# Sourcing and Procurement Concept Card: [Category, supplier decision or course] > A concept card for the sourcing and procurement sessions of a second-year supply chain elective: total cost of > ownership (TCO) instead of unit price, quantity discounts, the Kraljic portfolio matrix for category strategy, > weighted supplier selection, make-or-buy through transaction cost economics, and supply contracts (buyback and > revenue sharing) that make a supplier and a retailer order the quantity that is best for both. It is for MBA students > in an operations or supply chain elective and for buyers, category managers and operations leads. It builds on > mba/mba-inventory-card (EOQ, safety stock, the newsvendor), which it uses without re-teaching, and on > mba/mba-relevant-costs-card for the make-or-buy arithmetic. Source basis: Kraljic (1983), Coase (1937), Williamson > (1979), Spengler (1950), Pasternack (1985), Cachon and Lariviere (2005), Ellram (1995) and the sourcing chapters of > the leading operations textbooks, written up in original words with fictional data (Northfield Outdoor Co., Corvane > Robotics and Tallow Creek Medical Center are invented; suppliers are generic labels). Replace every [bracketed] > value and every row marked *Example*. This is a learning aid, not legal, tax, customs or trade-compliance advice. ## Document control | Field | Value | |---|---| | Course or project | [Supply chain elective, sourcing sessions / category review] | | Learner or analyst | [Your name] | | Category and items | [Rain shells, membrane fabric (fictional) / your category] | | Suppliers compared | [Supplier F (far), Supplier N (near) / your shortlist] | | Cost data and dates | [Quotes dated YYYY-MM-DD, freight tender YYYY-MM-DD, holding rate from finance] | | Customs and trade data | [Tariff classification and duty rate confirmed by customs broker on YYYY-MM-DD] | | Tool | [Excel with Solver and Goal Seek / Google Sheets / Python with scipy] | | Reviewed by | [Study group / tutor / category lead] | | Last updated | YYYY-MM-DD | | Version | [0.1] | ## Contents - [When to use it](#when-to-use-it) - [The idea in plain language](#the-idea-in-plain-language) - [Formulas and notation](#formulas-and-notation) - [Assumptions and limits](#assumptions-and-limits) - [How managers use it](#how-managers-use-it) - [The sourcing process](#the-sourcing-process) - [Worked example A (fully solved): Northfield Outdoor Co. rain shells](#worked-example-a-fully-solved-northfield-outdoor-co-rain-shells) - [Worked example B (half solved): Corvane Robotics servo motors](#worked-example-b-half-solved-corvane-robotics-servo-motors) - [Exercise C (unsolved): Tallow Creek Medical Center IV fluids](#exercise-c-unsolved-tallow-creek-medical-center-iv-fluids) - [Connections to other cards](#connections-to-other-cards) - [Common mistakes and misconceptions](#common-mistakes-and-misconceptions) - [Self-test](#self-test) - [My notes and next steps](#my-notes-and-next-steps) - [Sources and further reading](#sources-and-further-reading) - [Answer key](#answer-key) - [Revision history](#revision-history) - [Standard and licence note](#standard-and-licence-note) ## When to use it **One-sentence rule:** use this card whenever a decision about **who supplies**, **on what terms** or **whether to make it yourself** is about to be made on the unit price alone. | Decision | Tool on this card | Key output | |---|---|---| | Which category deserves which strategy | Kraljic portfolio matrix (Kraljic 1983) | Strategic, leverage, bottleneck or non-critical | | Which supplier is cheaper in fact | Total cost of ownership (Ellram 1995) | Annual cost and cost per unit, all-in | | How much to buy when price falls with volume | All-units quantity discount on top of EOQ | Order quantity and price tier | | How to compare suppliers on more than cost | Weighted scorecard | Ranked shortlist with explicit weights | | Make or buy | Relevant costs plus transaction cost economics (Coase 1937, Williamson 1979) | In-house, contract or hybrid | | How to stop a buyer ordering too little | Buyback or revenue-sharing contract (Pasternack 1985, Cachon and Lariviere 2005) | Contract terms that coordinate the channel | | Use when | Do not use alone when | |---|---| | Two or more sources are feasible and the cost elements can be estimated | Only one qualified source exists: first build an alternative (bottleneck strategy) | | Demand for the item is reasonably stable or forecastable | The item is a one-off project purchase: use project/procurement-plan and business/rfp | | The buyer can change contract terms, not only volumes | Prices are regulated or set by a public tender rulebook you must follow | | Costs of quality, lead time and risk can be put in money terms, at least roughly | Disruption risk dominates: add mba/mba-supply-chain-resilience-card | ## The idea in plain language **The price on the quote is not the cost.** A unit bought far away at a low price must also be shipped, cleared through customs, carried for weeks on the water, protected with more safety stock because the lead time is long and uncertain, inspected because quality varies, and managed with visits and audits. **Total cost of ownership** adds every cost the buyer bears from the purchase order to the end of the item's life (Ellram 1995). A price gap of about 20% can shrink to 2% once all of it is counted, and the remaining gap must then be weighed against flexibility and risk. **Volume buys price, and price buys inventory.