Vendor Validation 101: What Is It and Why It Matters
Your company cannot and does not want to supply all business essentials in-house, and you realize that it is time to start outsourcing tasks and procuring supplies so that you can direct more time and effort to the core function of your business. The problem is that now that you are using suppliers, you are incurring a lot of expenses as a result of outsourcing inefficiency.
What is vendor validation, and why does it matter? Vendor validation is the process that confirms a supplier as a legitimate entity. It can save your company significant money by ensuring that you are not contracting with fraudulent vendors and that your existing vendors have not been renamed, relocated, or gone out of business.
The process for vendor validation becomes increasingly complex the larger a company becomes, with many multinational businesses requiring entire procurement departments to handle the vendor validation process. However, it is a necessary task, as roughly 30 to 40 percent of suppliers change information on any given year.
Why Is Vendor Validation Necessary?
Vendor validation is a necessary part of any business because you are likely to need to acquire supplies, materials, and/or services from outside entities to maintain your business function.
Let’s say that you are a manufacturer of laptop computers and rely on a vendor to supply you with semiconductors. If the semiconductors do not get to your business on time, you will not be able to make the computers, and any delays in production will certainly hurt revenue, putting your entire business operations at risk.
While you may have a trusted vendor of semiconductors who has served your business well over the years, it is not enough to trust that the semiconductors will continue showing up year-after-year, as any of the following may happen if you are passive in the procurement process:
- Your vendor goes out of business
- Your vendor has a change of address
- Your vendor changes names and/or is acquired by another company
- Your point of contact or person handling your account is changed
As the vast majority of payments today are handled online or via credit card, any of the above scenarios could keep payments from processing and delay and/or cancel the shipment. And while it should be considered common courtesy or “good business” to contact partners with any changes, it cannot be assumed. Therefore, vendor validation must be actively managed.
In addition to these considerations, vendor validation is necessary because, in the Internet era, there are many scams out there and businesses that are less than reputable. As such, your company must make sure that it is partnering with a real entity prior to using a vendor for the first time.
On top of confirming that the vendor with whom an organization does business is real, vendor validation is necessary to ensure that all end of year tax documents reconcile.
How Does Vendor Validation Work?
If you have ever worked for a large organization, especially a government agency of any sort, then you are most likely familiar with a “purchase request” or a “procurement request.”
This is generally some type of form or online submission in which the party of your organization desiring to do business with a vendor fills out all of the relevant vendor information, such as company name, address, and contact information of the responsible vendor agent and submits it to the procurement department.
After this step is taken, the organization’s procurement department will use this information to vet all potential and returning vendors through the following process:
- Verification of tax information, such as an active Tax Identification Number
- A public domain search
- Direct telephone contact
- Assessment by a third-party service, if necessary
Once the procurement department has validated the vendor along these lines, then a purchase requisition is submitted, or the original request is stamped and sent to accounting. This essentially is a green light from procurement services, saying that the vendor is a legitimate entity, and the purchase can be made, as long as funds are available.
In addition to the initial vendor validation, this process must be completed on at least a yearly basis for most organizations.
The Importance of Vendor Validation: A Detailed Look
Now that you understand why vendor validation exists in an organization and have a basic understanding of how it works, let’s take a look at some specific areas in which vendor validation can improve business performance.
Increased Efficiency and Decreased Costs
Many companies think that the key to increasing efficiency and decreasing costs is to find the right supply, get it at the right cost, and have it delivered at the right time.
While this is certainly an important business practice, any savings found in this area can be quickly erased and/or negated if vendor data is bad.
How A Company Loses Money From Bad Vendor Data
Take the example of the company that updated its terms and services and had to send out a letter to all vendors notifying them of this change, only to have a significant portion of these terms of service letters returned as undeliverable.
Not only did the company lose money on wasted postage, but efforts subsequently had to be redoubled in updating vendor data, slowing other business functions while the company waited for this information to get up to date.
This example is not an isolated exception. Research shows that average mid and large market companies are losing millions of dollars in potential savings annually due to inaccurate supplier records.
