Evaluating and Selecting Critical Vendors

A press item on the GC site announcing a conference speaking appearance a few months ago continues to draw daily interest. A lot of daily interest. The session topic? “The Proper Method for Vendor Evaluation and Selection.” Given the level of interest, we thought we would turn the presentation material used at that conference into a blog post to better satisfy those looking for concrete information on selecting critical vendors.

In 1985 Harvard professor Michael Porter wrote a book called Competitive Advantage in which he illustrated concepts called the value chain and value system.

The basic idea of the value chain is that the categories of activities in which an institution engages to deliver its products or services link together, one category to another, like a chain. The better and stronger the chain, the more efficient the organization will be in delivering value to its customers and ultimately in extracting a greater margin from its activities. A value chain illustration is shown in the image below.

Value Chain
Value Chain

The value system, as Porter envisions, encapsulates the institution’s own value chain in something bigger – a whole system of institutional value chains designed to feed and support the value of the connected parts. A value system illustration is shown in the image below.

Value System
Value System

Vendors, Value Chains and Value Systems

As illustrated in the value system diagram, credit union members have their own value chain that credit unions must support via relevant products and services (i.e., via the “value” a credit union provides). If what is offered by the credit union is not strongly connected to the value members desire, then the link between credit union and member will be weak and easily broken. Furthermore, if a credit union’s VENDORS have a similarly weak link to the value the credit union hopes to deliver, then those vendors may actually weaken the credit union’s ability to link to and support member value chains.

Credit union vendors are part of the broad infrastructure that drives the delivery of products and services to members. Vendors that properly support credit union strategy will strengthen the infrastructure, greatly enhance the credit union’s competitive ability, and help make credit union members happy. Vendors that do not match credit union strategies will weaken the credit union, leading to poor service delivery, competitive disadvantage, and broad member dissatisfaction.

The Importance of a Defined Value

How, then, is a credit union to ensure that its current vendors, and any vendor it selects for that matter, offer positive contributions to the credit union’s value chain? With a value-based method of vendor analysis, a method that starts with establishing an institutional ability to answer this important strategic question:

How do we know if a vendor is right for us?

A credit union will know if a vendor is “right” if that vendor enhances the institution’s ability to deliver its value proposition, plain and simple. However, most credit unions answer this question in a practical, operational or tactical way rather than a strategic way. For example, most credit unions would respond to a question of, “How do we know if an e-statement vendor is right for us?” by stating that the vendor offers e-statements, and that the e-statement platform integrates with the core system, etc.

The proper approach to this question is from a broad strategic perspective. Consider this basic response:

We know if a vendor is right for us if it supports the value we hope to offer our members.

The reason most credit unions address the “vendor fit” question from a tactical perspective is because many can’t answer the question from a strategic, value-driven perspective. Why? Many have no articulated, defined value proposition, and if there is no defined value proposition offered to members, there is no defined value to use for analyzing vendors.

Credit unions with an in-depth knowledge of the value they wish to deliver to members will make more effective decisions with regard to vendor selection because the decisions will be based on vendor ability to strengthen the value chain and, ultimately, the broader value system. Vendor features certainly matter, but perhaps not nearly as much as vendor support for the promises a credit union is making to its membership.

Value-Driven Vendor Assessment – An Example

Suppose a group of friends decide they want to open a company that sells good coffee. At the moment they make that decision, they have established a specific expectation of the value their company will offer consumers – good coffee.

Think about the impact of that strategic decision on vendor selection. The source of their coffee beans must have a similar commitment to quality. Poor-quality coffee beans make for poor-tasting coffee, so they cannot choose a provider of low-quality coffee beans as a vendor lest they violate their own value proposition.

Let’s carry the strategic decision-making a step further. Not only do they decide to sell good coffee, but they want to sell that coffee to consumers in their own store rather than via 3rd parties (through diners and doughnut shops). With regard to the store, they decide that they want consumers to sit, sip and enjoy rather than to carry out, and that they want them to do this in comfortable chairs and couches rather than at booths and counters.

