Most of you have heard about the effect of compounding. This is commonly known and spoken about in investments. According to Merriam-Webster it is “to pay (interest) on both the accrued interest and the principal.” The opposite is true as well. Although not often talked about, the effect of compounded savings, or reduction in expenses can be significant. We helped one association cut one particular expense, which over the next 10 years will save them, using some reasonable assumptions, over $240,000.
Depending on the size of the association, renegotiating a contract that results in savings of $23,000 in the first year, may or may not be worthwhile. If the annual budget is $20 million, it may be considered nickels & dimes, but if the annual budget is $200,000 it would be a significant amount. Our opinion is that it is worthwhile either way, because small savings add up and easily become large savings; if not the first year, over time.
For instance, have you ever called your personal cellphone provider and asked them to reduce the price of your monthly plan? If you haven’t, we highly recommend it. We, at the Folson Group, have never been declined either a reduction in price or increased services when we called our cellphone provider. Try it and let us know your findings!
But let’s get back to talking about “Compound Savings.”
In this real life case, the realized saving of $22,991 amounted to approximately 4% of this association’s total annual expenses. This is the amount of an average maintenance increase! More importantly, the renegotiated price now serves as the base for future increases.
- Old Price: $52,467
- Renegotiated Price: $29,476
- Savings: $22,991
Assuming that both the old price and the renegotiated price will increase by the same amount over the next 10 years, here’s the total costs for both at 1.5% increase per year.
- Old Price total: $561,540
- Renegotiated Price: $315,473
- Savings: $246,067
We used 1.5% as the growth rate of both the old and renegotiated price as this is the lowest increase we have ever seen in this particular category. If we use a more likely 3% increase, the actual total savings over the 10 years will add another ~$17,000. That’s the effect of compounding!
When it comes to savings, we are of the belief that all services, vendors, and contracts need to be thoroughly reviewed as every cost is lost money. As Warren Buffett said: “Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”