As a procurement professional, you’ve heard the terms “vendor consolidation” or “vendor rationalization” as a means to improve your supply base effectiveness and efficiency by down-sizing and right-sizing your vendors. While it’s a great idea, you still need to develop a business case before you embark on the project. Most vendor rationalization business cases are supported by additional cost savings achieved by consolidating spend across fewer vendors (meaning better discounts). While the spend savings and other tangible benefits (such as improved vendor performance) are the most significant ROIs for a vendor rationalization business case, don’t forget to include the organizational cost side—it costs your employer $$$ to manage multiple vendors and rationalizing vendors reduces those costs. Keep in mind that the reason that most folks don’t include the cost benefits in their business case is because they can’t really “produce” the results (more on that later). Regardless, I think the cost benefits should be included in the business case because the benefits do represent value.
If you’re not aware of it, it’s an industry accepted practice to take aggregated, relevant costs and divide those costs by the total number of vendors to determine what is called a vendor’s “carrying cost.” At the very least, the costs should include staff and systems used to support vendors. That means fully loaded salaries, training, occupancy, depreciation expense of systems, system operation expenses, system maintenance expenses, etc.
Here’s an example using a “typical” company’s procurement staffing model of 5 buyers, 3 A/P staff, and supporting systems: If my procurement department’s annual budget is $800K, my A/P department’s annual budget (related to vendor payments) is $400K, and I spend $300K annually keeping my purchasing, contract management, and payables systems running, I have roughly $1.5M in costs managing my vendor base. (Of course, some of those costs are working with customers, sourcing new vendors, etc., but this is a rule-of-thumb, rough order of magnitude industry accepted practice. Feel free to calculate exact carrying costs.) Assuming a supply base of 500 vendors, the annual carrying cost per vendor would be $3,000 ($1.5M costs / 500 vendors).
So, if you plan to “rationalize” 20% of your vendors (100 out of 500), your cost benefit would be $300,000!
As I implied earlier, the sticky part is what you’re going to do with the so-called “cost benefit.” Are you going to reduce staff or are you going to apply the “found” resources in some other way that benefits your employer? You likely won’t be reducing staff, so the best way to articulate the use of the found resources in your vendor rationalization business case is through improved customer service or taking on other projects that have gone to the wayside.