Calculating Cost Savings In Multiple Years

Imagine this situation:

• You are responsible for buying a certain item
• Last year, you bought 10,000 units of the item at $100 each
• This year, you’ve signed a 3-year contract with your supplier
• The contract price is $90 per unit of the item
• You will buy 10,000 units of the item in each year of the contract

How much cost savings will you calculate and when will you report the cost savings?

Did you say that you would report $300,000 in cost savings when the contract is signed?

Senior management may disagree with you.

As I’ve explained in previous editions of PurchTips, when you report cost savings, senior management expects to see a reduction in expenses from the previous year to the current year. So, in the scenario described, your expenses will not be reduced by $300,000 this year – they will only be reduced by $100,000 which is this year’s quantity multiplied by the difference in price.

Then, because there is no price reduction between contract year 1 and contract year 2, senior management usually doesn’t accept cost savings claims in contract year 2 or thereafter. So the first year of cost savings is all that is recognized by senior management.

This approach to calculating cost savings concerns many purchasing professionals. You may feel that you deserve more credit for achieving a price reduction and locking in that lower price for three years.

That is commendable but, unfortunately, not consistent with the way that executives typically account for cost savings. So how can you get credit for cost savings across the entire life of a multi-year contract?

One way is to negotiate a price that declines each year during the contract. For example, instead of starting at the $90 price, you would negotiate the price to be $95 in the first year, $90 in the second year, and $85 in the third. While the contract value is the same as the supplier, you’ll get to report savings in each year of the contract and senior management will recognize three years of year-over-year expense reductions.

Recommended Resource:

• Cost Savings Spreadsheet

Recommended Course:

• Best Cost Reduction and Performance Management Strategies

NLPA Learning: Looking for authoritative procurement templates, tools, webinars, and more? Stop trying to create resources from scratch and start taking advantage of having exactly what you need right at your fingertips in NLPA Learning.

Are you tired of not getting enough opportunities, respect, and money out of your procurement career? Well, guess what? Nothing will change unless you take action towards becoming a world-class procurement professional.

Earning your SPSM Certification is the action to take if you want to bring the most modern procurement practices into your organization and achieve your career potential. Download the SPSM Certification Guide today to learn how to get started on your journey to a more rewarding procurement career!

Are you a procurement leader whose team isn’t achieving the results you know are possible? Maybe it’s not enough cost savings. Or frustrating performance from the supply base. Or dissatisfied internal customers.

You need a performance improvement plan that’s easy to implement and quick to produce results. The NLPA can help.

Download our whitepaper “The Procurement Leader’s Guide To A More Successful Team.” You’ll learn the 7 steps for transforming your staff into a results-producing, world-class procurement team.

Members of the NLPA get more than just articles like this by email. As a member, you also get access to:

• The Procurement Training & Certification Starter Kit
• The latest Purchasing & Supply Management Salaries Report
• Leading-Edge Supply Management™ magazine
• Members-only webinars 10x per year
• And more!

If you haven’t been taking advantage of these benefits, why not log in and start now?