Cost Avoidance in Procurement
By Hugo Britt | March 8, 2022
Procurement teams are constantly tasked with finding ways to save the company money, and while these mandates often result in cost savings, smart procurement leaders also seek opportunities for cost avoidance.
Here’s what cost avoidance means and some areas where your procurement function could take advantage of this important practice.
What is cost avoidance?
Cost avoidance, also known as soft savings, occurs when a company makes a decision to reduce costs. The decision results in a lower spend than if the company had not undertaken cost avoidance measures. Essentially, cost avoidance means taking action to stop from incurring a cost.
Cost avoidance is also known as intangible cost savings because it can be difficult to measure. Sometimes, cost avoidance requires not doing something. Imagine a procurement team negotiates a price increase down from 20% to 10%; the balance sheet will still show an increase in costs, but the procurement team has avoided paying a far higher rate for the product.
There are other cost avoidance activities that have nothing to do with spending. For instance, cost avoidance can be achieved by updating or changing the equipment maintenance schedule to avoid a work stoppage. Or, imagine a restaurant owner realizes that a key ingredient is about to become out of season or more difficult to source. The owner might change the menu in anticipation of this higher cost, eliminating dishes with seasonal ingredients.
It is important to remember that cost avoidance in procurement is not the same thing as cost savings. Understanding the difference between these practices can help finance and procurement teams better sync on business priorities and improve the bottom line.
Ways to practice cost avoidance
Because cost avoidance is “hidden”, it is often rejected by procurement professionals as a valid strategy for staying within budget. But, there are plenty of opportunities for procurement teams to practice cost avoidance and build value for the organization.
Negotiation is one tactic that provides an opportunity for cost avoidance. For one-off purchases, such as buying a piece of equipment or renovating a building, it’s possible to negotiate a better deal (thereby avoiding paying too much) for the item or project.
Cost avoidance can also be achieved using substitutes. Refer back to the example of the restaurant owner dealing with a key ingredient increasing in price. Perhaps this occurs because one of the local suppliers has a limited supply. Instead, the restaurant owner could work with a different vendor or substitute a similar ingredient at a lower cost.
For any business, finding substitutes can not only avoid a price hike but also save the company money if the substitute is better quality, more efficient, or lasts longer.
Lastly, procurement can find long-term savings by locking in contracts with reliable suppliers, securing better rates despite market fluctuations or global supply chain disruptions. By agreeing at the outset of the relationship to find continuous improvement savings, the contract can stipulate that suppliers translate any methods to reduce total costs into cost avoidance for the supplier.
Likewise, buyers can build in value-add services to the total contract — so that installation costs, shipping costs, or maintenance continue to be free of charge.
Cost savings vs. cost avoidance
Cost savings appear on the budget and in financial statements as a decrease in spending. This metric shows the reduction from last year’s spend for the same item. Cost saving strategies could include things such as reducing employee benefits, cutting back on overtime allowances, or shrinking the marketing budget.
Cost saving measures are important, but they’re often less feasible than cost avoidance. At some point, operating costs are fixed: there are only so many areas in which you can cut expenses before the business becomes inoperable. This is why cost avoidance is so important.
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