What Is Cost Modelling in Procurement?

Wednesday, 26 August 2026

What is cost modelling?

Three suppliers quote for a maintenance contract at $840,000, $910,000 and $1.2 million. The obvious reading is that the first is cheapest. A cost model asks a different question: what would it cost someone to deliver this? Work out the labour hours the scope requires, apply a realistic rate, add vehicles, parts, supervision and overhead, allow a reasonable margin and you arrive at a figure of your own. If that figure is $1.05 million, the picture changes. The $840,000 bid isn’t cheap. It has either misread the scope or intends to make the difference back through variations.

So cost modelling is the practice of constructing that independent estimate. It’s sometimes called should-cost analysis, which describes the purpose more plainly. The model breaks the deliverable into cost elements, applies rates and quantities to each and produces a build-up you can defend line by line and argue about in a negotiation.

It sits alongside price analysis without replacing it. Price analysis compares what is being charged, against other bids, previous contracts or published benchmarks, and it’s quick and often sufficient. Cost modelling costs more effort and tells you something price analysis can’t: whether the whole market is expensive, whether a low bid is sustainable and which parts of the price are fixed by the physics of the work rather than by the supplier’s commercial preference.

What goes into a cost model?

Most models start from the same building blocks. Direct materials and direct labour, both quantifiable if you understand the work. Indirect costs, meaning supervision, facilities, equipment, insurance and administration, which are harder to allocate and where most disputes about a model occur. Then supplier margin, which is legitimate and should be included rather than argued away. A supplier making no money is a supply risk you’ll meet later.

The other half of a model is what happens after purchase. The Chartered Institute of Procurement & Supply (CIPS) describes whole life costing as an estimate of the end-to-end cost of providing a service or procuring a product, and notes it’s typically applied where the item is strategic or critical to the organisation. Its related guidance on total cost of ownership groups the picture into four categories: the amount paid to the supplier, acquisition costs, usage costs and end-of-life costs.

That last category is the one people forget until it arrives. Disposal, decommissioning, data migration, exit assistance and the cost of getting a new supplier up to speed are all real. They are also the costs an incumbent has the least incentive to draw your attention to during a renewal discussion.

Whole-of-life costs are not optional in Commonwealth procurement

This is where Australian buyers have something firmer than good practice to point at. The Commonwealth Procurement Rules state that price is not the sole factor when assessing value for money, and that an official must consider the relevant financial and non-financial costs and benefits of each submission, including whole-of-life costs. The rules then set out what those costs could include: the initial purchase price, maintenance and operating costs, transition out costs, licensing costs, the cost of additional features procured after the initial procurement, consumable costs and decommissioning, remediation and disposal.

Read that list next to a typical tender evaluation and the gap is usually obvious. Transition out costs and the cost of features added after the initial procurement are precisely the items that never appear in an evaluation spreadsheet, and precisely the items that determine whether the cheap bid stays cheap. An official who has built even a rough model of those costs is doing what the rules describe. An official comparing quoted prices is doing something narrower and calling it value for money.

Where cost models go wrong

The most common failure is a model built on assumptions that the team hasn’t tested, because the data wasn’t available and the deadline was. It still produces a figure, and the figure carries the authority of a spreadsheet regardless of what went into it. Documenting which inputs are observed and which are estimated is unglamorous. It is also the difference between a model you can defend and one you can’t.

Precision beyond the available evidence is a related problem. A model that outputs $1,047,382 invites an argument about the last three digits when the labour rate underneath it is a guess within twenty per cent. Ranges are more honest and, in a negotiation, harder to pick apart.

Then, there is analysis that never gets done at all. Reviewing procurement across Australian Government entities, the Australian National Audit Office (ANAO) found entities conducting procurements where they could not demonstrate that value for money had been considered or achieved. A lack of competition is not an excuse. Even where a procurement involves a single tenderer under a sole source arrangement, value for money still needs to be demonstrated, and a strong rationale for sole sourcing, surveying the market and using benchmarks to assess offerings and prices are among the ways to do it. Entities that skip the assessment risk complaints and legal action.

When is it worth building one?

Not for everything. A model takes time, and the effort should track the value and risk of the spend. The large, recurring and strategically important categories are where it repays the work. So is anything where you suspect the price isn’t explained by the cost.

The clearest triggers are few. A sole supplier, where competition can’t tell you whether the price is reasonable. A renewal where the incumbent has been in place long enough that nobody remembers how the original price was built. A market where all the bids cluster suspiciously close together. A category where input costs have moved sharply and you need to know how much of that a supplier can legitimately pass through. And a make-or-buy decision, where you’re comparing an internal cost against an external price and need both on the same basis.

The awkward part isn’t the arithmetic, which is mostly addition. It’s deciding what to include, finding defensible rates when suppliers won’t open their books, and then holding the model in a conversation where the supplier knows their cost structure better than you ever will. AcademyGlobal (AG) runs a half-day Cost Modelling in Procurement workshop on that ground, covering should-cost analysis, total cost of ownership and using a model in a supplier negotiation within a probity framework, taught through group discussions and case studies.

If you want to test whether this is worth doing in your organisation, take the largest contract you’re renewing this year and try to explain how its current price was arrived at. If nobody can, that’s the one to model.

Frequently asked questions

What is the difference between cost analysis and price analysis?

Price analysis compares the price being offered against other prices, such as competing bids, historical contracts or published benchmarks. Cost analysis examines the underlying cost elements that produce the price. Price analysis is faster and often sufficient. Cost analysis tells you whether the price is reasonable when comparison alone cannot.

What is a should-cost model?

An independent estimate of what a product or service ought to cost, built from materials, labour, overhead and a reasonable margin. It gives a buyer a defensible target to negotiate towards and a way to identify which elements of a quoted price are driven by cost.

What is included in total cost of ownership?

Purchase price, acquisition costs such as delivery, installation and training, usage costs including maintenance, consumables, energy and support, then end-of-life costs covering decommissioning, disposal and transition to a replacement. The later categories are routinely underestimated and frequently exceed the purchase price over a long asset life.

How accurate does a cost model need to be?

Accurate enough to change or confirm a decision, which is usually less precise than people expect. A model that establishes whether a price is roughly right, clearly high or unsustainably low has done its job. Chasing precision the input data can’t support wastes effort and makes the model easier to attack.

Do you need supplier cost data to build a model?

It helps considerably, and open-book arrangements are worth negotiating where the relationship allows. Without it, models are built from published input prices, industry benchmarks, award wage rates, your own operational data and reasonable engineering estimates. A model built from external data is less precise and still far more useful than no model.

References

Australian Government Department of Finance. Commonwealth Procurement Rules: Value for Money.

Australian National Audit Office. Insights: Audit Lessons, Procurement and Contract Management.

Chartered Institute of Procurement & Supply. Whole Life Costing and Total Cost of Ownership.