The Continuing Dangers of Vendor Rationalization

Posted on November 27, 2007

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As mentioned in my previous post, the feedback I receive from procurement professionals who attend my conferences never fail to make an impact in terms of the grassroots challenges they face on a daily basis.

Often times, it is the adherence to long held beliefs and strategies that undermine their efforts to deliver maximum value in an expanding global economy.

One such strategy centers on what is commonly referred to as vendor rationalization.  Even though the broad application of this practice has consistently been a major factor in the continuing high rate of initiative failures, its advocates continue to herald its purported benefits.

Dr. Spock, Vitamin C and Pluto (the planet not the dog)

With the recent birth of my son, I could not help but think back to the days when Dr. Benjamin Spock’s books were considered required reading for all new parents.  The ultimate handbook if you will for child rearing.

Starting with his first published work, The Common Sense Book of Baby and Child Care in 1946, many of Spock’s recommendations were later discredited by the very mainstream populace that had originally embraced him.  One such example was his position that infants be placed on their front when sleeping.  Research ultimately proved that this actually increased the odds for sudden infant death syndrome, with studies suggesting that as many as 50,000 infant deaths around the world could have been avoided had this advice not been given and taken.  Findings like this have been used by the medical community to advocate the importance of “basing health-care recommendations on statistical evidence.”

Beyond Spock, common misconceptions and debate continue to surround other long held beliefs such as the effectiveness of large doses of vitamin C in averting a cold, or whether or not Pluto is an actual planet in our solar system.  These as well as other innumerable examples provide further evidence of the elasticity of popular opinion.

While the consequences of this “elasticity” range from the critically important (i.e. SIDS) to the somewhat amusing like the status of a planet that shares the same name as a Disney animated character, it is the actual origins of “mainstream” concepts and ideas that needs to be better understood and quantified.

The elemental roots of vendor rationalization

While advocates point to several “common sense” reasons for a reduced or rationalized supply base, such as lower administrative and operational costs, increased quality control through more strategic relationships, and the ever popular volume discount savings, tangible statistical support has been less than convincing.  In fact, when broadly applied across an enterprise’s entire spend, statistics clearly indicate that the practice of rationalizing the supply base will actually lead to increased costs in areas such as Indirect Material procurement.

This of course leads to the million dollar question, why?  Why continue to perpetuate a practice that has yet to deliver the promised results, while simultaneously alienating key stakeholders such as regional or local buyers and suppliers?

Based on years of analyzing e-procurement initiatives in both the public and private sectors, the one common denominator in all failed undertakings is that the program originated as an adjunct to either an ERP-centric or IT-centric strategy.  Being built upon a somewhat static foundation, the dynamic nature of supply chains (especially in the case of a synchronized versus sequential architecture – see Metaprise) is often corralled or confined to the narrow framework of departmental understanding.

As a result, vendor rationalization is more a by-product of technological limitation versus true operational efficiency.  The resulting fallout has contributed to the growing problem of Double Marginalization whereby higher buy prices are mirrored by decreasing supplier profitability.

A picture is worth a thousand words

Keeping in mind that the problems posed by a vendor rationalization strategy will occur when it has been applied to all areas of an organization’s spend (i.e. commodities that demonstrate both Dynamic Flux as well as Historic Flat Line characteristics – see my paper Acres of Diamonds), the key to savings realization for the majority of purchases is for buyers to go deep into the market’s supply base.   Specifically, and in the area of low-dollar, high transactional volume procurement (which usually accounts for approximately 80% to 90% of all organizational purchasing activity), the buyer should engage the broadest number of potential suppliers possible.

Empirical studies clearly demonstrate that when a vendor rationalization strategy is expanded to include Dynamic Flux commodities (i.e. Indirect MRO materials), a negligible amount of the total available market savings are passed through to the buying organization.  One such example is the Department of National Defence who paid an average mark-up of up to 157% above market prices for IT spare parts over a period of several years.

Like high blood pressure, this is a silent bottom line profitability killer that usually goes unnoticed until it is too late.  At that point, and in an effort to “right the ship,” organizations usually pursue strategies that are commensurate with the Doom Loop described in Jim Collins’ book Good to Great.  In the case of the DND, they are encountering difficulties in finding vendors who are willing to service their equipment given the reactionary structure of their current contracts.

To help illustrate the inherent dangers of a misaligned rationalization strategy, I have prepared and am pleased to provide by way of a download link the Point of Reduction Graph.  Referencing the corresponding notations, the graph will hopefully provide you with a visual explanation of the research data that I first began capturing close to 11 years ago and have been monitoring ever since.

Asking the hard questions

In every seminar I give, I always encourage those in attendance to challenge my findings.  In short, don’t take my word for it, do your own research.

Any concept, strategy, methodology or findings must be able to stand the test of both scrutiny and time.

That same advice should also be applied to your own organization’s current practices.  There is no loss only gain from a pointed and sincere question as to why you have chosen (or have had chosen for you) the present course of action.

Regarding vendor rationalization, do you really know why your organization is pursuing this strategy given its far reaching (and some would assert) negative implications.

If you can’t answer this or for that matter any question with tangible, sink your teeth into it facts, perhaps a well-timed pause to reconsider your options is warranted and likely necessary.  Or to borrow a phrase from Big Blue’s Thomas Watson . . . THINK!

Next Installment: Are high technology companies in trouble, and can a more efficient procurement practice help to avert disaster?

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