Guide to cost avoidance in IT procurement

What is cost avoidance?

Cost avoidance is the practice of taking pre-emptive steps to reduce overall spend in the long term. Cost avoidance measures cast an eye towards potential future costs, making necessary decisions that should benefit company budgets further down the line.

Examples of cost avoidance include investing in proactive maintenance repairs and the procurement of new technologies and equipment. Although these initiatives represent immediate cost increases, the amount of money saved in the long term can be significant.

In SaaS and IT procurement, cost avoidance focuses primarily on contractual agreements that keep expenditures at their current level. It’s standard practice for IT vendors to use inflation, contract renewals, and global economic shifts as legitimate causes for price increases, but strategic sourcing teams can negotiate price locks for the duration of their contracts to mitigate against market volatility.

Procurement teams may have to pay a higher fee for price freeze guarantees — particularly if the contract covers a lengthy period of time — but the tangible financial benefit will be evident over the longer term. In these contexts, cost avoidance strategies accept additional upfront costs in exchange for future savings.

Calculating cost avoidance

The first step in cost avoidance is to calculate the amount that can be saved by introducing cost avoidance measures. Since cost avoidance often concerns hypothetical figures on future costs, there can be an element of guesswork at play here. Nevertheless, calculating potential savings is a vital step in the process and helps convince stakeholders to get on board.

There are two methods for calculating cost avoidance: first as an amount, and then as a percentage.

Calculating cost avoidance as an amount is a two-step process. First, using metrics such as historical data, projected trends, forecasting and market analysis, estimate the potential cost that could be incurred in the event that no preventative action is taken. Second, establish the cost of implementing a cost avoidance solution.

Once you’ve arrived at figures for both amounts, the formula is straightforward:

Cost avoidance amount = estimated cost of inaction – cost of solution

With a cost avoidance amount determined, calculating cost avoidance as a percentage is made possible:

Cost avoidance percentage = cost avoidance amount cost of inaction

Cost avoidance vs cost savings

Cost avoidance and cost savings are two terms often used interchangeably. Although they both target the same outcome — that is, lower costs — they represent two different approaches.

We’ve outlined the ways in which these approaches differ in the sections below.

Proactivity vs reactivity

Cost avoidance strategies are proactive. They identify the ways in which unnecessary expenses can be prevented before they have a chance to occur. With cost avoidance strategies, reductions in cost won’t always be immediately visible. In fact, the opposite is more likely to be true — cost avoidance typically results in a temporary increase in spend before an eventual decrease.

By contrast, cost-saving measures are reactive actions organizations take to reduce current levels of spending. In today’s business world, cost saving decisions often involve modernizing existing business workflows towards more streamlined processes.

The purchasing of new software is a perfect example. Software solutions target a specific business function — whether it’s the automation of social media posts, facilitating smoother outsourcing channels, or better analysis of financial statements — as an area for potential bottom line savings.

Existing processes replaced by new software may have been working fine before, but were expensive and complicated to run. New technologies enable organizations to carry out these tasks much more efficiently, leading to significant cost reductions.

Cost saving strategies therefore react to changing circumstances, such as the invention or roll-out of new business software.

Hard costs vs soft costs

The cost savings vs cost avoidance line can also be defined in terms of hard costs and soft costs.

Hard costs refer to the purchasing of tangible assets — direct costs immediately visible in balance sheets. Examples of hard costs include property, land, equipment and purchasing inventory, as well as rent and utility bills. Hard savings, therefore, are an association of cost savings, because reductions in spend are immediately apparent.

Soft costs, also known as indirect costs, are an analog of cost avoidance measures, relating to areas of spend that are more difficult to forecast. Examples include maintenance and optimization costs and outsourced services such as accounting and legal costs.

Long-term savings vs immediate returns

Cost avoidance measures tend to be part of a strategic long-term project to reduce overall spend in the future. In SaaS procurement, departments adopt a position of cost avoidance in order to prevent the shock of price increases and market volatility.

Risk management also forms a key part of cost avoidance. Failing to take the time to assess the potential for risk when selecting one supplier over another can be extremely costly down the line.

Cost savings are concerned with immediate financial returns. As opposed to the strategic planning of cost avoidance, businesses take the position of cost savings when company finances need to be immediately reduced.

Spiraling operational costs, supply chain breakdown and failing business partnerships are a few examples of reasons why companies implement cost-saving measures.

How to establish cost avoidance protocols

Implementing a proper cost avoidance strategy within IT procurement and beyond is essential for long-term financial health and sustainability. A proactive mindset goes a long way to preventing future expenses and maintaining optimal spending. Here’s a step-by-step guide to establishing cost avoidance protocols within your organization. 

