Types of Cost Savings in Procurement
By Hugo Britt | March 1, 2022
Getting your finance and procurement teams to align on the best cost saving techniques can help your company optimize spending and grow profitably. Cost savings, however, can mean different things, depending on whether you speak to a member of the procurement team or a member of the finance team. For finance leaders, savings are about the budget — lowering costs to improve the bottom line.
For procurement leaders, though, if they are able to save money on one product and put it toward a different product, that’s a saving — even if the total cost is over budget.
“These misunderstandings can lead to real pain between the two departments,” wrote Tarek Alaruri, COO and co-founder of Fairmarkit. “If procurement promises savings and (from finance’s perspective) doesn’t deliver, it can harm procurement’s credibility.”
Aligning on a common understanding of cost savings in procurement can help relieve some of the confusion and minimize approval delays or payment disruptions.
Here’s the difference between cost savings and cost avoidance, as well as some key cost saving practices that both teams can undertake.
Cost savings in procurement vs cost avoidance
There’s a key difference between cost savings and cost avoidance. Cost avoidance, also known as soft savings, means taking action to stop from incurring a cost.
Cost avoidance is often difficult to measure. This is because sometimes, cost avoidance requires not doing something. Imagine a procurement team negotiates a price increase down from 35% to 15%; the balance sheet will still show an increase in costs, but the procurement team has avoided paying a far higher rate for the product.
Cost savings are comparatively easy to identify. 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.
Where to look for cost savings
As procurement and finance teams approach cost savings, they generally consider hard costs and soft costs.
Hard costs are typically tangible assets; these direct costs hold some kind of intrinsic value, making the price easy to estimate. Hard costs include things such as equipment, inventory, or real estate. Soft costs, comparatively, are indirect costs that can be more difficult to forecast. Legal costs, banking, accounting, and overhead are examples of soft costs.
Typically, the easiest way to find cost savings is to examine hard costs. Soft costs often fall under the purview of cost avoidance.
Short-term cost savings
Short-term cost-saving strategies focus on lowering expenses typically within a year. Short-term cost savings opportunities can be found through the following tactics.
1. Review existing contracts
Regularly review existing contracts with vendors and suppliers to ensure you are receiving the best possible terms. As demand changes over time, sales and the price of components and products can also change.
Look for opportunities to negotiate more favorable agreements that could benefit both your business and suppliers, focusing on things like purchase frequency and pricing.
2. Lower maverick or rogue spend
Rogue spend is a term for any spending not managed by procurement. It’s often noncompliant and can open the company to high levels of risk. And, because it’s out of procurement’s control, it’s often untracked.
This means it can be eating away your bottom line without notice: By some estimates, maverick spend accounts for up to 80% of some organization’s total spend.
3. Consolidate supplier relationships
It takes time and resources to manage suppliers. Companies that consolidate their vendors can save money and negotiate better discounts through bulk ordering.
Short-term cost savings involves adding transparency to procurement throughout the organization, revisiting inventory as demand changes, and proactively managing supplier relationships to ensure your company is getting the best deal possible.
Long-term cost savings in procurement
Long-term cost savings practices are those that impact a company’s profit margin for four to 10 years. These methods can help steer the company’s growth trajectory.
1. Use technology
Procurement software, enterprise resource planning (ERP) tools, and inventory management platforms can all make it easier to optimize spending and resource management across the organization.
These tools can centralize purchasing and add transparency to the sourcing and procurement process, automating some of the more manual, time-intensive parts of purchasing.
2. Practice category management
Category management is an approach that strategically segments spending on goods and services into areas with similar or related products.
Category management enables procurement to capture cost savings with bundling, bulk ordering, and by reducing duplicate spending. Bringing together categories of hard costs is a key strategy for cost saving.
3. Minimize risk
Emergency purchases and noncompliant spending are among the most costly mistakes a company can make. Minimize risk by creating strong procurement policies, training employees, and using software that can help keep spending compliant.
Together, along with cost avoidance, these practices can help companies grow profitably and reduce inefficient spend.