Your 'vendors' should know what they're doing
There is no overall magic formula when compressing video from one format to another then converting again to another. Each stage introduces more and more loss. You'll get good results using MPEG-II or MPEG-4 for VOB to AVI conversion if filesizes are your prime consideration.
Assuming a 720x480 @ 29.97 fps + 48000Hz 192kbs AC3 DVD source ('Hollywood' studio quality)
Resize to 320x240 Video @1008 kbps + Audio @22050Hz 96kbs MP3
~6 mins high quality constant bitrate content per 50MB.
If you have resources to spare on your PC you could allow your conversion process to go through multiple passes and vary the video bitrate between fast and slow motion scenes which will give you a cleaner overall final product for the same filesize.
The tradeoff here being it will take 2-4 times longer to convert.