Component Supplier Choice
A factory uses 20,000 components a year. Supplier A charges £12 per component and historical data show 3% arrive defective. Supplier B charges £15 per component with a 0.5% defect rate. Every defective component costs £20 to rework, including labour and lost production. Both suppliers meet the same specification otherwise, and the factory must choose one supplier for the full year. The finance director wants a purely cost-based recommendation. The operations manager is worried that the defect estimates come from a single year of data and that a bad batch could stop the line for a day at a cost of about £40,000.
1. Compute the total annual cost of each supplier under the stated assumptions.
Read the worked answer
Supplier A: purchase 20,000 × £12 = £240,000. Defectives 3% × 20,000 = 600, rework 600 × £20 = £12,000. Total £252,000. Supplier B: purchase 20,000 × £15 = £300,000. Defectives 0.5% × 20,000 = 100, rework 100 × £20 = £2,000. Total £302,000. On these figures A is cheaper by £50,000, so the purely cost-based recommendation is A. The 3 percentage-point defect gap does not come close to covering B's £3-per-unit price premium.
2. At what rework cost per defective component would the two suppliers be equal? Interpret the result.
Read the worked answer
B's purchase premium is 20,000 × £3 = £60,000. B avoids 600 − 100 = 500 defective units. Break-even rework cost = 60,000 ÷ 500 = £120 per defective unit. Since the current estimate is £20, B would need rework to be six times more expensive than assumed before it wins on cost. The recommendation for A is therefore not sensitive to modest errors in the £20 figure; only an error of that magnitude, or a different kind of failure cost, would reverse it.
3. The operations manager notes that a line stop costs about £40,000. How many stops would make B worthwhile, and what do you advise?
Read the worked answer
B's premium is £60,000, so it needs to prevent 60,000 ÷ 40,000 = 1.5 line stops a year to break even. If a stop is triggered by a single bad batch rather than by individual defects, the relevant question is not the average defect rate but the chance of a bad batch: A has 600 defectives and B has 100, so A has roughly six times the exposure. With only one year of data, a prudent answer is to choose A on base cost but add incoming inspection sized to catch a bad batch, or negotiate a quality clause. Switching to B purely on a speculative stop is not justified by the arithmetic.