Cost Avoidance and Cost Savings: What’s the Difference?

Keeping a lid on excessive costs and generally making sure that you’re keeping to your budget is a basic tenet of good business practice. Cost control is prudent. But there’s a difference between cost savings and cost avoidance, and understanding that difference is important for procurement teams, the finance department and all business managers.

Think about a basketball team that puts in its star player in the final quarter of a game even if they know they’re going to lose. That player’s presence could close the gap from 25 points to only 10 points because the coach decided to keep the player on the court. The loss is still recorded, but it is not as large as it would have been had the star player been benched. In a procurement setting, the equivalent is if a supplier intended to raise their prices by 25%, and the CPO negotiated them down to only a 10% increase.

It can be challenging to identify cost avoidance strategies on traditional balance sheets — and they may even incur a higher outlay in the short term — but they can be incredibly powerful. In fact, the only time cost avoidance measures hit the balance sheet is when they are not implemented—because the lack of action has resulted in a cost increase.

On the other hand, cost savings are pretty easy to identify and are the number one metric for most procurement teams. They will appear on the budget and in financial statements as a decrease in spending. Put another way, it’s the reduction from last year’s spend for the same item. The simple cash calculation for cost savings is to subtract the new price from the original price.

Cost avoidance is the measure that lowers potential increased expenses as a way of decreasing a company’s future costs. On the other hand, cost savings have to do with tangible savings and action that is taken in order to result in a company’s benefit financially.

Costs Savings vs Cost Avoidance

What is cost savings?

Cost savings are expense mitigation strategies that lower existing spending or debt quantities. Cost savings are usually tangible and measurable. Cost savings measures will appear in documents such as your budget and financial statements since they affect existing line items, when comparing one accounting period to the next. These types of strategies are usually easier to use for justifying new projects and initiatives because they are measurable and documented.

What is cost avoidance?

Cost avoidance, which differs from cost savings, refers to strategies that prevent a business or organization from spending unnecessary money in the future. Since the expenses saved using cost avoidance are usually hypothetical, they dont typically appear in documents such as a budget or financial statement. If a cost avoidance measure doesnt work, it might appear on a financial statement as the additional expense that you were unable to avoid.

By preemptively solving the need for future spending, you can reduce future financial pitfalls and challenges. Cost avoidance can sometimes be used to support an organizations projects and initiatives, though it can also be challenging to do so because the costs avoided are usually hypothetical and variable.

Cost avoidance vs. cost savings

Although cost avoidance and cost savings serve a similar purpose for a business or organization, they differ in a few important ways. Here are some differences between cost avoidance and cost savings:

Cost avoidance

Here are some characteristics of cost avoidance:

Cost savings

Here are some characteristics of cost savings:

Examples of cost avoidance

To help support your understanding of the difference between cost avoidance and cost savings, here are some examples of cost avoidance strategies:

Example 1

A small retail shop owner purchases candle holders from a particular vendor. Although the wholesale cost of candle holders has remained stable for the past few years, the shop owner has noticed that the general market value of those items is increasing. In order to avoid a future cost increase, the shop owner preemptively negotiates a stable price contract to last the next several years. By avoiding a potential future cost increase, the shop owner is using a cost avoidance strategy.

Example 2

A manufacturer obtains a new piece of equipment that must be shut down and serviced on a biweekly basis. After analyzing the companys production schedule, they notice a span of a few hours at night, every two weeks, when almost no units are being produced. Since this is already down time in the companys manufacturing flow, they schedule maintenance for these hours instead of shutting down when demand is high. This is an example of cost avoidance, because they are anticipating and avoiding future expense.

Example 3

A restaurant decides to revamp their menu to include a seasonal seafood entree as a dinner item. They know that one particular ingredient is likely to fluctuate in price and availability because of historical changes in weather conditions. To anticipate possible supply chain interruptions, they source that ingredient from several suppliers in different locations. By mitigating future cost increases through diverse suppliers, they are practicing cost avoidance.

Examples of cost savings

To help support your understanding of the difference between cost avoidance and cost savings, here are some examples of cost savings strategies:

Example 1

A construction company has provided concrete work for many years. Recently, their cost of cement has increased due to higher demand and market conditions. A company representative negotiates a lower cost with the supplier on the condition that they will do business together long-term. This is an example of cost savings because it lowers an existing, documented business expense.

Example 2

A local bakery is doing well in their sales, and they decide to leverage their increased profitability to redistribute some of their debts. Based on their most recent account ledgers, they are able to renegotiate the terms of the mortgage on their building to a lower interest rate, which lowers their monthly payment and overall amount due. By doing so, they are exercising cost savings by reducing a known, measurable current cost.

Example 3

Employees at a retail bookstore have typically been allowed to work unlimited overtime if they choose to do so. Due to market pressures and internal changes, the company decides they need to find a way to practice cost savings to increase profitability. The company decides to save on costs by limiting overtime for their employees unless they receive prior approval from a manager. This reduces their known labor costs and saves them money.

FAQ

What are examples of cost avoidance?

Cost avoidance is the preservation of existing spending to prevent price increases due to inflation, economics or the rising costs of products or services. An example of cost avoidance is when a company purchases an extended equipment warranty to limit maintenance costs or out-of-pocket expenses.

What are avoided cost savings?

Definition: “Soft” cost savings/avoidance can be described as actions that lower potential price increases so that a company does not have as many costs in the future. Process improvements that positively impact efficiency, productivity, customer satisfaction, etc.; over time, the cost avoidance becomes cost savings.

How is cost avoidance savings calculated?

Cost saving can occur when a business reduces an existing expense. For example, swapping out incandescent bulbs for LEDs can result in a lower monthly electric bill. An avoided cost, on the other hand, is one that is not incurred. For example, spending on cybersecurity can avoid costs of a data breach.

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