** A supplier offering a lower price for larger orders is trading its set-up and selling costs against your holding cost. The EOQ from mba/mba-inventory-card is the starting point; the quantity discount question is whether jumping to the next price tier saves more on purchase cost than it adds in holding cost. **Not every category deserves the same effort.** Kraljic (1983) asked purchasing to classify what it buys on two dimensions: how much the item affects profit (spend, value added, effect on product quality) and how risky supply is (few suppliers, scarce materials, long qualification). Leverage items are bought competitively; strategic items need partnerships and joint planning; bottleneck items need security of supply first; non-critical items need simple, cheap processes. **Make or buy is a question of governance, not only cost.** Coase (1937) asked why firms exist at all if markets set prices; his answer was that using the market has costs. Williamson (1979) showed when those costs are high: when the investment one party makes is specific to the other (asset specificity), when the future is uncertain and contracts cannot foresee it, and when the exchange recurs often. High specificity and uncertainty favour making in-house or a close partnership; standard items favour the market. **Contracts change behaviour.** When a supplier sells to a retailer at a wholesale price above its cost, the retailer faces a newsvendor problem with a smaller margin than the chain as a whole earns, so it orders too little. This is the supply chain version of double marginalisation (Spengler 1950). If the supplier agrees to buy back unsold units at a well-chosen price (Pasternack 1985), or takes a share of revenue in exchange for a lower wholesale price (Cachon and Lariviere 2005), the retailer's critical ratio rises to the chain's critical ratio, the chain earns more, and the wholesale price can split the gain so both firms are better off. ## Formulas and notation **Landed cost and total cost of ownership** for a supplier (per year, steady demand): $$ c_L = c_{FOB} + f + \tau\,c_{FOB}, \qquad H = h\,c_L $$ $$ TCO = D\,c_L + \frac{D}{Q}S + \frac{Q}{2}H + \bar{d}\,L\,H + z\,\sigma_{LTD}\,H + D\,\delta\,k + M $$ with $\sigma_{LTD} = \sqrt{L\,\sigma_d^2 + \bar{d}^2\sigma_L^2}$ as in mba/mba-inventory-card. The seven terms are purchase, ordering, cycle stock, pipeline (in-transit) stock, safety stock, quality and supplier management. **All-units quantity discount.** For each price tier $c_k$ valid for $Q \in [q_k, q_{k+1})$: $$ Q_k^{EOQ} = \sqrt{\frac{2DS}{h\,c_k}}, \qquad Q_k = \max\big(Q_k^{EOQ}, q_k\big) \ \text{if} \ Q_k^{EOQ} < q_{k+1}, \qquad TC_k = D\,c_k + \frac{D}{Q_k}S + \frac{Q_k}{2}h\,c_k $$ Choose the tier with the lowest $TC_k$. **Weighted supplier score:** $V_j = \sum_i w_i\,s_{ij}$ with $\sum_i w_i = 1$. **Newsvendor with a supply contract** (retailer price $p$, wholesale price $w$, supplier unit cost $c$, salvage value $v$, buyback price $b$ with $v \le b < w$): $$ \text{Retailer: } F(Q_r) = \frac{p - w}{p - b}, \qquad \text{Channel: } F(Q_c) = \frac{p - c}{p - v} $$ $$ \text{Coordinating buyback: } \frac{p - w}{p - b} = \frac{p - c}{p - v} \;\Longrightarrow\; b = p - \frac{(p - w)(p - v)}{p - c} $$ Without a buyback the retailer salvages leftovers itself, so $b = v$ in the first formula. The salvage value is written $v$ here (it is $s$ in mba/mba-inventory-card) because $S$ is already the cost per order. Under **revenue sharing** the retailer keeps a share $\varphi$ of revenue and salvage and pays $w = \varphi\,c$ per unit, which gives the retailer the channel's critical ratio for any $\varphi$ (Cachon and Lariviere 2005). Expected sales $= \mu - \sigma\,G(z)$, expected leftover $= Q -$ expected sales, with $G(z)$ the standard normal loss function from mba/mba-inventory-card. | Symbol | Meaning | Unit | |---|---|---| | $c_{FOB}$, $f$, $\tau$ | Supplier price at origin (free on board), freight per unit, duty rate on $c_{FOB}$ | currency per unit, %, | | $c_L$ | Landed cost per unit | currency per unit | | $D$, $\bar{d}$, $\sigma_d$ | Annual demand; mean and standard deviation of daily demand | units per year, units per day | | $S$, $Q$ | Fixed cost per order, order quantity | currency per order, units | | $h$, $H$ | Holding cost rate, holding cost per unit per year | % per year, currency per unit per year | | $L$, $\sigma_L$ | Mean and standard deviation of lead time | days | | $z$ | Standard normal quantile of the cycle service level | none | | $\delta$, $k$ | Defect rate, cost per defective unit (inspection, rework, returns) | %, currency per unit | | $M$ | Annual supplier management cost (audits, visits, quality engineers) | currency per year | | $c_k$, $q_k$ | Price of tier $k$, minimum quantity of tier $k$ | currency per unit, units | | $w_i$, $s_{ij}$ | Weight of criterion $i$, score of supplier $j$ on criterion $i$ | share, 1 to 5 | | $p$, $w$, $c$, $v$, $b$ | Retail price, wholesale price, supplier cost, salvage value, buyback price | currency per unit | | $\varphi$ | Retailer's share of revenue under revenue sharing | share | | $\mu$, $\sigma$ | Mean and standard deviation of season demand | units | **Excel equivalents.