Should Cost Panel

How to Turn Cost Data into Business Impact

Should-cost models have been around for a while, but only a handful of manufacturers have figured out how to use them as tools for collaboration rather than contention with suppliers. Even fewer have figured out how to get engineering, procurement, and suppliers to agree on accurate should cost numbers. So, what makes a should-cost model credible? What makes it actionable? And how do you present should cost data in a way that drives real negotiation outcomes? That’s what we’re exploring today in this should-cost panel led by aPriori.

April Guenet: Welcome to our panel chat about how should-cost data drives tangible business impact. Today I’m joined by Ashok Kaliyaperumal, Cost Analysis Center Lead at Danfoss, and Wendy Sifuentes, Commodity Manager Team Lead for North America at Signify.

What Key Factors Make a Should-Cost Model Credible?

What are some key factors that make a should-cost model credible, both internally and with suppliers?

Wendy Sifuentes:  I think what we have found by having this methodology applied to our negotiation and integrated into our way of working, is there are three fundamental aspects. One of them is the data accuracy and granularity. Real data, real-world cost data, I think that’s a key factor and fundamental. Another very fundamental aspect is the transparency of the methodology. Be very clear on the framework of what you are trying to achieve and how. And most importantly, the last one is the collaboration and supplier engagement. I think that not only should the should-cost methodology be brought right in front of the suppliers, but it should also be framed as a cost collaboration. I think that’s a very important and fundamental aspect of what we have seen here in Signify.

3 Key Factors that Make a Should-Cost Model Credible

1. Data Accuracy
2. Transparency of Methodology
3. Supplier Engagement

Ashok Kaliyaperumal: In the early days, it was really difficult to explain what should-cost was internally. There are people who don’t really believe, and it varied between the competence and understanding of our internal people. Once we got going, it helped to explain by opening the tool and showing how the calculation was done, based on hourly rates and so on. That built internal confidence. And then on the outside with our suppliers, we give a very crisp and simple report to procurement, which gives them confidence to use with those offers.

How to Shift Suppliers From Price to Cost

April Guenet: When you start going into supplier negotiations, how do you tend to introduce should-cost? Have you found any specific techniques to help shift the conversation from pricing to cost drivers when talking with your suppliers in negotiation?

Wendy Sifuentes: I’m passionate about that topic, because we try to make it a cost collaboration effort and not a negotiation. It’s different when you just come back and say, “Your price is too high.” We never use that. Instead we try to say, “Let’s analyze your cost.”

Let’s make this a win-win situation because this will work in both ways. Not only for price reductions. Nowadays is the best example ever. We have a lot of things going on. Market pricing has already started rocking up everywhere. Aluminum market pricing just increased 45% in the last two months. When you have a clear understanding of your should-cost and how different elements impact your pricing, it’s an easier conversation.

Ashok Kaliyaperumal: We use more or less a similar way what Wendy was mentioning. And then on top of that, that is an annual executive Business Review Meeting, or BRM, which happens where we present all of their journey with Danfoss, and then what are we looking ahead to accomplish in the next two to five years. We ask what new business they are getting into, and what kind of initiatives, for example, on sustainability and so on. And then we basically amend the signed contract during that time.

In that business presentation, we also put their top 10 or top 20% of should-cost analyzed parts with their current price. Then we say, “Okay, you need to reduce somewhere around 3 to 5%.” So we don’t dictated the cost or the price that we need, and we don’t put a value on what it is. But we say this is a window three to five percentage we might need. And then list down the top three to five cost drivers. So maybe it’s raw material optimization, or process optimization, or batch size optimization. We put that in front of the team.

That goes to the executive, the CEO, or the supplier listens to that, and then there is a commitment, and the pressure builds up at the supply base. It is cascaded into the manufacturing teams. And then we give some time frame, like maybe six to eight weeks in which they work it out. So to sum up, it is not a straight should-cost presentation. It is part of the regular supplier relationship management.

April Guenet: How do you incorporate supplier feedback into your cost models without losing leverage?

Ashok Kaliyaperumal: After we started building confidence with procurement teams in the early days, we agreed with the procurement team to involve us in the negotiations. It could be a virtual or an on-site negotiation sometimes when the business case is very big. Then we also get an alignment with procurement to map the supplier machine park and get more details on their overheads and financial model. We don’t get everything that we ask. But we do as much as we can before we go for negotiation, before putting the targets to our suppliers. Then we try to come back and revisit our digital factory. If possible, we try to build a copy of the digital factory with supplier A. If not, we try to add similar processes, materials, and so on. Then we redo our cost calculation and present it back to the procurement partner. Then, after the negotiations, there are always some new hidden black boxes that are opened by the supplier. For example, “Oh, my volume has dropped, my labor rate has increased, there are some sustainability requirements from the local government, I need to buy green power,” and so on.

So what we do is if we are on the spot, if our questioners are there in the meeting, then we open the scenario, and those points are taken straight away. Then we say, “Oh, your electricity price has doubled, but the power price will go up only by 2%.” This we can simulate on the spot. Sometimes his has worked well. But we have to be really careful about what do we share on the spot, particularly with our cost engineers. That’s why we ensure that the cost engineers who travels to our supply place has a strong procurement background so that they know what to spill and what not to.

April Guenet: So you have that prep work with your procurement team ahead of time? And then when you go into it, you can update some things on the spot, but maybe other things you say, “Let’s come back to that and evaluate it further.”

Ashok Kaliyaperumal: Exactly, yes.

Wendy Sifuentes: From our side, it’s similar. We always put all this data in front of our suppliers and allow them to come back and tell us how it aligns with their own numbers. I think that’s important to hear them out because having shared that feedback between them and us, it’s really important. But also, we usually come back with benchmarking. Because while we’re doing a net scenario with one supplier, we usually have done at least two or three scenarios with similar suppliers in the same region. So we can share that benchmark.

You also encourage your supplier to collaborate with you to try to have a little bit of granularity in how they present their numbers. I think that has worked very well in the past. It has created a safe environment for them to come back with real data, with real numbers, and keep adjusting themselves and challenging their own internal cost. And I think that has been very successful on our side.

Speaker 1: To learn how you can negotiate better based on accurate should-cost models, visit apriori.com/podcast. There you’ll find a link to our guide on should-cost analysis and negotiation.