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Benchmarking and Cost Modelling for Successful Procurement: The Basics of a Good Process

The procurement process can be a daunting task for any business. There are lots of

different cost models to choose from, and each one has its benefits and drawbacks. Cost

modeling is the process of predicting how much money will go into production before

anything comes out – it's essentially an estimate of what something should or must cost.

Benchmarking is the practice of gathering data about past performance on projects

similar to yours and using that information to predict your future costs. It's important not

only to know which type of model you're using but also when you should use them to get

accurate results with minimal wasted time.

Cost modeling is a must to ensure the project you are managing has all aspects of cost

accounted for. Here's how it can help in planning, budgeting, forecasting, and

performance management...

There are four types of cost modeling tools. These are: must cost, should cost,

benchmarking, and total cost. The right type of tool will get you good results and save you

lots of wasted time. The wrong type can lead to poor procurement performance, higher

costs, or both. Any one of these tools can be used to drive TCO reduction. Let’s take a

look at when each model should be used to achieve the best outcomes.

’Must Cost’ Model

This model is a budgetary constraint model. It is not standard practice to tell a supplier

what the budget is, however, this is the one exception to that rule. The ‘Must Cost’ model

is used when you don’t have enough finance for what you need to purchase and you

know that price exceeds budget under all scenarios.

In this scenario, you would approach the supplier giving details of your exact budget and

requesting a proposal from them on what they are able to offer in terms of a custom deal

to match your budget. Whether it’s changing the scope of work or the specifications, or

some similar solution to reduce costs in line with your available budget. If the supplier

initially states they are unable to help, simply give them 48 hours to go away and think

about it. They will almost always come back with an innovative solution to enable the deal

to happen.

‘Should Cost’ Model

This model takes into account the three components needed for a usable should cost:

labor, material, and logistics.

‘Should costing’ can become very complex very quickly and can take a lot of time and

resources. Therefore, the only time this should be used is in the case of a custom product

or service, or a sole-source provider.


The ideal time to use benchmarking is in the case of undifferentiated products or services

ie. when the customer is indifferent to which supplier is chosen as long as the product /

service is the same. The process is a very simple but powerful one of comparing various

suppliers to ascertain which one can provide the lowest total cost solution.

‘Total Cost’ Model

This model should be used when there is a material difference between the acquisition cost

and total cost.

We don’t always consider the total/lifetime cost when making a purchase and often only

focus on the initial acquisition cost. However, this can be a big mistake as further costs, later on, may make certain purchases that appear to be the best deal initially, the most

costly as a whole.

Another important cost-saving practice during your supplier negotiations Is that you don’t

just think about variable costs and expect only purchase price discounts based solely on

variable costs. Securing your business may be helping them to dramatically reduce their

average fixed cost per unit and therefore the supplier must know you are aware of this

and that you are expecting purchase price discounts also based on The average fixed

cost per unit reduction that is coming from your business.

Key rules and cost modeling strategies:

  • Have a team in place that has visibility to the various cost components

Whenever you are involved in a big negotiation it is important to have a team in place that

has visibility to the various cost components ie. finance, accounting, receiving.

  • Differentiate between assumptions, estimates, and facts

Assumptions and estimates introduce risk and variability into the cost model and these

need to be minimized as much as possible.

  • Start with basics and add complexity later

The more complex a cost model is, the higher the likelihood that it is wrong. The smaller

and more basic it is, with the fewest assumptions and estimates the more accurate and

successful it will be.

  • Do ‘what if’ cost model analysis instead of just ‘what is’

Innovation is an important factor. Ask questions. Ask ‘what if we did this?’, ‘What if we

changed this?’, ‘What if we removed this?’, ‘What if we eliminated that process?’ Always

try to do cost analysis based on ‘what could be’.

  • Do Pareto analysis on data findings

Pareto was a French economist who said that 80% of the costs are going to be in 20% of

the transactions. It makes sense to focus on the largest expenses and start with the most

expensive components to drive reductions there first to ensure the biggest impact in cost


  • Separate controllable from uncontrollable costs

Some costs are mostly uncontrollable. The focus should be on eliminating these to enable

focus on controllable costs.

When it comes to procurement, hopefully, it’s now clear that having the right cost

modeling tool can make all of the difference. You need a plan that is tailored specifically

for your organization’s needs and provides you with accurate numbers every time. This

article has offered some insight into when each model should be used; now it's up to you

to decide which one might work best for you and the negotiations you are involved in.

What are your thoughts on these different types of models? Which of these keys to

success do you think will be most beneficial for you in your negotiations?

Let us know in the comments below and be sure to let us know if we can help you further.

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