Cost Breakdown: products vs. services, and negotiation
Objective: Adapt the Cost Breakdown method to services (whose structure differs from products) and use the should-cost as a basis for negotiation.
Method for products (5 steps)
- Disassemble: Break the product into its components (bill of materials, BOM)
- Price the components at market prices: Use the reference indices and databases
- Estimate the transformation: Machine time, operator time, energy according to the routing
- Apply overheads and margin: Overheads (10-15%) + normal sector margin (5-10%)
- Compare with the supplier price: Identify the gaps item by item
Method for services
The cost structure of services is fundamentally different from products:
| Cost item | Typical % | Content |
|---|---|---|
| FTE cost | 55-70% | Fully loaded salaries of consultants, operators, agents |
| Management and supervision | 8-15% | Line management, project manager, account management |
| Tools and technology | 5-12% | Software licences, hardware, infrastructure |
| Overheads | 8-15% | Premises, HR, finance, management, insurance |
| Training and upskilling | 2-5% | Initial training, certifications, knowledge management |
| Margin | 5-15% | The provider's EBIT |
🏢 Example: Should-cost of a call-centre service
The provider charges EUR 32/hour for a call-centre agent. Let's rebuild the should-cost:
| Item | Calculation | Amount/h |
|---|---|---|
| Loaded agent salary | EUR 28K/year / 1,600 productive hours | EUR 17.50 |
| Supervision (1 for 12) | EUR 38K / 12 / 1,600h | EUR 1.98 |
| Tools (CRM, telephony) | EUR 200/month / 160h | EUR 1.25 |
| Premises and overheads | 12% of direct cost | EUR 2.49 |
| Training | 3% of direct cost | EUR 0.62 |
| Total cost | EUR 23.84 | |
| Margin (8%) | EUR 1.91 | |
| Should-Cost | EUR 25.75 |
Gap: 32.00 - 25.75 = EUR 6.25/h (i.e. 19.5% of the invoiced price, or +24% versus the should-cost)
Using the should-cost in negotiation
Two possible approaches depending on the context:
Collaborative approach (open-book)
Share the should-cost with the supplier and work together to identify gaps and optimisations. Suited to strategic suppliers in a partnership logic. Goal: joint optimisation, gain sharing.
Competitive approach (confrontation)
Use the should-cost as a negotiation basis without fully sharing it. Ask targeted questions on the items with the largest gaps. Suited to leverage suppliers. Goal: bring the price down to should-cost level.
Key negotiation questions
- What is your machine utilisation rate on this product? (to check the machine item)
- How do you explain a material cost of EUR 15.75 when the LME index gives EUR 13.50? (to challenge the material)
- What is your overhead/direct-cost ratio? (to check the overheads)
- What productivity do your operators achieve on this routing? (to check the labour)