Cost savings vs. cost avoidance: What's the difference?

Cost avoidance and cost savings are similar-sounding terms, but while cost avoidance is the ability to prevent or reduce expenses in the future, cost savings involves identifying and capitalizing on immediate opportunities to reduce current expenditures right now.

Cost avoidance and cost savings are fundamental concepts in procurement that can significantly impact your company's bottom line. And while both achieve the same result, they’re different strategies.

By leveraging both of these approaches, you can achieve long-term cost optimization and gain a competitive advantage. But first, let’s explore the differences between cost avoidance vs. cost savings.

Cost avoidance vs. cost savings in procurement: Key differences

Cost avoidance, also known as soft savings, is the ability to prevent or reduce future expenses. The primary goal is to optimize spending by identifying and addressing potential waste, inefficiency, or unnecessary expenditure before it occurs.

In contrast, cost savings involves directly reducing current expenditures by identifying and capitalizing on immediate opportunities. The primary goal of cost savings is to reduce the overall expenditure associated with acquiring goods and services.

Cost avoidance and cost savings both have the same end goal of saving your company money, but while cost savings is focused on reducing your current expenses right now, cost avoidance is about preventing or reducing costs you expect to encounter in the future.

Let’s break down both cost avoidance and cost savings into a few categories so we can highlight their differences:

Benefits of cost avoidance and cost savings

Now that we’ve clarified the key differences between cost avoidance and cost savings, let’s look at the benefits of each strategy.

Cost avoidance

Cost avoidance saves money in the long term and establishes a more sustainable procurement strategy. It does this by empowering you to redirect resources toward valuable investments like innovation, expansion, or employee development.

Cost avoidance demonstrates procurement's strategic value beyond cost-cutting by mitigating financial risks.

Benefits of a cost avoidance strategy include:

• Being prepared for the future: Proactively addressing potential cost increases, inefficiencies, or regulatory challenges through cost avoidance results in more substantial long-term savings over time
• Streamlined processes: Cost avoidance involves eliminating waste and optimizing your procurement process, leading to not only reduced costs but also greater operational efficiency overall
• Improved profitability: Reducing costs through cost avoidance puts your business in a stronger financial position so you can allocate more resources toward other value-creating initiatives

Cost savings

While cost avoidance is focused on long-term savings, a cost-savings strategy lets you start saving money right now and free up resources that can be reinvested into other areas of your business.

Benefits of a cost-savings strategy include:

• Immediate savings: With a cost-savings strategy, you’ll start to see the benefits of less money going out the door immediately after you implement it
• Improved profitability: The money saved with a cost-savings strategy is a direct contribution to your bottom line, leading to higher profit margins
• Streamlined processes: Although not often viewed as a long-term strategy like cost avoidance, cost savings can still involve optimizing processes, streamlining operations, and eliminating waste as part of reducing your current costs

As you can see, improved profitability and streamlined processes are benefits of both cost avoidance and cost savings. A key difference is that while you can expect to start reaping the benefits of a cost-savings strategy immediately, a robust cost avoidance strategy will prepare you for expenses likely to come your way in the future.

Challenges of valuing cost avoidance and calculating cost savings

Identifying and quantifying savings from cost-avoidance initiatives can be challenging since the benefits aren’t always immediately measurable. Accurately attributing savings to specific initiatives requires a deep understanding of your organization's processes and data.

Cost savings are easier to track than cost avoidance, but factors like market fluctuations, supplier changes, and long-term strategy complicate precise calculations. Later, we’ll provide guidance on how to effectively measure both.

Hard costs vs. soft costs

When we think about saving money, it can be helpful to divide our costs into hard costs and soft costs so we can determine the best strategies for reducing each.

Hard costs are tangible, easier to track, and often tied to cost savings. The immediate savings you see from negotiating a better deal with a current supplier can be seen as a specific figure and represents a hard cost.

Soft costs are intangible, more difficult to track, and often tied to cost avoidance. Reducing risk and avoiding future expenses are soft costs, as they tend to be more vague and you may not be able to tie a specific dollar value to them.

It’s because soft costs are so hard to quantify that many businesses aren’t willing to invest in cost avoidance.