We can develop an extreme number of sample decisions, but let’s stop here. The totality of the decisions above define the value of the coffee shop (good coffee enjoyed in living-room comfort). Our fictional coffee shop knows a vendor is right if that vendor supports/elevates/enables the shop’s ability to offer good coffee enjoyed in living-room comfort.

Credit Union Value Propositions and Vendor Evaluation

Consider the following examples of credit union value proposition:

  • Rate/price leader
  • Location convenience
  • High-tech convenience
  • Personal service

Any one of these value propositions defines specific types of vendor evaluation/selection criteria. If you are a rate/price leader, for example, then any vendor you utilize should help you offer the best rates and prices through more efficient and cost-effective operations. If your value is based on locational convenience, then any vendor you utilize should allow you to expand your locational convenience more efficiently and cost-effectively. So on, and so forth.

Of course the actual evaluation and/or selection of a vendor is more complicated than this, so let’s explore the minutia by looking at a vendor evaluation scenario for a credit union with “price leadership” (highly-competitive rates on all products) as its value proposition.

Again, the first question to address is vendor fit with regard to the value proposition. For a “price leader” credit union whose value proposition is highly-competitive rates, a vendor is first judged by its support of the credit union’s ability to offer highly-competitive rates. Vendors that cannot illustrate at least surface-level support of the value proposition are excluded from further consideration.

Once the basic vendor connection to credit union value is established, the next task in vendor evaluation is to separate the degrees to which various vendors support the value. The only way to do that is to have an institutional understanding of the key components that make up the value proposition. For a price-leader credit union these components might include:

  • Operations costs;
  • Staffing (costs and level requirements);
  • Systems/process efficiencies;
  • Equipment requirements.

Vendor evaluation and selection is a process of determining which vendor has the highest degree of support for the value proposition (we say highest degree because we know there are no perfect vendors in the world). In any case, determining the degree of fit requires that the vendor(s) in question be evaluated for their ability to support the components making up the value proposition.

This last paragraph illustrates a key difference between proper vendor evaluation and selection vs. the practices that are pervasive in the credit union community. Most credit unions make decisions on vendors (performance evaluation, selection, etc.) based on the features of the vendor’s offering – or as I said earlier, from a tactical or operational perspective. For example, credit unions concerned with cost, but without a value-driven connection between cost and value proposition, often choose the low-cost provider rather than the provider that helps them offer the lowest costs. There is a BIG difference between these two points of analysis!

Conducting the Vendor Analysis

Getting back to our fictional price-leader credit union, we have identified the key components that drive its price-leader value proposition, which the credit union can then use as a basis for vendor evaluation and/or selection. Now let’s suppose the credit union has decided to offer a home banking platform that allows credit union members to conduct a variety of transactions online, and that the credit union made this decision because they want to minimize the growth of branch costs with the hope that operating expenses decrease enough to drive even more competitive rates.

The credit union must, of course, collect a listing of providers that offer such a platform. Once the listing is complete, evaluation is the next activity. Again, we are evaluating not on product features, but on the fit of the vendor (company + product) with the credit union’s value proposition.

In the table below I have illustrated such an evaluation, comparing two vendors against the value proposition components for our fictional credit union (click for larger image):

Vendor Evaluation Matrix

I will go into a more detailed description of the table components shortly, but consider the results of the analysis. The bottom row lists the weighted score for each vendor. The higher the score, the better the vendor supports the totality of the elements making up the value proposition. What is interesting about the comparison of the two vendors is that the vendor with the best cost score (Vendor A) is not the best overall fit for the cost-leader value proposition (Vendor B). The bottom line is that Vendor B has the higher degree of support for the credit union’s value proposition, and therefore would be the best strategic choice even though it is not the low-cost solution.

Deconstructing the Table

So how does this table work? How is the analysis conducted?

Lets start with the components column. Again, the listed components reflect the core components making up the price-leader value proposition of our sample credit union. To start, your credit union must know what components drive the value your credit union offers members.

Once you have your component listing, know that all evaluation categories are not necessarily equal. For our sample credit union, considering it’s price leader value proposition, the cost implications of any particular vendor are more important than other components. This is reflected in the weighting column, where cost is allocated 40% of the total weight. You will need to define the weighting for the components making up your credit union’s value proposition.

