The ability to select the most appropriate supplier is essential for the success of any manufacturing entity. A firm may opt to deal with a few preferred suppliers to avail the required raw materials, components and parts that are transformed into usable products. The concept of dealing with the few chosen suppliers in a manufacturing setting is referred to as direct procurement. While it can be convenient, it also has several disadvantages.
Relatively High Costs
Direct procurement results in various additional costs to the firm. There’s no competitive bidding, which entails sellers competing to offer the items at the lowest possible cost to the advantage of the buyer. The firm may spend more money when making its small-scale purchases because of its low bargaining power and lack of quantity discounts. The firm also may incur high search costs when seeking information about the most reliable and cheapest suppliers.
Risk of Stock-Outs
Relying on a single supplier is a risk to any firm’s operations. The supplier may fail to deliver the right quantity at the stipulated time, leading to stock-outs. Stock-out costs are the economic costs of not being able to meet both the production requirements and customer orders from the current inventory. These stock-outs may lead to loss of sales, lower profits and loss of customer goodwill.
Sourcing from a single supplier may compromise the quality of the procured items. Unlike in competitive bidding, where every supplier endeavors to offer the best quality, a single supplier in a direct procurement arrangement may fail to maintain the quality of the items. The firm may face dire consequences from the deteriorated level of quality. Poor-quality materials may increase wastage and overall operation costs, which in turn affects profitability, competitiveness and customer loyalty.
Direct procurement requires that the firm maintain a close relationship with its core suppliers. This involves vast investment in time, research and resources. The firm acquires all the information available on suppliers and selects the most appropriate. The firm is then expected to communicate and share information with the selected parties. The handling of these buyer-seller relationships can be very involved for a manufacturing entity.
Stanley Wilson has been writing since 2001, with work published in the "Financial Outlook Journal." He holds a Master of Finance from the MIT Sloan School of Management, a Bachelor of Science in management in accounting and finance from the Manchester Business School and a diploma in journalism from the Cardiff School of Journalism, Media and Cultural Studies.