Balancing Supplier Relationships with Cost Savings

Written by Andrew Goldman for Gaebler Ventures

With small businesses, every cent counts. As a result, small business owners must pay close attention to how they purchase materials and supplies. There is a fine line between cost-savings and good supplier relationships, which are critical to small business success.

In order for a small business to grow and remain competitive in their market, they must have positive relationships with their suppliers while operating in a cost-effective manner.

It is not enough for a company simply to seek out the low-cost vendor, and it is equally ineffective to remain blindly loyal to individual vendors. There is a fine line between cost-savings and vendor loyalty that is a crucial element of small business success.

The Low-Cost Approach

To start with, a small business can ill-afford to overpay in the procurement of materials and equipment. As a result, a natural tendency to seek out the lowest cost develops. While on the surface this seems like a viable strategy, there are serious flaws in this approach that can cost the company far more than the initial savings.

In a perfect market where all things are created equal, the lowest cost is the best option. There are a plethora of externalities, however, that alter the purchasing decision. Some of these externalities include: the reliability of the vendor, the long-term viability of the vendor, the flexibility of the vendor, the quality of the vendor's material, and the level of vendor customer service.

Developing Quality Relationships

A company should not simply shop based on the lowest price. Maintaining a positive supplier relationship is critical for a small business' long term success. While this may result in higher procurement costs, it usually results in better handling of the aforementioned externalities.

Although this may typically be the case, maintaining the same vendors in order to establish loyalty and trust does not guarantee the elimination of some of these issues. This strategy can easily backfire on the small business if its vendors become complacent and confident that they can charge unreasonable premiums for their products.

As a result, the small business must keep its vendors honest, and find the happy medium between the low-cost vendor and positive supplier relationships.

Where Problems May Arise

Recently I consulted for a firm where this balance had become a glaring issue and a major hindrance to the growing firm's success.

The company manufactured and bottled liquid supplements for distribution throughout the country, and hoped to establish itself in the market with packaging and product design that would capture the customer's attention. As a result, the company invested heavily in packaging materials and its relationship with the packaging supplier was a crucial component to its profit margins and overall success.

During the company's inception, several packaging companies submitted product quotes and essentially bid for the company's business. The purchasing department, under direction of the CEO, wanted a reliable supplier with who they could build a long-term relationship.

Consequently, one supplier was chosen for all packaging materials and the small business received satisfactory customer service and its desired level of supplier flexibility. Two years later, when I began consulting duties, I noticed a trend of rapidly increasing material costs and mediocre customer service. The sales representative had grown complacent, and recognized his position and high degree of supplier power. As soon as the sales representative realized his prices were not being cross-checked with other vendors, he had free reign to increase prices and boost his own sales commissions.

Learning From Mistakes

It's extremely important for the small business owner to understand that sales representatives, especially those in material and service procurement, negotiate their own prices and receive increased commissions depending upon how much more they can charge the customer.

Keeping this in mind, a firm must constantly cross-check their prices with other vendors in order to maintain an acceptable level of buyer power. The small business can still retain the high levels of customer service and reliability with cross-referenced prices. Chances are when confronted with lower competitor's prices, the sales representative will match or reduce his prices in order to retain your business. If it cannot reduce its prices, the small business should feel comfortable trying new vendors for materials in order to find the best fit for the small business needs.

Understanding the mindset of the sales representative is a fundamental component for any successful purchasing department.

Small businesses tend to feel they must maintain a loyal relationship with their supplier in order to receive high levels of customer service and flexibility.

What the small business owner needs to understand is that the sales representative wants your business, and blindly ordering from the same vendor puts all the power in the supplier's hand — a situation that no small business owner can afford.

Andrew Goldman is an Isenberg School of Management MBA student at the University of Massachusetts Amherst. He has extensive experience working with small businesses on a consulting basis.

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