The next column to consider is the rate column. The scale we use in the sample is 0-5, with 5 being the best. You can use any scale you choose, but we find that 0-5 provides enough flexibility to properly rate a vendor’s support of specific components. As an aside, doing this analysis is the most challenging part of the process. Rating a vendor a 5 versus a 4 on any one component can make a big difference in the vendor’s score, so being sure on your scale measurements is very important – both in establishing the scale (what it takes to receive a 5 vs a 4 for example) and in using it for vendor evaluation.

The final column is the score column, which is simply the result of the rating given the vendor multiplied by the component’s weight. These columns are then totaled to determine each vendor’s weighted score, which is a reflection of each vendor’s degree of support for the credit union’s value proposition. The total score is shown in the last row of the table, and again, the higher the score the greater degree of support for the credit union’s value proposition.

A side note: In some respects the features of a vendor’s offering are incorporated into the analysis process. For example, in our scenario one home banking platform might be offered by the core system provider and another offered by a 3rd party that requires its own hardware. The impact on the scores for staffing and equipment would reflect the differences between vendors. That said, it is still useful to compare features of competing vendors, but as supplemental information to the value-based analysis. Call this a “score+features” analysis, where the score is given the greater consideration.

A Little Pushback on the Process

Some credit union executives I have discussed the process with believe that the process itself is too simple to be usable in decision making. My response is always that the effort involved in determining the score to give a vendor for the various categories of analysis is masked by the simplicity of the table and process description. Yes, the calculation of a weighted score is a simple concept, but truly knowing and understanding the elements that make up a value proposition and using those elements to analyze, in depth, a vendor’s impact on the value proposition, is quite a complex endeavor – especially for mission-critical vendor selection projects such as choosing a core system.

This leads me to a discussion I had once with a credit union CEO about their core system. The credit union had decided that their value proposition was providing a high level of personalized financial service and support to members. As we talked about their value proposition, the CEO commented that the core system made it difficult to extract the data necessary to efficiently deliver the more personalized service they wished to offer. I asked when their contract was up, and she said they had just renewed the contract the month before.

From the year they decided on sticking with the status quo for their core system, their HealthScore, a measurement of credit union performance calculated by Glatt Consulting, went from generally stable to serious decline. As of this post their score is 1.727, substantially less than the industry average of 2.245.

The point I am making is that they made a major decision to (re)invest in a system at odds with the very value they wished to provide. My suspicion is that the more they pushed to offer better service, the harder their system made it for them to deliver. And to the members who were lured by the promise of a defined service benefit… they quickly found that the credit union could not live up to its promise. The credit union’s own value chain crumbled due do weakness in the connections between vendor and credit union, and credit union and member.

The big question is why the made the choice to stick with that particular core system? They felt that it was a better fit given their budget.

Had they done the more comprehensive vendor analysis outlined in this post, however, they would have found that while the budget-friendly features of the core system would have been a plus in favor of the vendor, they would have qualified its great weaknesses in other, critical areas making up the credit union’s service-oriented value proposition. Had they gone through the exercise they might have found a solution with attributes offering far greater support for the value proposition. Instead, they looked at licensing costs, plus conversion costs, and decided, because of cost, to stay put – to their unfortunate disadvantage.

Vendors Must Add Value

Because there is no perfect vendor, the task for any credit union in evaluating vendors is to understand the degree of vendor support for the value a credit union hopes to offer its members. Only by evaluating vendor options from this value-based point of view can a credit union be reasonably sure vendors are actually adding value. While many credit unions have not had to think too much about vendors over the long history of the industry’s existence, the ever-increasing role vendors play in service delivery to members will require a much greater commitment to proper evaluation and selection in the future.

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Glatt Consulting helps credit unions answer important strategic questions. We especially excel at answering questions concerning corporate direction, financial objectives/expectations, merger, succession, CEO compensation and performance evaluation, branding, growth, execution and budgeting, efficiency, workflow, and vendor selection. Contact us at (888) 217-5988 to talk about how we might help your credit union.

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