** Landed cost: `=FOB+freight+FOB*duty`. EOQ: `=SQRT(2*D*S/H)`. Safety stock: `=NORM.S.INV(CSL)*SQRT(L*sd^2+d^2*sL^2)`. Contract order quantity: `=NORM.INV((p-w)/(p-b),mu,sigma)`. Weighted score: `=SUMPRODUCT(weights,scores)`. Break-even duty rate: Goal Seek on the TCO difference. ## Assumptions and limits | Tool | Key assumptions | What breaks it | What to do | |---|---|---|---| | TCO | Steady demand; costs per unit are linear; the holding rate captures capital, space and obsolescence | Fashion or seasonal items, where long lead times also raise forecast error and markdowns | Add a markdown or obsolescence term; for one-season items use the newsvendor with each supplier's lead time | | Pipeline cost | The buyer owns goods in transit (it pays at origin, as under FOB terms) | Delivered terms where the supplier owns the goods until arrival | Check the Incoterms rule in the contract; with delivered terms the supplier prices the pipeline into the quote | | Quantity discount | All-units discount; holding cost proportional to price; storage is free up to any quantity | Incremental discounts, limited storage, shelf life | Use the incremental formula, add a storage constraint, cap at shelf-life demand | | Kraljic matrix | Two dimensions capture what matters; scores are honest | Scores set to justify a decision already taken | Score with a cross-functional team; write the evidence for each score | | Scorecard | Criteria are independent and weights reflect strategy | Double counting (cost appears in TCO and again in "price") | One criterion per idea; agree weights before seeing the scores | | Buyback or revenue sharing | Demand distribution known to both firms; retailer effort does not depend on the contract | Revenue sharing weakens the retailer's incentive to sell (Cachon and Lariviere 2005); returns are costly to handle | Add effort or sales targets, set return logistics costs, audit sales data | | Make or buy | Costs can be compared on a relevant-cost basis | Capabilities, learning and control have no line in the cost sheet | Use transaction cost questions alongside the numbers | Duty rates, rules of origin and trade measures change, sometimes within weeks, and the right rate depends on the tariff classification of the item and its origin. Use the official tariff schedule of the importing country and a licensed customs broker; the 8% on this card is an *Example* only. Sustainability and human-rights due diligence on suppliers is becoming law in some jurisdictions. As of October 2026, the European Commission's page on the EU Corporate Sustainability Due Diligence Directive (Directive (EU) 2024/1760) states that it was amended by Omnibus I: Directive (EU) 2025/794 postponed the dates and Directive (EU) 2026/470 (in force 18 March 2026) amended the substance. In scope are EU companies with at least 5,000 employees and EUR 1.5 billion net worldwide turnover; Member States must transpose it by 26 July 2028 and apply it from 26 July 2029. Check the current text on [commission.europa.eu](https://commission.europa.eu/business-economy-euro/doing-business-eu/sustainability-due-diligence-responsible-business/corporate-sustainability-due-diligence_en) and EUR-Lex before you rely on it, and take legal advice on what applies to your company. Information exchange between competing buyers or suppliers raises competition-law questions: check with counsel. ## How managers use it - **Sourcing awards.** Category managers present TCO, not price, to the sourcing committee. The committee asks which inputs drive the gap (here the pipeline cost and duty) and how robust the answer is to them (the break-even duty rate in A1). - **Category strategies.** The Kraljic matrix sets the playbook per category: tenders and e-auctions for leverage items; long-term agreements, joint development and shared forecasts for strategic items; buffer stock, second sources and redesign for bottleneck items; catalogues and purchasing cards for non-critical items. - **Negotiation preparation.** The TCO model tells the buyer what a concession is worth: one day less lead time, one point less defect rate, a delivered rather than an origin price. Pair it with mba/mba-negotiation-planner to set the reservation price and trade-offs. - **Make or buy.** Operations and finance compare relevant costs (mba/mba-relevant-costs-card); strategy asks whether the activity is a source of advantage (mba/mba-value-chain-card) and whether a contract could govern it. - **Contract design.** For seasonal and short-life products, buyback, revenue-sharing and quantity-flexibility clauses are common in publishing, video rental, fashion and electronics distribution. They are worth modelling whenever a partner says the buyer "never orders enough". - **Supplier development.** Scorecards feed quarterly business reviews and decide where the buyer invests engineering help. A supplier that improves quality by one point lowers TCO for every unit after that. - **Risk and compliance.** Kraljic's supply risk axis connects to resilience work (mba/mba-supply-chain-resilience-card) and to due-diligence duties on labour and environmental standards (mba/mba-stakeholder-esg-card). ## The sourcing process The process runs from spend to contract and back again: analyse what is bought, set a strategy per category, decide make or buy, find and qualify suppliers, compare them on TCO and the scorecard, negotiate the contract, then manage performance and feed the results into the next cycle. ```mermaid flowchart TD A["Spend analysis: what, how much, from whom"] --> B["Kraljic classification per category"] B --> C{"Which quadrant?"