Not only does inaccurate vendor data lead to increased costs at the source of the business/vendor relationship, but it will create inefficiencies for all company employees involved in the supply chain, including those in accounts payable, legal, and other areas.
It has been proven that functional silos (leaks in the system) in organizations that require more than two levels of authorization for purchase orders are at an increased risk of loss or duplication of data, both of which will lead to costly errors.
What Happens to Vendor Data Without a Validation System?
Let’s consider our previous example of a computer manufacturing company to demonstrate how vendor data can get lost, confused, or duplicated if an appropriate vendor validation system is not in place:
- The research and design department (R&D) learns of a new, high-efficiency semiconductor that they want to use for an updated laptop set to release next year
- After quickly filling out the vendor information and part specifications, R&D sends the proposed semiconductor over to production, asking to see if the company’s manufacturing equipment is compatible with the alternated semiconductor
- Once checked with production, the proposal is sent to the legal department, asking to do some research as to whether there is any liability in making the semiconductor switch and if there are potential breach of contract considerations when switching suppliers
- The legal department then sends the request to accounts payable to see if there are sufficient funds to place the order at the requested quantity
Using this model, it is easy to see where vendor information can get lost in translation without a designated procurement department to validate all information, especially when taking into consideration that the supply chain is not this simple for most companies, with added layers and a higher degree of outsourcing added to the process.
By aggregating supplier data in a standardized way, whether it be through a procurement department or specialized vendor validation software, an organization can improve operational efficiency and see increased returns at the bottom line.
Many organizations like to use analytics to boast about the performance of their firms and use it as the groundwork for their competitive advantage. For example, you may hear any of the following statements regarding a company’s performance:
- “We were able to increase year-over-year revenue by 5%.”
- “We sold 100,000 more units than the next leading competitor.”
- “Our price to earnings ratio has improved for three straight years.”
However, over time, data output will only be as good as data input, making strong data readiness and cleansing protocols essential in attaining optimal competitive advantage.
To get very technical, some vendor validation firms and software programs are able to assign values to pieces of input data, increasing competitive advantage by allowing companies to see just exactly how vendor information can influence output analytics.
The Data Readiness Level
The Data Readiness Level (DRL) is the quantitative measure of the value of a piece of data at a given point in the processing flow. The DRL is a vigorous assessment, based on quantifiable and relevant metrics, of the value of data in various states of readiness.
Therefore, accessing and utilizing the correct data will increase the DRL, which will ultimately result in better output analytics. To prepare this data in the context of supply chain management requires a number of distinct processes:
- Data acquisition – the first step in any vendor validation process is the collection of the “raw” data. This may come from a customer’s materials management information system (MMIS), group purchasing organization (GPO), or local suppliers. All relevant data of potential interest is collected in this step
- Data cleansing – the data is checked for completeness and accuracy. Accurate and properly coded data is foundational for category management, allowing for leveraging, pricing agreements, quantity discounts, value analysis, and other cost management opportunities. This step ensures the data is organized logically with no duplicates
- Data classification – in this step, data will be coded to correspond to different segments and products. This often involves some kind of automatic process augmented with manual verification to ensure efficiency and accuracy
- Database population – finally, coded data is then loaded into the appropriate application. This allows data to be leveraged by benchmarking and cross-referencing with other data forms
While implementing DRL processes into supply chain management is very complex and more prevalent in very large, highly competitive industries, such as healthcare, it does clearly demonstrate the value supplier data can have on company output analytics, reinforcing why vendor validation is necessary for businesses of all sizes.
Diversity Reporting Needs
There is increasing pressure on procurement professionals and sourcing managers to show diversity when reporting their supply partners. Specifically, businesses in the public sector require small business set-asides, meaning that a certain percentage of suppliers come from a diverse pool of small businesses.
In addition, some federal contracts may mandate that those companies operating in the private sector choose a specified percentage of vendors from small businesses, as well.
Regardless of any mandates, leading companies choose to have supplier diversity policies in their company protocol, as there are numerous benefits to using small business vendors and choosing from a diverse pool of suppliers.
