Tuesday, February 5, 2013

Vendor Consolidation: A Solution to Reduce Soft Cost

After reading the article Rethinking Procurement in the Era of Globalization, I Realised that it is really important for a company to quantify the risk of transaction during procurement. To measure the risk, we need to pay attention on two kinds of cost: hard cost and soft cost. The former is relatively easy to measure because most of the hard costs are direct costs that we can put a price tag on. While the latter is always intangible which makes it difficult to predict and measure.

But as mentioned in the article, in a globalized market, the role of soft cost has become more and more important when making a procurement decision – Even when the hard cost is really low, sometimes the company still won’t go for it if the soft cost were high. Now you might want to ask the same question as I did: then how to reduce the soft cost?

One of the most popular solutions is Vendor Consolidation. Below is a video by Ian Johnson giving an overview of how vendor consolidation will affect transaction costs?

Simply speaking, vendor consolidation is to choose the best suppliers that you trust, and minimize the number of vendors. By dealing with fewer vendors, the billing process will be clearer, the payment period is more likely to be reduced, and orders will be easier to manage and track. (Johnson, 2010) What is more, since the partnership will last for a longer time, the possibility of misunderstanding during the transaction will become tiny. Thus we do not need to worry about cultural differences and labor issues any more. To sum up, the overall risk of the transaction will be largely reduced.

Besides soft cost, vendor consolidation also helps to cut down the hard cost. In the video, Ian mentioned five benefits of vendor consolidation.
First of all, it will increase the company’s purchasing power, which will help to lower the purchasing price. Second, it will lower the freight cost since all of the goods are shipped from the same supplier. Third, the quality of the product or service will be largely improved because the deal is now based on trust and cooperation instead of simply a buy-sale relationship. Fourth, the company will gain a stronger contract agreement, which is, as the vendor is willing to hold parts for a longer time, the level of obsolescent and damage will decrease, and pilferage is also less likely to happen. All these four benefits lead to the fifth one – improve vendor acquisition, which help the company to better evaluate and choose new vendors. As shown in the graph above, this will reflect back to the first four benefits and thus create a virtuous cycle.

For now, we have seen so many benefits from vendor consolidation. But does it mean that it is always the perfect solution? For me the answer is no. Stick with one or two vendors will decrease the resilience of the supply chain. For example if Apple only buys its flash memory from one Japanese vendor, then at the time when tsunami struck Japan, its entire supply chain will shut down. Besides, without looking for new suppliers, the company will stay away from learning new ideas from different suppliers, and thus lose the opportunity of innovation.

Above is what I learnt about vendor consolidation. Please share with me if you have any new ideas.

JohnsonIan. (Oct 2010). How Business Soft Cost Reductions Leads to Hard Cost Reductions. Accessed: 5 Feb, 2013, From: DriveYourSuccess: http://www.driveyoursuccess.com/2010/10/how-business-soft-cost-reductions-leads-to-hard-cost-reductions.html

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