PurchTips edition #325

Here are three fictitious, but realistic, examples of procurement professionals’ cost savings claims. As you read them, think about the amount of cost savings you’d report in these situations. At the end of this article, I’ll share my analysis of these cost savings claims and how much cost savings I’d claim or approve.

Cost Savings Claim #1: “My company bought this product twice last year. We paid $500 the first time. We paid $402 the second time. We bought it twice this year for $400 each time. My savings is $200, right?”

Cost Savings Claim #2: “My company never bought this product before. I got three bids: $100, $90, and $80. After negotiating with the low bidder, I got a price of $70. My savings is $30, right?”

Cost Savings Claim #3: “My company bought this product last year for $10,000. The supplier proposed that this year’s price would be $11,000. I negotiated and got the price down to $10,800. My savings is $200, right?”

Now for my analysis…

Analysis of Cost Savings Claim #1: Because this product was purchased in the prior fiscal year, I would use the average price paid in that fiscal year as the baseline. The company paid a total of $902 for the two units in the prior fiscal year, so that’s an average price of $451 per unit. For each unit bought this year, you’d subtract the current price from $451. So, at a current price of $400, the savings is $51 per unit. The savings on the two units bought this year, then, would be $102.

Analysis of Cost Savings Claim #2: Without having purchased the product in the past, the baseline to be used is the lowest conforming bid prior to negotiation. In this case, that would be $80. The difference between that bid and the price paid of $70 would be $10 and that would be the cost savings/avoidance/offset in this case.

Analysis of Cost Savings Claim #3: Again, the average price paid in the prior fiscal year was $10,000, so that’s the baseline. If this company bought the product for $10,800 – regardless of what the supplier quoted – it would not be a cost savings, but a cost increase of $800. The one exception would be if the product was agreed by senior management and the procurement department to be a volatile commodity. In that case, this buyer may have been able to claim credit for “partially offsetting the rising price of a volatile commodity” as described in my book, The Procurement Game Plan.