Reverse Vendor Rationalization

pinterest-missinglink-300x240We are all familiar with the terms vendor rationalization or vendor consolidation.

The concept is pretty simple.

Basically you look to increase supply base efficiency and savings through decreasing the number of suppliers with whom you deal.  When I talk about savings, I am of course talking about increased price discounts by channeling more business through a smaller, core group of suppliers and the lowering of what is known as vendor carrying costs.

From an industry standpoint, vendor carrying costs usually includes staff salaries and training relating to vendor support.  Specifically this means system operation expenses including maintenance and depreciation as well as other related costs, divided by the number of vendors.  Once again, pretty straight forward.

So for example let’s say that it costs a company $2 million per year to support their existing vendor base of 500 suppliers.  This would mean that the carrying cost per supplier is $4,000.  Based on this figure, if a company can “rationalize” their supply base by 25% (125 suppliers), it is estimated that they will save $500,000.

Given the above anticipated savings, it is not surprising that vendor rationalization or consolidation has been a common practice in the purchasing world.

But here is the problem . . . rationalization – especially when broadly applied across an organization’s entire spend – is a two-edged sword.  In other words there is a hidden yet very costly downside.  While rationalization strategies are in certain cases best suited to Direct Material acquisition, it is less than advantageous when you talk about Indirect Material procurement, particularly MRO products.

On average, Indirect Material purchasing accounts for 20% of a company’s overall spend yet 80% of its process cycle time.  Based on the sheer volume of individual transactions, it is this latter element that has been a driving factor behind the decision to pursue a rationalization strategy.  The reason is that P2P functional limitations associated with traditional enterprise applications that were more suited to low volume, high dollar transactions meant that process challenges in areas such as invoice reconciliation presented a significant problem.  In the absence of a viable solution alternative, the best way to address the situation was to decrease the number of suppliers, and thus eliminate has many transactional variables as possible.

Unfortunately, by reducing the number of suppliers, organizations began to lose touch with fluctuations in market pricing to the extent that one government department saw their average cost relating to Indirect Material MRO purchases increase above the going market price by an average of 23% [1].  This meant that any savings achieved through a rationalized supply base was offset by the fact that dealing with a much smaller pool of suppliers led to a more static price point that no longer reflected pricing in the larger, real-world market.

One of the many advantages of the emergence of cloud-based P2P solutions, and in particular the one offered by Nipendo, is that transactional volume is no longer an issue.

Capabilities such as Rapid Supplier Onboarding and the virtual elimination of incoming invoice errors means that it is no longer necessary to artificially limit the number of suppliers with whom an organization can and should do business.

In this context, reverse vendor rationalization going forward, is likely to become an emerging practice for many organizations.

Resource Link: Clalit Healthcare Case Study

[1] Source: Procurement Insights (Dangerous Supply Chain Myths Revisited (Part 7): Enabling Technology – The Emergence of the Metaprise)

Back to main Blog page

Leave a Reply

Your email address will not be published. Required fields are marked *

Post comment