Cost Avoidance – The Unsung Hero Of Procurement Benefits

Posted 21st Feb

Whilst there is growing recognition of the value of good practice procurement outside of financial savings, we as procurement professionals are still, quite rightly, expected to demonstrate a return on our organisation’s investment. Continuity of supply, supplier performance and development, risk management, and – increasingly – innovation are all very welcome and vital elements of well-developed procurement functions, but the ‘show me the money’ factor will never go away.* 

Clearly such benefits come in a variety of forms, from the classic cost reduction by reducing Total Cost of Ownership, through to revenue increase, mitigated risk and everything in between. This is a complex area, and has given rise to consulting firms that focus solely on the calculation and reporting of procurement benefits. But let’s focus for now on the notion of Cost Avoidance, i.e. those cases where cost increases are minimised or avoided all together, rather than costs actually being reduced. 

The great shame of cost avoidance benefits is that they are often treated as the poorer relation of savings – the runt of the litter, reported below the line or [shudder] not at all. The logic goes that benefits are not realised when new deals / category strategies actually take effect, but when a budget can be reduced . This is a debate I’ve had with several CFOs and other board-level stakeholders before they fully recognise the value that is being ignored. 

Consider the following typical scenarios, and how we can best show the benefits of the work we have done:

  • Costs are pegged at current levels in a rising market . It is rare that we work for organisations whose spend is so large that our buying behaviour influences entire markets. What we need to demonstrate is how we have managed and minimised the delta between market price and the costs we incur. In many cases these are index-linked, allowing for precise calculation of cost avoidance benefits.
  • Threatened increases are staved off or minimised . Here, the distinction between cost reduction and avoidance is surely artificial. If we wait for such increases to kick in, it becomes a cost reduction opportunity anyway – and whilst that may make the difference between the benefit qualifying for a savings tracker and not, I’m sure the business would not thank us for doing so…
  • Benefits are created outside of price . Progressive Procurement teams take a wider view than negotiation on price, and generate benefits through reduced demand, specification change, operational improvements, etc. My current client, for instance, has run a series of workshops with its suppliers of sheet steel. We recognised that the market was going through the roof (material and fuel increases, anti-dumping levies, the weak pound, etc. etc.) and so our best way of minimising increases was to more fundamentally challenge what we were buying and how. The benefits we found through changing material grades, pack sizes, stockholding, etc. irrefutably represent financial benefits to the business – even though the spend on steel as a whole next year will be higher than it was for the same volume this year.
  • We get more for the same, instead of the same for less . It is important to assess the cost of the ‘do nothing’ option, particularly where we are improving the quality of products/services that are being sourced. I often report a dual-benefit when reducing costs whilst improving quality, to show (a) the cost reduction benefit from the pure ‘before vs. after’ saving, plus (b) the cost avoidance benefit that shows how much more we would be paying had we started buying the better items without running our category project. Where the requirement is entirely new, the absence of a baseline undoubtedly adds a further layer of complexity to benefit calculation. Our best option is to base our benefit assertions on initial quotes, or an assessment of the costs that would have been incurred without Procurement involvement. Whilst this is open to abuse through inflated/unrealistic opening bids, professional Procurement teams know that the long-term reputational damage of this would far outweigh the short-term benefit of inflated savings, and work with Finance throughout to agree a reasonable assessment of benefits. 

So let’s ensure we don’t underplay the benefits of the work we do. Let’s recognise – and ensure our organisation recognises – that whilst the items used in the budgetary process may be a subset of procurement performance reporting, it’s key that cost avoidance benefits are given the recognition they deserve.

* the value adding concepts listed can, of course, also be quantified, but are less commonly reported in procurement benefits trackers

Tagged by topic: Cost Reduction

  by Paul Haycock

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