} C -->|"Leverage"| D["Competitive tender or e-auction"] C -->|"Strategic"| E["Partnership: long-term agreement, joint planning"] C -->|"Bottleneck"| F["Secure supply: buffer, second source, redesign"] C -->|"Non-critical"| G["Simplify: catalogue, bundled orders"] D --> H{"Make or buy?"} E --> H F --> H H -->|"Buy"| I["Supplier market scan and qualification"] H -->|"Make"| M["Build the business case in-house"] I --> J["Compare on TCO and weighted scorecard"] J --> K["Negotiate price, terms and contract type"] K --> L["Manage performance and develop suppliers"] G --> L L --> A ``` ## Worked example A (fully solved): Northfield Outdoor Co. rain shells **Situation (*Example*, fictional).** Northfield Outdoor Co. sells a three-layer rain shell all year through its stores and web shop: $\bar{d}$ = 65 units a day with $\sigma_d$ = 20 (days independent), so $D$ = 23,725 units a year. Finance sets a holding rate $h$ = 25% a year on landed cost and the buyer targets a 97% cycle service level ($z$ = 1.8808, `=NORM.S.INV(0.97)`). Two qualified suppliers have quoted: | Input *(Example)* | Supplier F (far, ocean freight) | Supplier N (near, truck) | |---|---|---| | Price at origin $c_{FOB}$ | USD 40.00 | USD 47.80 | | Freight per unit $f$ | USD 2.00 | USD 1.20 | | Duty rate $\tau$ on $c_{FOB}$ | 8% | 0% (preferential origin, confirmed by broker) | | Fixed cost per order $S$ | USD 900 (container booking, customs broker, inspection) | USD 300 | | Lead time $L$, $\sigma_L$ | 70 days, 10 days | 21 days, 3 days | | Defect rate $\delta$, cost per defect $k$ | 2.0%, USD 18 | 0.8%, USD 18 | | Supplier management $M$ | USD 12,000 a year (two audits, quality engineer visits) | USD 4,000 a year | **A1. Total cost of ownership.** | Line | Supplier F | Supplier N | Excel (Supplier F) | |---|---|---|---| | Duty per unit | USD 3.20 | USD 0.00 | `=40*8%` | | Landed cost $c_L$ | USD 45.20 | USD 49.00 | `=40+2+40*8%` | | Holding cost $H$ per unit per year | USD 11.30 | USD 12.25 | `=25%*45.2` | | EOQ $Q^*$ | 1,944.02 units (12.20 orders a year) | 1,077.98 units (22.01 orders a year) | `=SQRT(2*23725*900/11.3)` | | Purchase cost $D\,c_L$ | 1,072,370.00 | 1,162,525.00 | `=23725*45.2` | | Ordering cost | 10,983.70 | 6,602.63 | `=23725/1944.02*900` | | Cycle stock holding | 10,983.70 | 6,602.63 | `=1944.02/2*11.3` | | Pipeline stock (units) | 4,550 | 1,365 | `=65*70` | | Pipeline holding | 51,415.00 | 16,721.25 | `=65*70*11.3` | | $\sigma_{LTD}$ (units) | 671.19 | 215.46 | `=SQRT(70*20^2+65^2*10^2)` | | Safety stock (units) | 1,262.38 | 405.24 | `=NORM.S.INV(0.97)*671.19` | | Safety stock holding | 14,264.84 | 4,964.24 | `=1262.38*11.3` | | Quality cost | 8,541.00 | 3,416.40 | `=23725*2%*18` | | Supplier management | 12,000.00 | 4,000.00 | input | | **Total cost of ownership (USD a year)** | **1,180,558.24** | **1,204,832.15** | `=SUM(...)` of the lines above | | TCO per unit | 49.76 | 50.78 | `=1180558.24/23725` | | Costs beyond the purchase price | 108,188.24 (USD 4.56 a unit) | 42,307.15 (USD 1.78 a unit) | `=TCO-purchase` | ```vega-lite { "$schema": "https://vega.github.io/schema/vega-lite/v5.json", "description": "Northfield rain shell: costs beyond the landed purchase price by supplier, USD per year (fictional, computed)", "width": 360, "height": 220, "data": {"values": [ {"supplier": "Supplier F", "cost": "Ordering", "usd": 10983.70}, {"supplier": "Supplier F", "cost": "Cycle stock", "usd": 10983.70}, {"supplier": "Supplier F", "cost": "Pipeline stock", "usd": 51415.00}, {"supplier": "Supplier F", "cost": "Safety stock", "usd": 14264.84}, {"supplier": "Supplier F", "cost": "Quality", "usd": 8541.00}, {"supplier": "Supplier F", "cost": "Supplier management", "usd": 12000.00}, {"supplier": "Supplier N", "cost": "Ordering", "usd": 6602.63}, {"supplier": "Supplier N", "cost": "Cycle stock", "usd": 6602.63}, {"supplier": "Supplier N", "cost": "Pipeline stock", "usd": 16721.25}, {"supplier": "Supplier N", "cost": "Safety stock", "usd": 4964.24}, {"supplier": "Supplier N", "cost": "Quality", "usd": 3416.40}, {"supplier": "Supplier N", "cost": "Supplier management", "usd": 4000.00} ]}, "mark": "bar", "encoding": { "x": {"field": "supplier", "type": "nominal", "title": "Supplier"}, "y": {"field": "usd", "type": "quantitative", "aggregate": "sum", "title": "USD per year beyond purchase cost"}, "color": {"field": "cost", "type": "nominal", "title": "Cost element"} } } ``` **Reading A1.** Supplier N's price at origin is 19.50% above Supplier F's (`=47.8/40-1`), so Supplier F quotes 16.32% less (`=1-40/47.8`). After freight and duty the landed gap is USD 3.80 a unit (Supplier N 8.41% higher), worth USD 90,155 a year in purchase cost. The costs beyond the purchase price claw back most of it: Supplier F needs 3,185 more units in the pipeline and 857 more units of safety stock, and its quality and management costs are higher. The full TCO gap is USD 24,273.91 a year, or 2.06%. Supplier F is still cheaper, but now by USD 1.02 a unit, and a small change in an input reverses the ranking: Goal Seek on the duty rate shows that at **10.39%** the two suppliers cost the same. The A1 model also leaves out two costs that favour Supplier N: the markdowns caused by committing to a colour and size mix 70 days ahead, and the larger disruption exposure of the far supplier's site (mba/mba-supply-chain-resilience-card, Worked example A). A 2% cost gap is within the error of the inputs, so the decision moves to the scorecard in A3. **A2. Quantity discount from Supplier N.