Cost savings or cost avoidance?
Consider these scenarios:
A law enforcement agency negotiates a 10 percent decrease in the price of an information technology service contract, resulting in a savings of $100,000 that year.
A different law enforcement agency resists a vendor’s attempt to raise prices by 5 percent, allowing the agency to avoid spending an additional $200,000 that year.
The first scenario is an example of cost savings. Cost savings occur when there is a reduction that causes future spending to fall below the level of current spending. These cost savings may then be removed from budgets, reinvested, or redirected to other spending priorities.
The second scenario is an example of cost avoidance. Cost avoidance refers to reductions that cause future spending to fall, but not below the level of current spending. Often cost avoidance involves slowing the rate of cost increases. In other words, future spending would have increased even more in the absence of cost avoidance measures.
From the standpoint of cost-benefit analysis, both cost savings and cost avoidance can be counted as taxpayer benefits, because both reduce the amount of resources necessary to fund government operations.
From a budgetary perspective, however, the difference between cost savings and cost avoidance has practical implications. If strategies focus on cost avoidance rather than on cost savings, surplus dollars for reinvestment may be slower or more difficult to generate. On the other hand, cost avoidance initiatives can help to contain and control costs and may create cost savings over time.
For specific examples on defining cost reduction and cost avoidance from a procurement perspective, see the eSourcing Wiki. For more on marginal costs, read our Guide to Calculating Justice-System Marginal Costs.
This month on the blog we’re focusing on costs.