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Business Finance: Cost Reduction Strategies

In corporate finance, particularly procurement, or small and mid-size businesses with accounting departments that 'do it all', two terms often discussed are cost savings and cost avoidance. While they share the ultimate goal of reducing costs, they differ significantly in how they function, are measured, and recorded. It’s a dual mindset best applied in tandem everyday. 

1. Definitionsexpenses1

Cost savings are realized, measurable reductions in current or past spending. These impact existing budget line items and financial statements, hard numbers, tangible outcomes.

Cost avoidance refers to preemptive actions taken to avoid future expenditure entirely. These are potential savings that may never hit your P&L (profits & loss) sheet because the expense never materializes.

2. Similarities and Shared Purpose

Despite their differences, both forms of savings align in several crucial ways:

Goal Alignment Both aim to improve the company's bottom line, either by reducing costs or averting future expenses.

Procurement Impact Procurement teams play a key role in driving both—whether renegotiating contracts (savings) or foreseeing cost spikes (avoidance).

Strategic Value While cost savings may win immediate stakeholder approval, cost avoidance demonstrates foresight and long-term thinking.

3. Differences Comparison Matrix

                                                          Cost Savings                                               Cost Avoidance

Trait

Reactive

Preventative

Identifying Elements

Hard savings are easier to prove; they ‘hit the books’ directly. 

Tangible, Actualized, Measurable and documented.

Soft savings are more subjective and forecast-based.

Hypothetical, Speculative, not reflected in P&L.

Visibility

Present in budget and financial statements.

Forecasted Activity, Applied economic trends and Project Estimation (sourcing).

Measurement

Calculable in period-over-period comparisons of line items from the budget.

Difference of discounted prices/contract  cost, prevented expenses, rise in costs saved via locked multi-year rates.

Associated Positions

CFO, Controller/Comptroller, Procurement, Accounts Payable/Receivable.

CFO, Leadership/Management Team, Procurement, Program/Project Managers.

 

4. Examples of Each

Cost Savings (Hard Savings)

Vendor Negotiation: Lowering HVAC inspection costs from $5,000 to $4,000 monthly → $12,000 annual savings.
Volume Discounts: Committing to a larger order to secure per-unit cost reduction.
Substitution: Switching to open-source software instead of paid tools.
Process Optimization: Consolidating suppliers to gain scale and lower costs.

Cost Avoidance (Soft Savings)

Price Fix agreements: Locking vendor rates before a forecasted price hike.
Maintenance Timing: Scheduling maintenance during downtime to avoid future emergency failures.
Multi-Supplier Strategy: Diversifying suppliers to avoid future disruptions.
Risk Mitigation: Spending on preventative measures to avoid costly breakdowns later.

Combined Scenario

Moving to a cheaper HVAC vendor (savings) and reducing inspection frequency to avoid future breakdown costs (avoidance) realized a combined $36,000 improvement.

5. Measuring, Tracking and Execution Strategiesexpense2

Measure For Cost Savings via:

  • Historic savings: comparing current vs. previous costs.
  • Technical savings: using materials or processes that cost less.
  • Budget savings: the gap between budgeted vs. actual spend.
  • RFP savings: comparing awarded bids vs. original RFP estimates.
  • Supplier consolidation: using fewer vendors to negotiate better rates.

Track For Cost Avoidance via:

  • Projected cost increases avoided: estimated based on contracts or forecasts.
  • Risk avoidance measures: like maintenance schedules and diversification.
  • Budget vs. potential budget: if forecasts pointed to higher costs, but they didn’t materialize.
  • Procurement tools: platforms like SpendHQ allow tagging and tracking of avoidance initiatives.

Execution Approaches and Practices for Procurement

  1. Set Baselines with Finance
    Align with Finance on how you'll measure cost savings and avoidances. Define baselines like historic pricing, RFQs, budget benchmarks.
  2. Use Simple Savings Metrics
    Aim for clear, auditable savings in ~80% of cases; the rest can be exceptions needing finance's review. Soft savings (avoidances) must be defendable.
  3. Procurement Performance Management Tools
    Platforms like SpendHQ help record projects, track sourcing pipelines, tag cost savings/avoidances, and create audit trails.
  4. Forecast and Monitor Spend
    Use spend analytics to spot inefficiencies and identify avoidance opportunities, such as contract or price surges.
  5. Communicate Value Transparently
    Show both hard and soft savings to the business to build credibility and stakeholder trust.
  6. Grow Procurement Maturity
    As teams mature, they should introduce non-financial metrics—like ESG Reporting (Environmental, Social and Governance), supplier diversity, and risk reduction, alongside cost avoidance and savings.

Executive Summary: Why Both Matter

Cost savings provide immediate, visible ROI. They impact the bottom line, simplify reporting, and legitimize procurement. Cost avoidance drives future resilience and strategic foresight. Especially in volatile markets, staying ahead of price spikes, equipment failures, or supply chain interruptions is crucial. By mastering this dual approach, procurement doesn’t just save money, it safeguards and optimizes value.

About the Author
 Jon Kovar-Tooke, Management Advisor at Sea Change Advisors. Passionate about helping organizations unlock operational excellence and lean processes through strategic change, engagement, and scalable leadership.

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