Tuesday 23 September 2014

Cost Savings and Methods of Calculation

Authored by  Junaid Khan

While cost saving may seem to be a tactical measurement, it is a component of value that is tangible. Some organizations only permit the reporting of hard savings, which result from the negotiated reduction of amounts already contracted with a vendor. Other organizations result from negotiated reductions in a vendors initially proposed pricing. Many organizations combine hard and soft savings, and simply use the term “cost savings” to refer to the collective savings. 

In any case to ensure consistency of reporting among Vendor management staff, standards should be developed indicating what can and cannot be counted as cost savings. The cost savings standards should also be reviewed with customers to ensure their understanding of how cost savings are being calculated and reported appropriately. The following list is an example of the elements of cost savings standards, what is permitted to count as savings, what is not, and the method of calculation.

Permitted Cost Savings:
  • Actual cost saving, such as reducing the cost of goods or services already being purchased. For example, reducing the cost of annual software maintenance.
  • Cost avoidance, such as reducing the proposed cost of goods or services that is being negotiated for. For example, reducing the cost of a hardware component from what was originally proposed by the vendor.
Cost Saving Exclusions:
  •  Cost saving resulting from contract audits and reviews performed by other departments.
  • Cost savings associated with established discounts for ongoing purchase beyond a maximum three-year period.
  • Cost Saving associated with procurement where the Vendor management was not materially engaged such as where the vendor management did not strategic, lead, or materially participate in a negotiation.
 Methods of Calculating Cost Savings:
  • Cost savings cannot be calculated from list price, rather, cost savings must be calculated from the first proposed non-list price.
  • The total of multiple-year cost savings can be accounted for in the year that the negotiation occurred, provided that the savings are projected for a maximum three-year period and provided that savings are not recounted in future years.
  • Actual reduction of penalties, liquidated damages, terminations fees or settlement amount also can be counted as cost savings.