The short answer
What should a product or service cost?
A should-cost model builds an independent estimate from the resources needed to deliver something: materials, labor, overhead, logistics and a stated supplier profit assumption. It gives you a structured way to question a quote. It does not prove what a particular supplier actually spends.
Build the cost before debating the price
Start with a specification and a unit: one finished part, one delivered project, or one month of service. Keep the geography, volume, currency, quality and delivery terms consistent. A low-volume domestic quote cannot fairly be compared with a high-volume offshore model that omits freight.
Ask which costs change with the work and which are allocated. Machine setup spread over 100 units costs more per unit than the same setup spread over 10,000. For a service, hours by role often matter more than a materials estimate.
- Materials: quantity per unit × unit price, adjusted for expected waste.
- Labor: hours per unit × an explicit hourly cost. State whether benefits are already included.
- Overhead: define the allocation base. Do not add benefits or factory costs twice.
- Landed costs: freight, duty, packaging and required delivery costs.
- Supplier profit: state whether the assumption is a margin on price or a markup on cost.
References: McKinsey: What should it cost?
Worked example: $85 of cost becomes a $100 price
Our fictional component uses $45 of materials, $20 of labor, $15 of overhead and $5 of delivery. Total cost is $85 per unit. A 15% margin on selling price means $85 ÷ (1 − 15%) = $100. The supplier earns $15, or 15% of the $100 price.
A 15% markup would instead produce $85 × 1.15 = $97.75. Its margin would be $12.75 ÷ $97.75 = 13.04%. These two conventions answer different questions.
Against a $112 quote, the modeled gap is $12 per unit. At 10,000 units, the annual gap is $120,000. Call it a modeled opportunity until you confirm achievable pricing, volumes, transition costs and service requirements. It is not booked savings.
Try it yourself
Build the price from the cost
Fictional per-unit costs in USD. Margin is a percentage of selling price. All other costs stay fixed when you change an input.
| Cost or price component | Per unit |
|---|---|
| Materials | $45.00 |
| Labor | $20.00 |
| Overhead | $15.00 |
| Delivery | $5.00 |
| Total modeled cost | $85.00 |
| Modeled supplier profit | $15.00 |
| Modeled selling price | $100.00 |
A positive gap is an investigation opportunity, not realized savings.
Turn a price gap into a better question
Separate a questionable assumption from a genuine operating difference. The supplier may face a higher wage rate, a smaller production run, more testing, a longer warranty or a different shipping obligation. A model is most useful when it makes those differences discussable.
- Request evidence for the largest cost drivers, not every immaterial line.
- Test volume, waste, utilization, lead time and payment terms.
- Compare quality, delivery reliability and switching cost alongside price.
- Track negotiated savings against a documented baseline after implementation.
References: McKinsey: Using should-costs to reduce does-costs
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Common questions
A few useful clarifications
Can I use a should-cost model for services?
Yes. Build the delivery effort from hours by role, rates, software or equipment and overhead. Check capacity, rework and scope. Do not assume that billed hours equal productive delivery hours.
Can AI build the model?
AI can help organize supplied evidence and draft questions. Keep arithmetic in a spreadsheet or calculator. Label missing inputs and verify any proposed benchmark before using it in a negotiation.
Sources & scope
Reviewed October 9, 2026. Numerical cases are fictional teaching examples, not current market quotes or individual advice. Assumptions appear beside each calculation. Rules, program requirements and source material can change.
- McKinsey: What should it cost?Consistent scope, geography and cost assumptions.
- McKinsey: Using should-costs to reduce does-costsInvestigating gaps between modeled and quoted costs.
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Practice procurement and sourcing
Use the full course workflow to connect the model to a sourcing recommendation.