What is meant by Cost Savings in Purchasing?
Cost savings in purchasing can be divided into different categories. Typically the differentiation is between:
Since what is considered corporate cost savings in purchasing is a question of definition (and logistics), most companies ascertain that although cost reductions are deemed as cost savings, cost avoidances are, in many cases, not. This may be due to the fact that cost reductions yield a measurable cash effect. Cost avoidance, however, does not, since here “only” a negative effect in terms of a potential (unplanned) increase in costs is being avoided.
This is why the finance department with the CFO at its head usually refuses to recognize cost avoidances as cost savings and to enter these into a corporate procurement scorecard.
In principle, something similar applies to availability effects as well. According to their definition, they are certainly cost savings since liquidity is saved thereby simplifying one’s own financing. Despite this without a doubt important task, measures for the improvement of liquidity, for example by means of amended/shortened payment terms and conditions for suppliers, are subordinate priorities of the strategic purchasing department.
The so-called baseline is of significance concerning the important question of when a business transaction depicts cost savings and when it is an avoidance. Reference points or baselines can be formed through
- a prior period
- a predefined plan or budget value
- a benchmark value
Normally, cost reduction measurements are made against reference points a) and b), whereas cost avoidance measurements orientate themselves on c).
The measurements of (average) actual values of the current period against average actual values from the past or prior periods are also referred to as “historical” cost savings. A good example of this is the material price change (MPV) key figure. For this, the price difference is (usually) calculated from the price average of the last fiscal year and the average price of the current year. It is then multiplied by the current amount.
The measurement of cost savings against a plan or budget value is also referred to as budget savings. This is only possible when a budget value exists, for example as a planned spend budget or if a planned price as well as planned amounts exist.
Negotiation success can serve as an example of cost savings as per c). Here, alternative asking prices are compared (benchmark). The “best” price (benchmark value) is then compared to the final negotiated price and the cost avoidance is calculated.
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Here you will find important terms related to spend management explained in a clear way. Small knowledge base for quick information or in full for your further education. This controlling glossary is constantly being expanded and improved.
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