While the economic impact of local sourcing can be significant, small businesses have a tendency to be more unstable than more established corporate suppliers, so scrupulous vendor validation needs to be undertaken when fulfilling diversity reporting needs.
Vendor Validation and Vendor Management: The Intersection
As mentioned earlier, the need for vendors arises when a company cannot or does not want to source all supplies and/or labor in-house and must outsource in order to better focus its efforts on its core competency.
Going back to the example of our hypothetical computer manufacturing company, the firm’s core competency would be building computers–not manufacturing semiconductors, plastic for the keys, or any of the pencils, paper, or infinite list of cleaning and office supplies that may be necessary to keep the firm operational.
As such, the computer company can more efficiently use vendors to supply all of these products and allow it to focus on what it is good at–making computers.
While the selection of vendors may be more or less involved based on the size of your company or the scope of the need that you are outsourcing, many organizations know that successful vendor relations can make or break their firm, so the vendor selection process can become quite involved.
The vendor management process involves four basic steps that allow companies to fulfill their supply needs, of which vendor validation is an essential component.
Step Number One: The Need to Outsource Arises
The vendor management process starts when the need to outsource a supply or task arises. The organization will then begin an extensive search of vendors who can fulfill their outsourcing requirements. Potential vendor candidates may be located from any of the following sources:
- Internet searches, such as through business networking platforms like LinkedIn
- Professional references
- Industry fairs and other in-person networking events
Once a sufficient pool of vendors is obtained, the firm will perform the following steps:
- Negotiate contract terms
- Receive a price quotation from each prospective vendor
- Do an in-depth performance evaluation of each vendor’s previous work
- Prepare all necessary vendor related documents
- Negotiate payment processing methods
Step Number Two: Evaluation of Vendor Pool
After the potential vendor pool has provided the firm with all of the aforementioned requirements, the organization will then proceed with an extensive vendor evaluation process.
The following considerations are weighed and ranked by the firm prior to coming to a conclusion on who to select as a vendor:
- Who has the best track record of quality performance?
- Which supplier can give us the terms we are looking for?
- Which vendor is the most affordable?
- What is the vendor’s reputation in terms of ethicality?
- Does the firm have a past history with the vendor, and, if so, is it positive or negative?
Step Number Three: Vendor Validation
After a quote has been accepted, and the best vendor has been chosen, the vendor validation process starts.
The firm will check all references and perform an extensive online search of the vendor’s particulars. The firm will scrupulously check all of the vendor’s financial documents, where available, to make sure that its financial solvency is not in question, and the selected vendor can meet the firm’s supply needs for the life of the contract.
During the validation process, all contact data and tax information is carefully inputted to the company’s records. In addition, the firm will also give careful consideration to ensure that the vendor has all of the proper certifications and the required level of insurance to be able to supply the company as needed.
Finally, if the company has any confidential information to which the vendor may be exposed as a result of the partnership, any and all appropriate non-disclosure agreements must be signed.
Step Number Four: Vendor Begins Supplying the Firm
After a vendor has been chosen, all of the required vendor information has been vetted during the vendor validation process, and a contract has been entered, the vendor enters into the company’s network of suppliers and must be managed by the sourcing manager or procurement department.
In addition to the ongoing validation process through updating any and all information that may change for the vendor, the sourcing manager or procurement department should be performing ongoing evaluations of the vendor’s performance and ensure that the agreed-upon contract terms are being met.
Again, major organizations will have a large network of vendors that will provide a variety of functions for the firm. Through the ongoing evaluation of each vendor, secondary and tertiary options should be taken into consideration if a primary vendor is no longer willing or able to perform at the required levels.
Vendor maintenance requires huge documentation. Significant investment needs to be made in vendor management software, with some firms even employing entire IT departments specifically for vendor relations.
The Costs Associated with Vendor Validation
As with anything in the business world, it costs money to make money.
However, the costs of vendor validation can often be begrudgingly spent, as the investment in vendor validation is not necessarily a means of making money, but, rather, a means of saving money.
