Understanding the difference between cost avoidance and cost savings
Discover the difference between cost avoidance and savings, and understand how to apply the two approaches for a more cohesive spend management strategy.
Finance and procurement leaders are routinely concerned with lowering company spending.
The lower your expenses, the less your hard-earned revenue goes to operational costs. Then, you can invest in company growth initiatives like hiring and expansion.
Two popular methods for achieving the goal of lower spending are cost avoidance and cost savings.
To many, these sound like the same thing and are often used as synonyms. However, cost avoidance and cost savings are two very different practices that require different approaches.
Of course, they share the same goal: reducing business spending.
Discover the difference between cost avoidance and savings, and understand how to apply the two approaches simultaneously for a cohesive spend management strategy.
Cost avoidance vs. cost savings: What’s the difference?
Cost avoidance reduces the possibility of incurring a future cost, whereas cost savings is the practice of lowering your current costs.
Both cost savings and avoidance have the principal goal of lower company spending, but they pull different levers to achieve this.
Cost avoidance looks at potential future costs and puts strategies in place to protect your organization against them.
For example, a procurement manager might predict a future increase in price for their project management software as they analyze market changes in the price of cloud storage. To avoid this cost, they contact their supplier and lock in their current pricing for the next 18 months.
Cost savings, on the other hand, looks for ways to reduce the costs you currently have. If, for instance, you were to get in touch with your project management software vendor to negotiate a lower per-user price, you’d be practicing cost savings.
Hard costs vs. soft costs
In practicing either cost avoidance or cost savings, it’s essential to understand that most new spending includes two types of costs: hard costs and soft costs.
Hard costs are the tangible, noticeable, easy-to-account-for costs associated with a purchase. Soft costs are unseen expenses related to a purchase, and because they often go undetected, they’re difficult to account for.
Say you’re about to purchase a new skills-based hiring platform. The hard cost is the monthly or annual price for the software.
When assessing the purchase of this platform, you might engage your legal firm to review and approve the software contract. The legal costs associated with this purchase are soft costs.
When practicing cost avoidance and savings, you need to consider the impact of your decisions on both types of costs.
You reduce the cost of your spending on software by removing a tool from your tech stack and subtracting a hard cost from your monthly budget.
There may also be some soft savings to consider here, however. Because there’s one fewer vendor relationship to maintain, you also save the soft costs of the procurement team’s time.
What is cost avoidance?
Cost avoidance is a spend management strategy focused on anticipating and reducing the likelihood of future costs.
Because good cost avoidance eliminates costs before they appear, the results of the practice are difficult to quantify.
As such, the cost avoidance is not reflected in financial statements. However, the impact is estimated based on understanding the potential costs you’ve avoided.
Examples of cost avoidance
Successful cost avoidance requires procurement teams to understand where expenses might appear (that aren’t there now) and implement cost avoidance measures to mitigate them.
Here are a few examples.
Locking in a price to avoid increases
A company is outsourcing social media marketing efforts to an external agency. Their procurement leader comes across a post on LinkedIn that discusses that, on average, agencies increase their prices once a year.
To mitigate the likelihood of this price increase, the procurement leader negotiates a contract renewal to lock in their current price.
A finance manager notices that their inside sales team’s computers are becoming outdated and will likely incur more repair costs.
They organize to replace these units in advance to prevent unexpected repair bills.
Strategic timing of servicing
To reduce the likelihood of a data storage failure and associated costs, an organization’s CIO arranges a quarterly data audit and cleanse rather than the standard yearly one.
The procurement department at a marketing agency identifies a historical fluctuation in the price of ad purchasing, an important aspect of their offering.
This fluctuation primarily comes down to the relationships their ad vendors hold, which the agency themselves cannot control.
To avoid these cost increases, the team increases supplier diversity by sourcing several new providers. If pricing increases at their main supplier, they can purchase ads from a different vendor rather than paying the increased price.
Implementation of process improvements
An IT leader identifies that the number of monthly API requests their software stack requires is approaching the limit of their current plan.
To avoid paying more to upgrade to a plan with a higher limit, they look for ways to optimize internal processes to reduce the number of API requests required.
What is cost savings?
Cost savings is a spend management tactic specifically concerned with identifying opportunities for cost reduction. Implementing these cost-saving measures is primarily aimed at improving the bottom line.
Compared to cost avoidance strategies, cost savings strategies have an easy-to-measure tangible financial benefit.
To calculate the amount of money you save from a given cost-saving measure, apply a simple formula.
Original Price - New Price = Price Difference (costs saved in dollars)
Then, to visualize cost savings as a percentage:
(Price Difference / Original Price) x 100 = Cost Savings Percentage
As an example, let’s say you’ve just renegotiated your monthly CRM platform bill. You were paying $10,000 a month, but you’ve gotten this down to $9,000.
Your Price Difference is $10,000 (the Original Price) minus $9,000 (the New Price), which equals $1,000.
To calculate this as a percentage, you’ll divide the Price Difference ($1000) by the Original Price ($10,000) and multiply that by 100:
($1000/$10,000) x 100 = 10%
Examples of cost savings
A procurement professional sees an opportunity to reduce costs and free up some company budget by negotiating a lower price with their HR software supplier in return for signing a 24-month contract.
Strategic software sourcing
A CIO invests in a new technology that eliminates the need for a lot of manual work, allowing the company to reduce its outsourced labor cost.
A vendor relationship manager uses an upcoming software renewal to negotiate a lower per-user price, thereby reducing their total expenditure under the new contract.
The head of finance at a fast-scaling company leverages recent revenue growth to pay down their debt levels and restructure existing high-interest loans to agreements that bear less interest, resulting in a lower cost overall.
The senior leadership team, concerned with a growing software overages cost, decides to implement a more stringent approval procedure.
Employees must now seek sign-off from a manager before incurring overages, allowing the company to exert better control over additional spending.
Cost avoidance vs cost savings: Key differences
Vendr: Helping you avoid – and save on – SaaS spending
Cost avoidance and savings strategies are an important tool in every finance and procurement leader’s belt.
To make these measures as effective as possible, you’ll need accurate and real-time insights into spending at the company, department, and vendor levels.
If you’re looking to reduce SaaS expenditure, Vendr is your secret weapon. It’s packed with features to cut costs, like:
- Price benchmarking from the biggest set of SaaS buying transactions around
- Real-time spending and savings monitoring
- Negotiation support from our team of SaaS purchasing experts
- Overlapping spend alerts
- Upcoming contract renewal notifications
Discover how much lower your annual SaaS bill could be with our free savings analysis.