** Supplier N offers an all-units discount on its delivered price: USD 49.00 below 1,500 units an order, USD 47.90 from 1,500 to 3,999, USD 47.40 from 4,000. With $S$ = 300 and $H$ = 25% of the tier price (pipeline, safety stock, quality and management do not depend on the order size, so they are left out; a lower tier price would also cut their holding cost slightly, which only strengthens the discount): | Tier | Price | $H$ | EOQ at that price | Feasible $Q$ | Purchase | Ordering | Holding | Total | Excel (total) | |---|---|---|---|---|---|---|---|---|---| | 1 | 49.00 | 12.2500 | 1,077.98 | 1,077.98 | 1,162,525.00 | 6,602.63 | 6,602.63 | 1,175,730.25 | `=23725*49+23725/1077.98*300+1077.98/2*12.25` | | 2 | 47.90 | 11.9750 | 1,090.29 | 1,500 | 1,136,427.50 | 4,745.00 | 8,981.25 | 1,150,153.75 | `=23725*47.9+23725/1500*300+1500/2*11.975` | | 3 | 47.40 | 11.8500 | 1,096.02 | 4,000 | 1,124,565.00 | 1,779.38 | 23,700.00 | 1,150,044.38 | `=23725*47.4+23725/4000*300+4000/2*11.85` | The EOQ at tiers 2 and 3 falls below the tier minimum, so the best quantity within each tier is the minimum itself. Tier 3 wins by only USD 109.37 a year while ordering 2,500 more units at a time (about 38 days of demand) and holding 1,250 more units on average (2,000 against 750), in a colourway that may change next season. Most buyers would take tier 2 and use the 4,000-unit tier as a bargaining point: ask for USD 47.40 at 1,500 units. The quantity discount also narrows the TCO gap in A1: at tier 2 Supplier N's annual cost falls by USD 25,576.50 against tier 1 (`=1175730.25-1150153.75`), more than the A1 gap of USD 24,273.91. **A3. Category strategy and supplier scorecard.** A cross-functional team scored Northfield's main purchase categories from 1 (low) to 5 (high) on profit impact and supply risk, with 3.0 as the dividing line: | Category *(Example)* | Profit impact | Supply risk | Quadrant | Playbook | |---|---|---|---|---| | Waterproof membrane fabric | 4.5 | 4.2 | Strategic | Long-term agreement with the mill, joint forecasts, second mill qualified over time | | Finished rain shells (contract manufacturing) | 4.6 | 2.6 | Leverage | Competitive sourcing between F and N, TCO-based award | | Certified down fill | 2.4 | 4.0 | Bottleneck | Buffer stock, certification of a second source, design alternatives | | Waterproof zippers | 2.2 | 3.8 | Bottleneck | Buffer stock, standardise zipper types across products | | Outbound parcel delivery | 3.8 | 2.0 | Leverage | Tender, volume bands, service-level penalties | | E-commerce platform | 3.6 | 3.4 | Strategic | Partnership, exit plan and data portability clause | | Store fixtures | 2.0 | 1.5 | Non-critical | Framework agreement, catalogue buying | | Office supplies | 1.0 | 1.0 | Non-critical | Purchasing card, one supplier, no tender | ```vega-lite { "$schema": "https://vega.github.io/schema/vega-lite/v5.json", "description": "Northfield Kraljic matrix: profit impact versus supply risk by category (fictional scores)", "width": 360, "height": 300, "data": {"values": [ {"category": "Membrane fabric", "impact": 4.5, "risk": 4.2, "quadrant": "Strategic"}, {"category": "Finished rain shells", "impact": 4.6, "risk": 2.6, "quadrant": "Leverage"}, {"category": "Down fill", "impact": 2.4, "risk": 4.0, "quadrant": "Bottleneck"}, {"category": "Zippers", "impact": 2.2, "risk": 3.8, "quadrant": "Bottleneck"}, {"category": "Parcel delivery", "impact": 3.8, "risk": 2.0, "quadrant": "Leverage"}, {"category": "E-commerce platform", "impact": 3.6, "risk": 3.4, "quadrant": "Strategic"}, {"category": "Store fixtures", "impact": 2.0, "risk": 1.5, "quadrant": "Non-critical"}, {"category": "Office supplies", "impact": 1.0, "risk": 1.0, "quadrant": "Non-critical"} ]}, "layer": [ { "mark": {"type": "point", "filled": true, "size": 90}, "encoding": { "x": {"field": "risk", "type": "quantitative", "title": "Supply risk (1 to 5)", "scale": {"domain": [0.5, 5]}}, "y": {"field": "impact", "type": "quantitative", "title": "Profit impact (1 to 5)", "scale": {"domain": [0.5, 5]}}, "color": {"field": "quadrant", "type": "nominal", "title": "Quadrant"}, "tooltip": [{"field": "category"}, {"field": "impact"}, {"field": "risk"}] } }, { "mark": {"type": "text", "dx": 6, "align": "left", "fontSize": 10}, "encoding": { "x": {"field": "risk", "type": "quantitative"}, "y": {"field": "impact", "type": "quantitative"}, "text": {"field": "category"} } } ] } ``` For the rain shell award, the team agreed weights before seeing the scores and then scored both suppliers: | Criterion | Weight | Supplier F score | Supplier N score | F weighted | N weighted | |---|---|---|---|---|---| | Total cost of ownership (A1) | 35% | 5 | 4 | 1.75 | 1.40 | | Quality | 20% | 3 | 4 | 0.60 | 0.80 | | Lead time and flexibility | 15% | 2 | 5 | 0.30 | 0.75 | | Supply risk and resilience | 15% | 2 | 4 | 0.30 | 0.60 | | ESG and compliance | 10% | 3 | 4 | 0.30 | 0.40 | | Innovation | 5% | 4 | 3 | 0.20 | 0.15 | | **Total** | 100% | | | **3.45** | **4.10** | Excel: `=SUMPRODUCT(B2:B7,C2:C7)` for F and `=SUMPRODUCT(B2:B7,D2:D7)` for N. Supplier N leads by 0.65 points. The recommendation the committee received: award 70% of the volume to Supplier N at the tier 2 price and keep 30% with Supplier F, which keeps a low-cost benchmark in play and a second qualified source. Note one risk the scorecard does not show: both suppliers buy their membrane fabric from the same mill (*Example*), so dual sourcing at tier 1 does not remove the strategic fabric risk (see mba/mba-supply-chain-resilience-card, Worked example A). **A4. A buyback contract for a seasonal vest.