While it is easy to see that buying a bunch of computer components and manufacturing them together to sell as a computer whose final cost is greater than the sum of its parts is a profitable enterprise, investments in vendor validation can seem like unnecessary expenses if you do not have a proper understanding of the value of data.
The following are some, but not necessarily all, of the costs that may be associated with a successful vendor validation program.
Any way you want to look at it, vendor validation is going to cost your business some money. It will be manifested in a number of ways, depending on the size of your business:
- Small businesses – if you run a sole proprietorship or any other small business that does not have a specifically assigned procurement department, vendor validation still has to occur. The cost will often come in the form that you or your partner cannot focus on production, marketing, or sales efforts as you commit time to verify vendor data
- Mid-size businesses – these organizations are large enough that the list of suppliers cannot be managed by an associate and/or employee who is expected to provide other functions for the business, so a sourcing manager must be hired, requiring a salary, benefits, and any other commensurate perks of the position
- Large businesses – for corporations and government agencies, entire procurement departments are established, requiring a full staff of employees of various responsibility levels. Not only does this increase the direct costs of compensating these employees, but an additional strain is placed on payroll and HR to maintain this department
While this may not impact small businesses significantly, any business that needs to hire additional employees to conduct vendor validation will have to invest in more offices and office materials for these employees.
For those large entities that need to create procurement departments, this could even lead to increased rent expenses due to needing additional buildings, floors, and/or wings to house this department.
At the very least, a solid database software will need to be purchased, even for small businesses, to ensure that vendor records are properly maintained and organized.
For larger organizations, the technological investment will be even steeper, with additional computers, servers, and storage space likely to be required.
For those firms in very large, competitive industries that rely on DRL analysis to optimize output analytics, specialized software will need to be purchased to aid in data acquisition, cleansing, and classification. Some popular vendor validation software includes ConnXus and SmartScrub.
The Necessity of Vendor Validation: Final Thoughts
Despite the many costs that may be associated with a successful vendor validation program, preventing the multitude of losses that can result from inaccurate and/or unvalidated vendor information makes vendor validation a necessary undertaking for any business.
Studies have shown that some 30 to 40 percent of vendor information can change on a yearly basis. The following are ways that a lack of vendor validation can hurt an organization:
- Incorrect information – as many payments are conducted with credit cards or other online transfers, missing, or incorrect information such as billing addresses that have changed or credit cards that have passed their expiration date can delay scheduled shipments
- Duplicate information – vendor information that is not properly organized and maintained can create situations in which purchase requisitions are duplicated throughout the procurement chain, creating a situation in which too much supply is ordered and cannot be used
- Defunct suppliers – as many companies are required or choose to choose from a diverse pool of local, small business vendors, there is a chance that some suppliers may go out of business between shipments, causing the business to have to scramble to find a secondary supplier in order to keep production on schedule
- Change in agents – you may have relied on a specific agent in the past as your point of contact with an important supplier. If this person changes for any reason, your contract may be at risk of being left unattended or falling through the cracks, putting the shipment of your supply at risk
- Fraudulent vendors – as much business is conducted online nowadays, the prevalence of scams and illegitimate business practices has skyrocketed. Not only will trying to use a fraudulent supplier lose a business money in the form of missing supplies, but some costly tax implications could arise, as well
- Diversity penalties – public businesses and companies involved in large government contracts are required to use a diverse pool of suppliers. Inaccurate vendor information can lead to penalties as a result of a company thinking it had an equitable proportion of diverse suppliers
- Low competitive advantage – many companies rely on output analytics as a means of measuring organizational performance. However, over time quality output can only be attained by ensuring quality input. Well organized and cleanly acquired vendor data will give a business a competitive advantage over its peers
Vendor validation is a complex process that has become additionally nuanced in the information age, with the prevalence of online commerce and a proliferation of data presenting increased challenges for businesses.
These challenges become increasingly complex for large companies and corporations, as the difference between good vendor data and poor vendor data can create a significant difference in a firm’s bottom line.
As such, vendor validation is a necessary undertaking for a business to verify its suppliers as legitimate entities, creating a smooth, uninterrupted supply chain.