1. Develop a cost avoidance mindset

From the outset, you need to develop a culture of cost avoidance across your workforce. Ensure that all members of the procurement department understand the difference between proactive cost avoidance and reactive cost savings, and highlight the importance of future expenses and indirect spend management. Training sessions and workshops can be held to illustrate the benefits of cost avoidance, providing real-life examples of cost savings achieved through proactive measures.

To promote a culture that values cost avoidance, consider recognizing and rewarding employees who successfully implement preventive measures. Ultimately, the goal is to encourage a mindset shift from immediate cost-cutting towards more strategic, long-term planning. 

2. Pre-empt costs

Proactively managing costs starts with regular benchmarking of your spending against industry standards in order to identify areas where future expenses can be avoided. This practice not only helps maintain competitive spending, but highlights inefficiencies that can be addressed through cost avoidance strategies.

Consider investing in preventive maintenance to avoid costly repairs or replacements later on. This includes maintaining optimal spending on software licenses and hardware upkeep. Scheduled maintenance helps ensure systems run smoothly, reducing the likelihood of unexpected breakdowns that can result in significant expenses.

3. Optimize license management

It’s essential to keep track of software license usage across your organization to ensure you’re not overspending on underutilized subscriptions. This way, you can reallocate seats or downsize contracts where necessary, avoiding unnecessary costs at renewal. Software asset management (SAM) tools can help here, providing detailed insights into license utilization and associated costs.

You should regularly review and renegotiate your contracts too. Things to consider include fixed subscription fees and longer-term agreements — these often lead to more favorable terms that avoid yearly price increases, while boosting budget predictability at the same time. 

4. Assign responsibilities

Define clear roles and responsibilities within the procurement department, with specific team members assigned to focus on cost avoidance strategies. This specialization ensures there’s dedicated attention to identifying and implementing cost avoidance measures.

Once you’ve identified your cost avoidance specialists, empower these team members with decision-making authority to implement avoidance measures promptly. Swift and effective action is often necessary to make the most of savings opportunities, and by providing the right resources and authority, you can avoid delays that could negate the benefits of proactive cost management. 

5. Implement monitoring and reporting

Conducting regular audits of procurement activities is vital if you want to identify and rectify potential cost issues before they escalate. These audits should be comprehensive, covering all aspects of procurement to uncover hidden inefficiencies and opportunities for cost avoidance.Don’t just focus on hard savings. You should also document and report soft savings, such as time saved and risk mitigated, to provide a comprehensive view of cost avoidance benefits. This helps build a complete picture of the value derived from cost avoidance efforts — and makes a case for a continued focus on them — even if they don’t translate immediately into financial gains.

How Vertice supports cost avoidance and cost savings in financial management

In the course of an organization’s lifetime, it’s likely that cost avoidance and cost savings processes will be repeated many times over. These processes are clearly essential for the running of a successful business, but aren’t always easy to achieve.

Vertice can help. Our SaaS Purchasing Platform facilitates both cost avoidance and cost savings by helping businesses gain greater SaaS visibility over expenditure and platform usage.

The platform monitors user interactions to analyze the importance of specific products and the features within them. By gaining a comprehensive understanding of a platform’s usage data, the Vertice platform can make intelligent suggestions on ways in which the subscription can be improved, such as enhancing, modifying, or retiring certain capabilities.

Our solution also keeps a close eye on contract renewals and scorecard dates, giving relevant teams sufficient time to prepare for upcoming appraisals. Auto-renewal clauses are a cornerstone of software vendor profits: through the assumption that their customers are simply too busy to pay attention to renewal dates, suppliers can rest on their laurels as contracts tick over year-on-year, often at increased rates.

Vertice says no more.

On top of this, our customer purchasing teams are experts in negotiation and can save you money across the procurement cycle. In the interest of cost avoidance, they’ll secure new contracts on your behalf at optimized rates, ensuring price increases are kept to a minimum or removed altogether. If a platform is vital to your business needs, we’ll secure long-term contracts with favorable terms such as warranties and maintenance assurances.

Our purchasing teams also facilitate cost savings by inserting themselves into a unique market position. We have access to historical supplier deals, giving us visibility over the precise amounts other businesses pay for the same subscriptions. With these insights, we approach the negotiating table with greater leverage, ensuring our clients never overspend on SaaS procurement again.

For more information on how Vertice’s SaaS Purchasing platform can help facilitate cost avoidance and cost savings, click on the link and get in touch.