** Northfield buys a limited-edition down vest from a contract manufacturer for one winter season. Retail price $p$ = USD 180, wholesale price $w$ = USD 90, the manufacturer's cost $c$ = USD 45, and leftovers clear through an outlet channel at $v$ = USD 30. Season demand is normal with $\mu$ = 2,000 and $\sigma$ = 600, and there is no second run. | Step | Wholesale price only | Integrated channel | Excel | |---|---|---|---| | Critical ratio | $(180-90)/(180-30) = 0.6000$ | $(180-45)/(180-30) = 0.9000$ | `=(180-90)/(180-30)` | | $z$ | 0.2533 | 1.2816 | `=NORM.S.INV(0.6)` | | Order quantity | 2,152.01 | 2,768.93 | `=NORM.INV(0.6,2000,600)` | | Expected sales | 1,829.00 | 1,971.59 | `=2000-600*(NORM.S.DIST(z,FALSE)-z*(1-NORM.S.DIST(z,TRUE)))` | | Expected leftover | 323.01 | 797.34 | `=Q-sales` | | Expected lost sales | 171.00 | 28.41 | `=2000-sales` | | Channel profit | USD 242,069.54 | USD 254,205.15 | `=180*sales+30*leftover-45*Q` | With the wholesale price alone, Northfield (the retailer) earns USD 145,229.17 and the manufacturer USD 96,840.37: the chain reaches 95.23% of its potential and leaves USD 12,135.61 on the table. The retailer orders too little because it bears all the leftover risk while earning only USD 90 of the USD 135 margin. The coordinating buyback price at $w$ = 90 is $b = 180 - (90 \times 150)/135 = 80.00$ (`=180-(180-90)*(180-30)/(180-45)`). The retailer's critical ratio becomes $90/100 = 0.9$, it orders 2,768.93 units, and the manufacturer takes back 797.34 leftover units at USD 80 and clears them at USD 30. Profits are now USD 169,470.10 for the retailer and USD 84,735.05 for the manufacturer: the chain gains, but the manufacturer loses USD 12,105.32. The fix is to move along the family of coordinating contracts. At $w$ = 100 the coordinating buyback is $b$ = 91.11 (`=180-(180-100)*(180-30)/(180-45)`); the retailer earns USD 150,640.09 (+5,410.92) and the manufacturer USD 103,565.06 (+6,724.69). Both are better off and the extra USD 12,135.61 is shared. Where exactly to land on that family is a negotiation (mba/mba-negotiation-guide); the analysis shows the size of the pie. ## Worked example B (half solved): Corvane Robotics servo motors **Situation (*Example*, fictional).** Corvane Robotics buys servo motors for its warehouse robots: $D$ = 12,000 motors a year, $S$ = USD 400 per order, holding rate $h$ = 20% a year. A domestic supplier offers an all-units discount: USD 310 below 1,000 motors an order, USD 300 from 1,000 to 2,999, USD 294 from 3,000. | Tier | Price | $H$ | EOQ | Feasible $Q$ | Purchase | Ordering | Holding | Total | |---|---|---|---|---|---|---|---|---| | 1 | 310 | 62.00 | 393.50 | 393.50 | 3,720,000.00 | 12,198.36 | 12,198.36 | 3,744,396.72 | | 2 | 300 | 60.00 | [ ] | [ ] | 3,600,000.00 | [ ] | [ ] | [ ] | | 3 | 294 | 58.80 | 404.06 | [ ] | [ ] | 1,600.00 | [ ] | [ ] | 1. Fill the blanks. Excel for tier 2 EOQ: `=SQRT(2*12000*400/60)`. 2. Which tier minimises annual cost, and by how much does it beat the next best? 3. An importer quotes the same motor at USD 268 at origin, freight USD 7, duty 4% (*Example* rate), lead time 56 days. Landed cost = [ ] (`=268+7+268*4%`). Pipeline stock = $12{,}000 \times 56 / 365$ = [ ] motors; its annual holding cost at 20% of landed cost = [ ]; per motor = [ ]. 4. Compare landed cost plus pipeline cost per motor with the domestic tier 3 price. Which other TCO lines from A1 would you need before deciding, and which way would each push? ## Exercise C (unsolved): Tallow Creek Medical Center IV fluids **Situation (*Example*, fictional).** Tallow Creek Medical Center uses 60,000 bags of IV saline a year, bought from one supplier (Supplier X) at USD 1.10 a bag. A second supplier (Supplier Y) would sell at USD 1.32 a bag if Tallow Creek committed 30% of its volume. The purchasing team estimates an 8% chance a year that Supplier X's plant stops for 8 weeks (the same estimate used in mba/mba-supply-chain-resilience-card Worked example B). During a stoppage, bags not covered by a contracted supplier must be bought on the spot market at USD 4.00. With the dual-source contract, Supplier Y can raise its deliveries to 60% of Tallow Creek's needs during an outage. a. Place IV saline in the Kraljic matrix and explain your two scores. b. Compute the extra annual cost of dual sourcing in normal times. c. Compute the expected annual cost of outages under single and dual sourcing (count only the price premium over USD 1.10; Supplier Y's normal 30% share is already paid for in part b). Is dual sourcing worth it on expected cost alone? At what outage probability does it break even? d. Shortages of IV fluids delay surgery and can harm patients. How would you bring that consequence into the decision, and who should own it? e. Which contract clauses (capacity reservation, allocation rules during shortages, notice periods) would you ask Supplier Y for, and why? ## Connections to other cards | Card or template | Connection | |---|---| | mba/mba-inventory-card | EOQ, safety stock and the newsvendor reused here; read it first | | mba/mba-relevant-costs-card | The cost side of make or buy | | mba/mba-value-chain-card | Which activities create advantage and should stay in-house | | mba/mba-supply-chain-resilience-card | Supply risk axis made quantitative: time to recover, time to survive | | mba/mba-network-design-card | Where to source and stock: facility and lane choices | | mba/mba-bullwhip-effect-card | Why supplier orders swing more than demand, and how contracts and information sharing help | | mba/mba-revenue-management-card | The demand-side mirror: selling fixed capacity at the right price | | mba/mba-negotiation-guide, mba/mba-negotiation-planner | Using TCO to set targets, reservation points and trades | | mba/mba-decision-trees-card | Valuing a second source as an option under uncertainty | | mba/mba-stakeholder-esg-card | Supplier due diligence, labour and environmental standards | | business/vendor-evaluation-scorecard, business/rfp, project/procurement-plan | Practitioner documents for running the sourcing event | | finance/working-capital-review | Pipeline and safety stock as working capital | ## Common mistakes and misconceptions 1. **Comparing unit prices at different Incoterms.