Should-Cost Analysis

Should-cost analysis is a structured government cost evaluation technique authorized by FAR 15.407-4 that goes beyond historical cost data and proposed rates to determine what a contract should cost based on rigorous assessment of the contractor's operations, workforce productivity, material costs, manufacturing methods, and business practices, identifying opportunities for cost reduction that the contractor has not proposed.

What is Should-Cost Analysis?

Should-cost analysis is the most intensive cost evaluation technique the government employs, used on large, complex, or sole-source acquisitions where the government cannot rely on competition to discipline pricing. Rather than asking "what does this contractor say it will cost?" (the question answered by cost realism analysis), should-cost asks "what should this work cost if performed with appropriate efficiency?" The distinction is significant: a contractor may have real historical costs that are inflated by inefficiency, and cost realism would accept those costs as realistic; should-cost would challenge them as avoidable.

Should-cost teams are typically multi-functional, including contracting officers, DCAA auditors, program office technical staff, and industrial specialists (engineers and management analysts) who can evaluate the contractor's methods against industry best practices. The team may conduct on-site reviews of the contractor's facilities, production processes, indirect cost pools, make-or-buy decisions, and workforce management practices, identifying specific inefficiencies with cost reduction potential.

FAR 15.407-4 distinguishes between "program should-cost reviews" (comprehensive analyses of a contractor's total business operations for major systems programs) and "overhead should-cost reviews" (focused analyses of indirect cost pools, G&A, and overhead structures). DoD uses should-cost analyses extensively on major acquisition programs where the government intends to negotiate price reductions below the contractor's claimed historical costs.

The output of a should-cost analysis is a government-developed cost objective, a target cost that reflects the government's view of what the work should cost after reasonable efficiency improvements. This target becomes the basis for negotiation: the contractor must explain why its proposed cost exceeds the government's should-cost target, or negotiate from a position where the government believes the proposed costs include avoidable inefficiencies.

Why Should-Cost Analysis Matters for Government Contractors

Contractors on large programs where should-cost reviews are anticipated should proactively identify and address operational inefficiencies before the government team arrives. A contractor that has already implemented productivity improvements and can document them with data walks into a should-cost review in a far stronger position than one defending historical cost levels against independent efficiency benchmarks. Should-cost reviews can result in negotiated price reductions that materially affect program economics, making advance preparation a direct financial return.

Example

The Air Force conducts a program should-cost review on a recompete for a $400M aircraft maintenance services contract. The should-cost team, four ACO representatives, three DCAA auditors, and five Air Force industrial specialists, spends three weeks on-site reviewing the contractor's workforce productivity data, indirect rate structure, subcontract management, and material procurement practices. The team identifies: 12% excess indirect labor in the overhead pool attributable to management positions that primarily support commercial work; a material procurement system that does not leverage volume discounts available through existing GSA Schedule vehicles; and a maintenance staffing ratio 18% higher than comparable operations. The should-cost target is set $28M below the contractor's proposed price, and negotiations result in a final price $19M below the proposal.

Frequently Asked Questions

Is should-cost analysis the same as price negotiation?

Should-cost analysis is preparation for price negotiation, not negotiation itself. The should-cost review produces the government's independent cost objective, its view of what the work should cost. That objective then drives the negotiation: the government uses the should-cost findings as specific, documented rationale for proposing a lower price than the contractor proposed. Without a well-supported should-cost analysis, the government's negotiation position is limited to general reasonableness arguments. With should-cost, the government has contract-specific cost reduction data supporting its position.

Can a contractor decline to allow a should-cost review?

Technically no, if the contract includes a should-cost clause or if the should-cost review is conducted as part of a competitive source selection. However, the practical dynamics depend on whether the contract is sole-source or competitive. On sole-source contracts for essential programs, refusing a should-cost review is effectively refusing to negotiate, not a viable position. On competitive awards, the government conducts should-cost analysis from the offeror's cost proposal and publicly available data rather than on-site review, so contractor cooperation is not directly required.

How does should-cost analysis relate to Earned Value Management (EVM)?

Should-cost analysis establishes what a contract should cost before award; Earned Value Management monitors actual cost performance during execution. On major acquisition programs, the initial should-cost target becomes the basis for the EVM baseline, the Program Management Baseline (PMB). If actual EVM data shows cost growth above the should-cost target, the should-cost findings become a reference point for understanding whether the overrun reflects execution problems or whether the should-cost assumptions were unrealistic. The two tools are complementary parts of the government's cost management framework on large programs.

What is an "overhead should-cost review"?

An overhead should-cost review is a focused DCAA examination of a contractor's indirect cost structure, specifically the overhead, G&A, and fringe pools, to identify costs that could be reduced through better management practices. Unlike a program should-cost review (which examines a specific contract), an overhead should-cost review examines the contractor's entire indirect cost structure. The output is a set of recommended reductions to proposed overhead and G&A rates, which the ACO uses to negotiate lower rates in the forward pricing rate agreement. Large defense contractors may be subject to overhead should-cost reviews every few years as part of the ongoing rate negotiation cycle.