I received a great question on a webinar I did today:  “What’s the difference between a should cost model and a landed cost model?”

This is a fun question to answer.  These two things could be the same in a certain application.  But how they are typically constructed and used in practice makes them distinct.

A should cost model is most commonly used to determine if a supplier’s price is fair in situations where there are too few suppliers for competitive bidding to yield that conclusion.  It is designed to answer what a product or service “should cost” when there isn’t enough information to estimate that intuitively.

A should cost model usually goes into great detail about the cost components of a product or service.  For example, for a piece of furniture, a should cost model would include line items for the cost of wood, the cost of fabric, the cost of hardware, the cost of labor, the cost of packaging, the cost of shipping, the cost of overhead, and the amount of supplier profit.  As such, a should cost model can be appropriate for both domestic and international purchases.

A landed cost model is more typically used in international procurement transactions.  The “landed” moniker implies that goods are landing via airplane or boat in a different country from which they were shipped.  Landed cost models are designed to determine costs associated with a product when the cost of international logistics are factored in.  Because competing suppliers are in different countries and logistics costs vary based on the country of export, landed cost models can be used to guide supplier selection.

Landed cost models don’t usually provide much detail about the cost of each component of a product.  They often just have one line item covering the final cost of the finished product itself.  The other line items go into detail on the costs of the international logistics involved in getting the goods from the supplier’s country to the buyer’s country:  inland freight in the supplier’s country, export duties, transportation between countries, import duties, inland freight in the buyer’s country, the cost of third parties such as customs brokers and/or freight forwarders, etc.

So, while should cost models and landed cost models both are used to help procurement professionals estimate the expenses for purchased products, there are some key differences between the two.  Apply the right title to the right model and look smart!

Charles Dominick, SPSM, SPSM2, SPSM3

Charles Dominick, SPSM, SPSM2, SPSM3 is the Founder of the Next Level Purchasing Association. Charles is also the Co-Author of "The Procurement Game Plan: Winning Strategies & Techniques For Supply Management Professionals."

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