** A price at origin and a delivered price are not comparable until freight, duty, insurance and ownership in transit are added. 2. **Ignoring pipeline stock.** In A1 pipeline holding is the largest single cost beyond the purchase price. It exists whenever the buyer owns goods in transit. 3. **Valuing safety stock at the supplier price instead of landed cost.** The money tied up includes freight and duty. 4. **Treating the Kraljic matrix as a one-time label.** A leverage item becomes a bottleneck when a supplier exits or a material becomes scarce; re-score each year. 5. **Running an auction for a bottleneck item.** Competitive pressure does not create suppliers that do not exist; secure supply first. 6. **Taking the deepest quantity discount by reflex.** In A2 the deepest tier saves USD 109 a year but orders 38 days of demand at a time, with obsolescence risk the model does not price. 7. **Double counting in scorecards.** Price, TCO and "commercial terms" as three criteria count cost three times. 8. **Believing the retailer orders too little because it is careless.** Under a wholesale price contract, ordering less than the channel optimum is the rational response to its own margin and risk (A4). 9. **Thinking a coordinating contract must hurt the supplier.** The family of coordinating contracts can split the gain so both firms win; the wholesale price is the lever. 10. **Dual sourcing at tier 1 while both suppliers share a tier-2 source.** Map the sub-tiers before claiming redundancy. 11. **Putting a fixed duty rate in a multi-year model.** Trade measures change; keep the rate as a scenario input and show the break-even rate. ## Self-test 1. List the seven cost lines of the TCO formula on this card and say which ones depend on the lead time. 2. In A1, why does Supplier F need 3,185 more units of pipeline stock than Supplier N? 3. Name the four Kraljic quadrants and one typical action for each. 4. In an all-units discount, why can the best quantity in a tier be the tier minimum and not the EOQ? 5. State the three transaction attributes Williamson (1979) uses to explain governance choices. 6. What is double marginalisation, and who first described it? 7. Derive the coordinating buyback price $b$ from the two critical ratios. 8. In A4, why does the buyback contract at $w$ = 90 make the manufacturer worse off, and how is that fixed? 9. Under revenue sharing with share $\varphi$, which wholesale price coordinates the channel? 10. Give one reason revenue sharing may fail in practice even when the arithmetic coordinates the channel. 11. A buyer says "Supplier F is 16% cheaper". What three questions do you ask before believing the saving? 12. Why is a 2% TCO difference, as in A1, usually not decisive on its own? ## My notes and next steps | Item | My note | |---|---| | The input that moved my answer most | [ ] | | A category I would re-score this year, and why | [ ] | | A contract clause I would now propose | [ ] | | Questions for my study group or tutor | [ ] | | Next card to read | [mba/mba-supply-chain-resilience-card / mba/mba-network-design-card] | ## Sources and further reading - Kraljic, P. (1983). Purchasing must become supply management. *Harvard Business Review*, September-October 1983. - Coase, R. H. (1937). The nature of the firm. *Economica*, 4(16), 386–405. - Williamson, O. E. (1979). Transaction-cost economics: the governance of contractual relations. *Journal of Law and Economics*, 22(2), 233–261. - Spengler, J. J. (1950). Vertical integration and antitrust policy. *Journal of Political Economy*, 58(4), 347–352. - Pasternack, B. A. (1985). Optimal pricing and return policies for perishable commodities. *Marketing Science*, 4(2), 166–176. - Cachon, G. P., and Lariviere, M. A. (2005). Supply chain coordination with revenue-sharing contracts: strengths and limitations. *Management Science*, 51(1), 30–44. - Cachon, G. P. (2003). Supply chain coordination with contracts. In *Handbooks in Operations Research and Management Science*, vol. 11, 227–339. Elsevier. - Ellram, L. M. (1995). Total cost of ownership: an analysis approach for purchasing. *International Journal of Physical Distribution and Logistics Management*, 25(8), 4–23. - Weber, C. A., Current, J. R., and Benton, W. C. (1991). Vendor selection criteria and methods. *European Journal of Operational Research*, 50(1), 2–18. - European Commission, Corporate sustainability due diligence (page on Directive (EU) 2024/1760 and the Omnibus I amendments), checked 2026-10-28. - Textbooks (further reading, by name only): Chopra and Meindl, *Supply Chain Management: Strategy, Planning, and Operation*; Simchi-Levi, Kaminsky and Simchi-Levi, *Designing and Managing the Supply Chain*; Cachon and Terwiesch, *Matching Supply with Demand*; Monczka, Handfield, Giunipero and Patterson, *Purchasing and Supply Chain Management*. - Open resource: OpenStax, *Principles of Management*, chapters on operations and organisational structure, openstax.org (check the licence shown on the book page). ## Answer key **Worked example B.