Cost Avoidance vs. Cost Savings

Instructor: Douglas Stockbridge

DJ Stockbridge is currently pursuing a Masters degree in Accounting.

In this lesson, we will compare cost avoidance and cost savings. We'll describe what each is, and we'll give examples of each and highlight the similarities and differences.

Retirement Home

Imagine you are the owner of a retirement home in your hometown. For many years, you enjoyed success because you were the only retirement option in town. That is until your estranged Uncle decided to build his own competing retirement home right next to yours, literally in the next plot of land. He is building the retirement home right now, but you want to start making changes to get ready for the new competition. In fact, you want to decrease your costs so you will have more profit to reinvest in the company. You've read about cost savings and cost avoidance. They seem similar. You want to know how they are different and examples of each. Luckily, you came across this lesson and you now have the knowledge to compete effectively with your Uncle.

In this lesson, we will first define what cost savings and cost avoidance are, and then we will give some examples of each as suggestions that you (the retirement home owner) can use.

Definition

Cost savings and cost avoidance are two different sides of the same coin. They both deal with reduction in expenses. The only thing is for cost savings those reductions are noticeable and quantifiable, while for cost avoidance the reductions are harder to measure. Therefore, some consider cost savings as 'hard' cost savings, while cost avoidance is 'soft' cost savings. First, 'hard' cost savings are savings that directly impact the company's bottom line (i.e. profit/loss). These are the savings you most likely think of when you hear the term cost savings. Examples include switching to a lower cost supplier, or replacing your regular light bulbs with lower-energy bulbs. Cost avoidance, or 'soft' cost savings, is a decrease in cost that is not detected by yearly comparisons, because it reduces a cost increase. The company, therefore, pays the higher cost, but they pay less than what they would have paid had the cost avoidance not been achieved.

Examples

Examples of cost savings include:

  • A reduction in the cost of purchased material. Like we mentioned above, this would be like buying your material/supplies from a lower cost supplier. The retirement home could get its daily supplies (like food and medical supplies) from different, lower vendors.
  • Cost savings from a change in system/technology/policy. At the turn of the 21st century, thanks to increases in the availability and affordability of technology, many businesses automated their processes. They saved on salary expense and lost time as a result. The retirement home may find some cost savings by automating certain routine processes, like payroll/billing.
  • Examination of existing services, contractual agreements. The retirement home may benefit from conducting a comprehensive review of all the services they offer. If some services consume a lot of time and resources, but not many residents use them, then there may be cost savings if they stopped offering them.

Examples of cost avoidance include:

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