Cost avoidance and cost savings strategies

Implementing the right strategies will help you get the most value from your cost-avoidance or cost-savings efforts. Let’s look at a few top strategies for each:

Cost avoidance strategies

• Thorough market research: Identify the best suppliers and negotiate favorable contract terms that minimize costs
• Standardization: Get your entire company on the same page with what products, services, and processes you’re using to leverage economies of scale and simplify
• Demand forecasting: Determine what you’ll need and when to avoid unnecessary purchases and minimize the need for expedited or emergency orders

Cost savings strategies

• Implement competitive bidding: Ensure you’re getting the best possible prices from suppliers for the products and services your business is using
• Analyze patterns: Conduct a comprehensive analysis of your organization's spending patterns to identify opportunities for cost savings, such as consolidating purchases or renegotiating contracts
• Implement sustainable procurement practices: This could mean using recycled or eco-friendly materials to reduce long-term costs and environmental impact

Both cost-savings and cost-avoidance strategies are about finding ways to reduce your costs. And here again, cost avoidance does this with an eye toward reducing future costs, while cost savings does it by looking for where costs can be cut right now.

By implementing a combination of these cost-avoidance and cost-savings strategies, you can maximize procurement efficiency, reduce overall spending, and improve your bottom line.

How to calculate cost avoidance and cost savings

We mentioned earlier that calculating the actual value of cost avoidance and cost savings can be quite challenging. That’s true, especially in the case of cost avoidance, but in both cases there are formulas you can use to value your strategies as accurately as possible.

Cost avoidance formula and example

Here’s the formula to use for calculating cost avoidance savings:

Estimated Cost of Inaction - Cost of Proactive Solution = Cost Avoidance Savings

So for example, say your company fails to perform demand forecasting for office supplies. When the office suddenly runs out of paper, you’ll need to order it immediately from whichever supplier can deliver it the soonest. Someone may also need to run to the nearest office supply store to purchase enough to get by until the delivery arrives.

This is highly unlikely to be the most affordable way to purchase new paper.

To follow the formula in this example:

• Cost of inaction: How much it would cost to get that paper at the last minute
• Cost of proactive solution: How much that paper would cost if you performed demand forecasting and thorough market research and got the best possible deal

Let’s say buying paper for the entire office at the last minute costs $1,000 and ordering it in advance after doing thorough market research costs $650.

Estimated Cost of Inaction ($1,000) - Cost of Proactive Solution ($650) = Cost Avoidance Savings ($350)

So in this example, you would’ve saved $350 with your cost avoidance strategy.

Cost savings formula and example

Here’s the formula for cost savings:

Original Cost - New Cost = Cost Savings

For this example, let’s say your office is having paper delivered regularly. If you implement competitive bidding as a cost-saving strategy, here’s how you would use the formula to determine your savings:

• Original cost: How much you were paying for paper to begin with
• New cost: How much you pay now that you’re getting the best possible price

Let’s say you were getting your paper delivery for $650, and then you implement competitive bidding and start getting it for $500.

Original Cost ($650) - New Cost ($500) = Cost Savings ($150)

In this example, you would’ve saved $150 with your cost-savings strategy.

How cost avoidance and cost savings impact procurement performance

Cost avoidance impacts your procurement performance in the most obvious way by changing the way your business does things now to save money in the future. But cost avoidance can also have a significant impact on procurement performance by strategically reducing costs right now.

By taking advantage of both sets of procurement strategies, your business can enjoy the best of both worlds: immediate and long-term savings as well as cost avoidance going forward.

Many businesses are on board with cost-savings strategies, but some are still reluctant to engage in cost avoidance due to the difficulty in measuring the impact. If you implement the cost-avoidance formula mentioned earlier, you can get some idea of how much you stand to save.

Short-term savings are important, but failing to strategize for future costs can be expensive for your business. To fully implement effective cost-avoidance strategies and control the procurement process, you’ll need full visibility into your spending as well as the ability to track it.

Using procurement software for better cost management

Understanding the differences between cost avoidance and cost savings can help you ensure that you’re implementing both strategies and reducing your company’s costs as much as possible—both now and for the future.

To effectively manage your procurement process and maximize its performance, you’ll need to be able to track, analyze, and act on both cost savings and cost avoidance. The solution? Procurement automation.

Ramp is a comprehensive financial management platform that combines the use of corporate cards, expense management, and procurement. With Ramp Procurement, streamlining the procure-to-pay process with powerful automation and cost-saving tools is easy.

Here’s what Ramp Procurement brings to the table:

• Enhanced supplier management: Access all vendor information in one centralized platform to instantly see who you’re doing business with and how much you’re paying.
• Price intelligence: Ramp Price Intelligence helps you leverage spend data from thousands of customers and millions of transactions to ensure you're getting the best deals.
• Savings opportunities: Gain complete visibility into spending to uncover savings on unused subscriptions, licenses, and memberships—eliminating unnecessary costs and reliance on outside accounting help.

What else can Ramp do for your procurement team? Try a demo and find out.