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Savings through Should-Cost: Building a Downstream Savings Roadmap

October 21, 2015 at 3:24 PM / by Wood Mackenzie Supply Chain

In our last three posts, we showed how downstream firms can use cost models and should-cost analyses to capture savings on chemicals and steel-heavy items.

Today, we'll demonstrate how to embed those analyses into a sustainable process for identifying savings and developing a roadmap to top market opportunities.

The Market Opportunity

As we all know, commodity markets have been favorable to the downstream market in the last year. Prices are down across the board, from metals to chemicals to fuel. But the challenge for downstream firms is to link commodity market declines to the items that you actually buy.

For instance, how does a 35% decline in steel impact your scaffolding, piping, or heat exchanger costs? How does a 20% decline in chemical prices affect your additives or catalysts? The challenge starts to magnify in complexity very quickly.

We believe that the answer lies in the cost model: a tool that helps you understand the cost breakdown of each of the items that you buy.

Below, we've included a simple cost model for tanks. As you can see by the slices of the pie, the cost of tanks and vessels is comprised 30% of steel, 18% of freight costs, and so forth.


But while cost models are powerful tools for understanding the make-ups of the items you buy, they're still abstract until they show how costs have moved with the market over time.

Imagine that you had an index for every slice of the pie that showed how that cost component moved over time. You could see, for instance, how the price of steel, freight, or even labor costs have recently moved. Combining all those indices would allow you to see a composite picture of how the full item has moved, allowing you to identify, in the case of our tanks example, that tank costs should have decreased 13% over the last year based on the market:


Data like this allows you to quickly identify which categories and items are heavily exposed to recent movements in the market. But of course, it's not just tanks that you're buying: you're also buying services, chemicals, catalysts, heavy equipment, and much more.

So how do you prioritize? With limited resources to strategically source new categories or renegotiate existing agreements, prioritization is a critical task for Supply Chain organizations.

Should-cost analysis provides the answer. By running should-costs on each of your items, you can quickly determine which areas of your spend present the greatest opportunity. The result is a savings roadmap that points the way to your strategic plan in the coming year.

For instance, the firm below identified which of their cost categories was heavily exposed to recent commodity declines and then compared their own pricing to the market. The result was a comprehensive strategic plan that helped set their organization's agenda in the coming months.


By embedding should-cost analysis in your organization, you too can easily develop a strategic roadmap for investing in the highest potential opportunities.

For more information on how to develop sustainable should-cost analyses, click here.

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