How do you measure savings?

It’s a tough question, but if you’re good at what you do, and you want to “win” at the end of the year, be sure you factor in currency fluctuation, inflation, and, if necessary, demand shift, because, on a per-unit basis, you can always save against market average if you’re good at your job and normalize the expenditures.

Here’s the foundation for a simple formula you can use to make this measurement. In reality, it will be a bit more difficult as you’ll have to calculate the actual increase in cost due to a change in the commodity index (as the commodity will only be one cost component in the total cost of the good being purchased), the realized difference in the exchange (as the currency conversion may cost you additional basis points), and the demand shift relative to a fixed interval, and not a fixed point, in time. But this simple example will suffice to show how, if you calculate appropriate unit costs, you really can’t lose even if the overall spend in the category goes up (because, without your efforts, it would have went up a lot more). And this is just fine (as long as you don’t double count the savings some other way).

Let’s say that, using appropriate benchmarking, backed up by indices and correlating cost models that are accepted by finance as reasonable, you calculate that the average market price per unit is $12 and you sign a contract for $10, for an expected savings of $2. Then, a year later, you find that the result of commodity inflation increases the cost per unit $1.20, for an increase of 10%, and the currency exchange increases $0.05 not in your favour, for an increase of 5%. What have you saved?

Savings/unit = (market cost/unit) – amount paid * (1 + currency increase) = 13.2 – 10 * 1.05 = 13.20 – 10.50 = 2.70

  market cost / unit = (base price/unit + cost increase/unit)

% Savings/unit = (savings/unit) / (market cost/unit) = 2.70 / 13.2 / 20% (WOW!)

Now, let’s say next year, you agree to a price increase to $10.50, but inflation increases unit costs by another $1.80 and the currency exchange only falls to $0.03 not in your favour. How did you do year over year?

Savings/unit = (13.2 + 1.80) – 10.5 * 1.03 = 15 – 10.5 * 1.03 = 4.19

% Savings/unit = 4.19 / 15 = 28% WOW!

  Costs increased 10%, but you increased your savings of 20% against market average to 28% against market average year over year! Looking at the big picture makes a difference since accepting 50% of the cost increase saved you considerably in the long run as prices continued to rise.