A Penny Avoided Is A Penny.....Nah

There's been some good discussion over in the LinkedIn groups recently about the definitions of "Cost Savings" and "Cost Avoidance". Never one to shy from controversy I thought I'd throw my own ten pence in on this since this is an area where it seems very few parties see things exactly the same way.

In my wanderings through the procurement landscape over the years I've seen many tens of different definitions of cost savings and cost avoidance but if I had to choose the most USEFUL definitions (note, not necessarily the most popular) in my opinion they would be:

COST SAVINGS are achieved when the cost of purchasing the same quantity of a good or service falls, e.g. achieving a reduction in the dollar cost of procuring the same market basket of commercial print by leveraging spend with fewer suppliers (note: some definitions would allow specification optimization in addition to simple price reduction such as substituting a different substrate for a printed sign; the total quantity of items purchased however would however remain the same).

COST AVOIDANCE is achieved when an unavoidable increase in the cost of purchasing the same quantity of a good or service is not completely eliminated but is partially offset, e.g. in the period 2007-2008 when paper prices rose by more than 20-30% or more depending on the grade it was impossible to avoid an increase in the cost of most commercial print items but by employing the same procurement best practices as above the cost increase percentage could at least be kept in the low single digits.

My opinion is that these definitions are most useful because they allow the positive outcomes of best practice procurement strategies to be unambiguously and fairly evaluated in both deflationary and inflationary environments. They also allow the CFO and his team to quantify the budget impact in both cases.

But what about goods and services with no previous purchasing history (i.e. no baseline) that are often thrown automatically into the cost avoidance category? I would argue that for these situations it is COST SAVINGS that is most appropriate. Why? Well, in fact you actually CAN establish a baseline for a new purchase by issuing an RFI/test bid to a group of suppliers (making it clear to the suppliers that you are conducting an exploratory evaluation for the purchase in question). The preliminary pricing thus obtained from the RFI effectively forms a baseline (think of it as a "RFI Baseline" for products without a purchasing history) against which to measure the cost savings from the ensuing RFP process. Using the "RFI Baseline" approach for new products allows measurement of RFP-created savings and also (from the CFO point of view) allows aggressive budget targets to be set for products that would previously have been given more "fat" due to their lack of purchasing history.

Oh, and one more thing...by using the RFI Baseline approach for new purchases some end user departments that have historically been responsible for high volumes of "non-baselineable" spend (e.g. travel and meetings, some marketing areas) would be held to tighter criteria of effective buying. By having to conduct RFIs and/or test bids they would alert their vendor base to a forthcoming competitive process and the expectation that likely double digit cost reductions would be expected when the actual RFP hits the streets.

There, that feels better...nothing like starting off the New Year by upsetting multiple constituencies of purchasing terminology idealists, sacred cow internal departments and hitherto unchallenged suppliers of previously unsourced spend!