Measuring Cost Savings For Mid-Year Deals
PurchTips - Edition #200
By Charles Dominick, SPSM
Do You Measure Mid-Year Cost Savings Properly?
Measuring cost savings in a way that CFO's embrace can be challenging. This is particularly true when you implement a negotiated deal in the middle of your organization's fiscal year.
In the fiscal year that the mid-year deal is finalized, do you report the annualized cost savings or just a prorated portion? Are there cost savings to measure in the next year? What about the following year?
Well, here is some insight. First, understand that CFO's like to compare fiscal year-over-fiscal year expenses. If this year's expenses are lower than last year's expenses, they consider the difference a cost savings.
Let's say that you spent $10,000,000 on a category of goods between January 1, 2008 and December 31, 2008. After sourcing in 2009, you reached a new deal with a supplier that brings the cost of a year's supply down to $9 million - a reduction of 10%.
However, the contract didn't go into effect until October 1, 2009. As a result, in 2009, you were paying the old price from January 1 until September 30 and the new price from October 1 through December 31.
So, for 2009, you spent $7,500,000 in January through September plus $2,250,000 in October through December for a total of $9,750,000 for the year. Therefore, your cost savings in 2009 would be $10,000,000 - $9,750,000 = $250,000.
Now, your lower price will continue to be in effect through 2010. Therefore, your spend in 2010 will be $9 million ($1 million less than your original baseline). But because CFO's like to compare expenses for a year with the expenses for the previous year, you would NOT be taking the difference between $10 million (in 2008) and $9 million (in 2010). You would be taking the difference between $9,750,000 in 2009 and $9,000,000 in 2010. So your cost savings would be $750,000 in 2010.
If your pricing remains the same in 2011, your cost savings for that year would be $0. Though it would be tempting to report $1,000,000 in cost savings for each year that the new contract is in effect, doing so is in conflict with how CFO's think about cost savings: fiscal year-over-fiscal year expense comparison. If you want your cost savings measurements to be accepted by the CFO, then you must think like a CFO!
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