modeling helps reduce price uncertainties, promotes mutually-beneficial relationships with suppliers and can elevate the role of procurement within the organization to that of a strategic collaborator in product development and re-engineering.

Comprehensive price models go beyond supplier price drivers to consider both internal customer and market factors. But these data requirements can act as a deterrent to some firms' willingness to embrace cost modeling.

With our infrastructure of supply market experts and real-time market data, we have built detailed cost models, drawing from our firsthand experiences with hundreds of customer sourcing and cost improvement projects.

Whether you're building your own model, or leveraging the expertise of a third-party, building a meaningful should-cost model takes several steps:

Step 1: Define desired depth. Start with these key questions: What are the key cost components of your product? What cost components can be addressed by your organization? What variables are dynamic and cause value leakage?

A comprehensive cost model is the goal, but start with the areas that generate the most cost and therefore have the most urgent control need. 

Step 2: Develop an internal baseline. Before approaching suppliers to discuss price, you'll need to establish a baseline by collecting, validating and converting internal requirements (such as product specifications and order sizes) into an analyzable format. Having in-depth and organized data sends a strong message to suppliers that you have done your homework and are ready to continue serious discussions.

Step 3: Sell the cost modeling idea to your suppliers. When a customer has a detailed price model, it poses a risk to the supplier that their information can be used against them or will simply be leveraged to negotiate a better price with the incumbent. Many suppliers will gladly give customers their best-and-final offer price, but hesitate to engage in the cost driver dialogue because they fear how the customer will use the data. A multi-step approach with Top-to-Top meetings may be required to build trust and confidence with suppliers. 

Step 4: Avoid common mistakes. Such as:
• Focusing exclusively on supplier margins. While margins need to be competitive to earn the business, over-emphasizing them forces suppliers to hide margin and cost components in the elements of cost structure and provokes defensive behavior.

• Ignoring internal drivers. The largest portion of supplier cost is driven by decisions made by customer business and R&D stakeholders regarding packaging specifications and requirements.

• Expecting the price model alone to drive the best price and product. Buyers and suppliers should closely monitor the market for changes in raw material costs, conversion technologies and product innovations—and challenge each other to explore new opportunities. 

Following these four steps can help your organization establish a should-cost modeling discipline and help drive considerable savings. And once you've got a good system in place, it's all that much easier to monitor and ensure that you maintain the maximum level of savings.

Vladimir Ryabovol

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