Tracking Cost Savings and Cost Avoidance to Measure Procurement’s Performance

Procurement is in the spotlight when it comes to saving money within an organization. The function primarily tracks success with cost savings. However, cost avoidance strategies are becoming increasingly important once businesses maximize their cost savings. Do you know what each one is and how you can capitalize on opportunities? Here are a few strategies you can leverage today.

Cost Savings and Avoidance

Cost savings happen when you reduce what you are paying and therefore improve financial gains for the business. On the other hand, cost avoidance occurs when you can simply remove the need for a cost altogether. You aren’t just spending less; you aren’t spending at all. Cost savings and cost avoidance both share the same goal of reducing expenses.  

Cost savings are often referred to as hard savings, whereas cost avoidance is usually coined soft savings.  

  • Cost savings: Hard savings are often considered to be easier to track. Hard savings refers to a reduction in the purchase price of an asset. This metric is easy to track by simply calculating the difference in price for the asset after you have negotiated a reduction in price. 
  • Cost avoidance: Soft savings are more difficult to determine as the monetary gains often come from categories such as legal fees, accounting costs, banking, other associated fees along with ongoing maintenance, and other risk mitigation measures. This metric is harder to quantify due to difficulty with forecasting. Although not seen on an invoice, soft savings are frequently a part of improvement initiatives and are often a valuable way to keep a project growing once Procurement has achieved maximum savings.

A real life scenario

Imagine that a company was paying for HVAC maintenance service for part of its critical system infrastructure. It had used the same provider for years because the business unit owner claimed to have expertise that would be hard to find elsewhere. The company was paying $5,000 per inspection every month. This service added a $60,000 line item to the budget every year.

A new CPO came on board who wanted to engage in a go-to-market sourcing exercise with the business unit leader. They discovered that they could move to a new qualified vendor who would charge only $4,000 per inspection. The move would equate to a $12,000 per year cost savings or 20% reduction in budget. Additionally, the team found that inspections were only necessary once every two months, thus reducing the cost by another $24,000. In this scenario, the company could book a cost savings of $36,000. 

From a cost avoidance perspective, there is additional value to be provided through ongoing maintenance. By paying the $24,000 a year for maintenance, the company was ensuring that it was not going to have a $100,000 or higher future expense to replace an expensive piece of equipment, but could also result in loss of profit if it caused delays or shutting down of the production line, spoilage of product, etc.

Cost Savings and Cost Avoidance Strategies

Both cost savings and cost avoidance offer the potential for enhanced value. Procurement teams specialize in cost reduction, but can also identify places where cost avoidance is more effective and can provide extra value. 

Cost savings strategies

Cost savings is a key metric when it comes to financial reporting. Reductions in the price of an item are not only immediately noticeable but also easily quantifiable and visible to key stakeholders. This may involve reductions in projected costs, staff time, materials, equipment, etc. Other cost savings can result in volume reductions by lessening the number of goods or services needed, also frequently referred to as demand management. 

Here are other ways procurement teams often engage in cost savings: 

  • Contract renewals: Cost savings often come from contract negotiations and renewals where a lower fee schedule is agreed upon, often as the result of a long-term agreement or negotiation of discount points. Locking in a longer contract also locks you into a lower fee schedule for the duration of your contract.  
  • Strategic partnerships: Another way to cut costs is to engage in strategic partnerships such as using a cloud option instead of on-premises infrastructure or switching to a lower-cost supplier.  
  • Forecasting: Using historical numbers as a baseline allows you to predict your needs so that you can anticipate supply needs in advance and are not faced with overages or rush costs.

Cost avoidance strategies

At a high level, cost avoidance involves actions that lower anticipated increases in expense for future needs. This could involve the following: 

  • Preventative maintenance: By incurring a small monthly expense to maintain equipment, you prevent catastrophic mechanical breaks, employee accidents related to equipment failure, repair or replacement costs, and loss of operational gains due to failure. 
  • Improved efficiency: By identifying better processes or supplies, you can lower costs through enhanced efficiency. An example might involve replacing LED lighting in your facilities to reduce the cost of light bulbs. 
  • Value adds on contract: Rather than negotiate price, procurement teams often identify value adds that help to avoid other costs. This might come in the form of extended warranties or maintenance on fleet vehicles or industrial machinery.  

Evaluating Procurement Performance

There is often misalignment between Finance and Procurement when it comes to measuring added value outside of cost reduction. In order to create greater collaboration and the ability to show where value is being created, you need a single source of truth for all procurement activity.This solution should house everything from sourcing engagement, sourcing pipeline, negotiation details, contracts and their renewal status, as well as any other cost avoidance activity. 

How can you ensure that you are accurately measuring the success of Procurement? Begin by establishing a baseline for each procurement activity using historical data and low/mean/high RFQ along with pricing data. You should also utilize industry benchmark data to help inform your analysis. Identify how you will measure each metric and categorize activities under divisions such as cost savings, cost avoidance, or segmented parts. Also, make sure you can tie each activity back to a specific business unit and budget holder.

Integrating a single source of truth into your tech stack

More and more, businesses are leveraging enterprise systems to consolidate data across the organization. Currently, procurement technologies that support a single source of truth and insight into the sourcing pipeline are difficult to come by. However, if organizations truly want to get value from insight into procurement activity, that single source of truth needs to integrate with other major platforms. 

SpendHQ supports more than 30 integrations with major P2P, ERP, and S2P technologies, empowering procurement teams with visibility into their activities and giving them the tracking capabilities to identify hard savings and soft savings. 

Want to learn more about how SpendHQ’s products provide visibility into hard savings and soft savings? Click below now to schedule a demo and see how our unified platforms can transform how you approach spend.