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Cost Avoidance vs Cost Savings: What’s the Major Difference?

Unseen expenses like expedited shipping fees or rush order charges often lurk in the procurement process, exemplifying hidden costs that can significantly impact a business’s bottom line. Solving this strategic relationship of cost avoidance vs cost savings in procurement can mean the difference between quick wins and sustainable financial health.

Cost avoidance is all about proactively preventing unnecessary expenses before they occur, a strategic move that sets the stage for effective savings management. This is closely followed by cost savings that result in the focus shifting to direct reductions that are being spent by a business’s procurement process. The order isn’t just about word choice; it’s a key strategy for managing money wisely.

The blog intends to tackle the details, weigh the use cases, find the best plan for purchasing teams, and control the cost of the businesses!

What is Cost Avoidance?

Cost avoidance in procurement refers to the strategic measures used to maintain existing expenditure levels. This prevents potential cost increases due to inflation, economic shifts, or rising prices of products and services.

The cost avoidance approach in strategic financial planning ensures avoiding additional spend without compromising quality or procurement needs. The use of advanced technology, procurement cost analysis, and analytics can play a significant role in cost avoidance and help organizations predict and mitigate potential cost increases.

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Ways to Calculate Cost Avoidance

Calculating cost avoidance helps businesses manage finances, allowing them to understand the real value of their proactive measures in avoiding unnecessary costs.

There are two basic methods to calculate cost avoidance: as an amount and as a percentage.

1. Cost Avoidance Calculation as an Amount

The first step is to estimate the potential cost that would be incurred if no action is taken. This projection should be based on historical data, market analysis, or anticipated cost trends.
Next, determine the cost of implementing a proactive solution. This includes all expenses associated with the chosen strategy to avoid the projected costs.

The formula for calculating cost avoidance as an amount is:

Cost Avoidance Amount = Estimated Cost of Inaction − Cost of Proactive Solution

2. Cost Avoidance Calculation as a Percentage

Once the cost avoidance amount is determined using the method above, it can be further analyzed in relation to the cost of inaction.

The formula for calculating the cost avoidance percentage is:

Cost Avoidance Percentage = Cost Avoidance Amount/Cost of Inaction

Examples and Use Cases of Cost Avoidance

Here are some examples and use cases of cost avoidance that an advanced procurement solution can facilitate:

Negotiating smaller price increases: Proactively negotiating with suppliers to limit price hikes.
Long-term contracts with price protection: Using contracts that guard against market price fluctuations to stabilize costs.
Purchasing below quoted prices: Acquiring goods or services at prices lower than initially quoted through various strategies like bulk buying or competitive bidding.
Delaying supplier’s price increase: Negotiating with suppliers to postpone price increases, often by leveraging future commitments.
Preventive maintenance and quality control: Implementing maintenance routines and quality checks to avoid costs from equipment failure or product defects.

What is Cost Savings?

Cost savings refers to the reduction in spend achieved through decisive actions that directly affect an organization’s bottom line, often initiated and driven by effective procurement strategies. This can include a variety of measures, such as enhanced operational efficiency, strategic sourcing and supplier negotiations, optimized procurement processes, and implementing advanced technological solutions.

Focusing on these areas, along with procurement cost analysis, businesses can significantly reduce their expenses, leading to a more streamlined and cost-effective operation. Such savings are crucial for maintaining competitiveness and profitability in the business.

Download eBook: Procurement’s Cost Savings Playbook: An Executive’s Guide to Sourcing Savings

Ways to Calculate Cost Savings:

There are two primary methods to calculate cost savings, which can usually provide a more impactful insight into the efficiency of procurement and negotiation strategies. These calculations assist businesses in evaluating their cost-reduction strategies.

Below is a guide on how to calculate cost reductions in simple steps:

1. Cost Savings Calculation as an Amount

Begin by determining the initial proposed cost for a product or service. This could be based on a pre-negotiated cost or the prevailing market rate.

Subtract the final contracted cost (the price agreed upon after negotiations or discounts) from the initial proposed cost.

The formula for calculating cost savings as an amount is:

Cost Savings Amount = Initial Proposed Cost − Final Contracted Cost

2. Cost Savings Calculation as a Percentage

Calculate the difference between the initial proposed cost and the final contracted cost using the method above.

To convert this saving into a percentage, divide the difference by the initial proposed cost.

The formula for calculating cost savings as a percentage is:

Cost Savings Percentage = Difference/Initial Proposed Cost

Examples and Use Cases of Cost Savings

Explore these real-world examples and witness the power of advanced procurement solutions to maximize cost savings.

Review purchasing needs: Regular analysis and adjustment of purchasing requirements to eliminate unnecessary expenses.
Request supplier discounts: Negotiating discounts for bulk or long-term purchases to reduce costs.
Check inventory: Efficient inventory management to minimize holding costs and prevent overstocking.
Optimize supply chain operations: Streamlining logistics and transportation for more cost-effective operations.
Utilize technology for efficiency: Using advanced software for procurement to reduce manual errors and improve spend analysis.

Differences Between Cost Avoidance and Cost Savings

Both cost avoidance and cost savings contribute to reducing organizational expenditures. Yet, their underlying principles and implementation methods diverge significantly.

The exploration analyzes the distinct roles of two financial strategies in procurement, uncovering hidden value and overcoming financial challenges.

Cost Avoidance	Cost Savings
The time frame of cost avoidance primarily focuses on future expenditures, aiming to avoid potential increases in costs pre-emptively.	Cost saving concentrates on the present, seeking to reduce existing expenditures compared to prior levels.
One basic example of cost avoidance can be engaging in long-term contracts to lock in prices and avoid future market volatility.	An example of cost saving is switching to more affordable suppliers, resulting in immediate expense reduction.
The approach to spending is to invest or implement in measures in the present to prevent future expenses.	Cost saving approach to spending is engaging in immediate negotiations to reduce current costs.
Cost avoidance involves understanding market trends and future risk management.	It involves challenges such as identifying immediate cost-reduction areas.
It is often intangible and less immediately visible, as it deals with hypothetical or future expenses.	Cost saving is highly tangible and readily apparent, reflecting direct reductions in current spend.

Wrapping Up

The discussion on cost avoidance vs. cost savings in procurement reflects the essential strategies for optimizing procurement operations. Cost avoidance, focusing on pre-empting future expenses, and cost savings, aimed at reducing current spend, are key aspects of a robust savings management strategy.

Now is the time to step up and choose the right balance of these methods to streamline buying processes effortlessly. Zycus’ iSave makes the difference by offering deep visibility into spending and uncovering hidden savings opportunities.

Discover transparent visibility, improved financial performances, and a valued procurement process. Request a demo today!

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