Reverse vendor rationalization

We 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)