** 1. Tier 2: EOQ 400.00, below the 1,000 minimum, so $Q$ = 1,000; ordering 4,800.00; holding 30,000.00; total 3,634,800.00. Tier 3: $Q$ = 3,000; purchase 3,528,000.00; holding 88,200.00 (`=3000/2*58.8`); total 3,617,800.00. 2. Tier 3, by USD 17,000.00 a year over tier 2 (`=3634800-3617800`). Check storage space and the risk of a design change before committing to 3,000-motor orders (three months of demand). 3. Landed cost USD 285.72; pipeline stock 1,841.10 motors; pipeline holding USD 105,207.58 a year (`=12000*56/365*20%*285.72`); USD 8.77 a motor. 4. Landed plus pipeline is USD 294.49 a motor against USD 294.00 domestic, so the import has no advantage before the other lines. Safety stock (longer, more variable lead time), larger order costs for containers, quality and supplier management would all push further against the import; only a lower defect rate or a further price cut could push the other way. **Exercise C.** a. Bottleneck: low profit impact (USD 66,000 a year of spend) but high supply risk (few qualified plants, a history of shortages, a critical clinical use). b. $60{,}000 \times 30\% \times (1.32 - 1.10)$ = USD 3,960.00 a year. c. Bags needed during an outage: $60{,}000 \times 8/52$ = 9,230.77. Single source: $0.08 \times 9{,}230.77 \times (4.00 - 1.10)$ = USD 2,141.54 a year. Dual source: Y's normal 30% is already in part b, so only the extra 30% that Y ramps up (premium USD 0.22) and the 40% bought at spot count: $0.08 \times 9{,}230.77 \times (30\% \times 0.22 + 40\% \times 2.90)$ = USD 905.35. Expected saving 1,236.18 is below the 3,960.00 premium, so dual sourcing loses USD 2,723.82 a year on expected cost. Break-even outage probability: $3{,}960 / ((2{,}141.54 - 905.35)/0.08)$ = 25.63% a year. d. The expected-cost frame omits patient harm, cancelled procedures and staff time. Options: treat supply continuity for critical items as a constraint set by clinical leadership (for example "at least 50% of need covered for 8 weeks"), or put a cost on a cancelled procedure and add it. The decision belongs to a clinical and supply committee, not to purchasing alone. e. Capacity reservation with a guaranteed share during allocation, a defined allocation rule in shortages, notice of plant changes, the right to audit sub-tier sources, and price adjustment rules; each turns a vague promise into a commitment that matters in the eight weeks that count. **Self-test.** 1. Purchase, ordering, cycle stock, pipeline stock, safety stock, quality, supplier management. Pipeline and safety stock depend directly on $L$ (and safety stock on $\sigma_L$). 2. Pipeline stock is $\bar{d}\,L$: $65 \times 70 = 4{,}550$ against $65 \times 21 = 1{,}365$. 3. Leverage (competitive tender), strategic (partnership and joint planning), bottleneck (secure supply: buffer, second source, redesign), non-critical (simplify the buying process). 4. Total cost within a tier is convex in $Q$ with its minimum at the EOQ; if the EOQ is below the tier minimum, cost rises with $Q$ throughout the tier, so the lowest allowed $Q$ is best. 5. Asset specificity, uncertainty, frequency. 6. When two firms in a chain each add a margin, the final price is too high and quantity too low compared with an integrated firm; Spengler (1950). In the newsvendor setting it appears as the retailer ordering too little. 7. Set $(p - w)/(p - b) = (p - c)/(p - v)$ and solve: $p - b = (p - w)(p - v)/(p - c)$. 8. The manufacturer now absorbs leftovers at USD 80 that are worth USD 30. Raising $w$ (to 100 with $b$ = 91.11) moves profit back to the manufacturer while keeping coordination. 9. $w = \varphi\,c$. 10. The retailer earns only a share of each extra sale, so it may under-invest in sales effort; sales must also be audited, which costs money. 11. Is the price at the same Incoterm and including duty? What are the lead time and its variability, and so the pipeline and safety stock? What are the quality and management costs? 12. The inputs (duty, holding rate, defect cost) are uncertain by more than 2%, and costs left out of the model (markdowns, disruption risk, flexibility) can be larger than the gap. ## Revision history | Version | Date | Author | Change summary | |---|---|---|---| | 0.1 | YYYY-MM-DD | [Your name] | First version from the template | | 0.2 | YYYY-MM-DD | [Your name] | *Example:* Updated freight tender and duty rate, re-ran TCO and break-even | ## Standard and licence note Based on the standard treatment of sourcing and supply contracts in operations and supply chain management (Coase 1937, Spengler 1950, Williamson 1979, Kraljic 1983, Pasternack 1985, Ellram 1995, Cachon and Lariviere 2005) and on the European Commission page on the Corporate Sustainability Due Diligence Directive, checked in October 2026. The text, examples and questions are original; no textbook or case text is copied or paraphrased, and Northfield Outdoor Co., Corvane Robotics and Tallow Creek Medical Center are fictional. The template is independent and not affiliated with or endorsed by any business school, authority, standards body or software vendor. Check the current official versions of every dated fact, duty rate and legal rule before you rely on them. Template licence: MIT.