Two Vendor Quotes and a Two Percent Rejection Rate
A 400-bed hospital consumes 4,800 units of a consumable each year, steadily. Vendor A quotes Rs 500 a unit on 15-day credit and offers a 2% discount for payment within 5 days. Vendor B quotes Rs 485 a unit on 45-day credit. The hospital's cost of borrowed funds is 12% a year. Vendor B's consignments have shown a rejection rate of 1.5%, and rejected units must be replaced from the open market at Rs 560 a unit; rejected units are still invoiced by B and are returned without a credit note until the quarter closes. Vendor A's rejection rate is nil. Both prices are exclusive of GST, which is fully input-creditable for the hospital and therefore neutral for the comparison. Vendor B is a registered micro enterprise under the MSMED Act. The purchase committee must place the full year's order with one vendor; splitting the order forfeits both price offers.
1. Compute the cash-equivalent annual cost of each vendor and recommend one. Show your working.
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Method. Cash-equivalent cost = invoice value minus the financing benefit of the credit period (interest the hospital avoids by holding cash longer), plus the cost of replacing rejected units.
Vendor A (discount taken, 5-day payment):
- Invoice: 4,800 x 500 x 0.98 = Rs 23,52,000
- Credit benefit: 23,52,000 x 0.12 x 5/365 = Rs 3,867
- Cash-equivalent cost = Rs 23,48,133
Vendor B (45-day payment):
- Invoice: 4,800 x 485 = Rs 23,28,000
- Credit benefit: 23,28,000 x 0.12 x 45/365 = Rs 34,442
- Cash-equivalent before rejections = Rs 22,93,558
- Rejections: 1.5% of 4,800 = 72 units, replaced at Rs 560 = Rs 40,320
- Cash-equivalent cost = Rs 23,33,878
Comparison. B is cheaper by 23,48,133 - 23,33,878 = Rs 14,255 a year, about 0.6%.
Recommendation. Award to B, but on a thin margin. Note two structural points: the entire advantage comes from B's longer credit period, not from its lower price, since the 45-day float is worth Rs 34,442 while the price gap only contributes 4,800 x 15 = Rs 72,000 before discounting is considered; and A's option depends on the hospital actually paying within 5 days, which few public hospitals reliably do. If the 2% discount window is missed, A's cost jumps to roughly Rs 23,88,000 and B wins comfortably. The recommendation is therefore conditional on payment discipline in both cases.
2. At what rejection rate for Vendor B does the recommendation reverse? What does the answer imply about how the contract should be drafted?
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Set-up. Every rejected unit is invoiced by B at Rs 485 and then bought again on the open market at Rs 560, so one usable unit costs Rs 1,045 instead of Rs 485. Each rejection therefore adds Rs 560 to total cost.
Headroom. B's advantage before rejections is 23,48,133 - 22,93,558 = Rs 54,575.
Break-even. 54,575 / 560 = 97.5 rejected units. As a rate: 97.5 / 4,800 = 2.03%.
Interpretation. At the observed 1.5% B wins by Rs 14,255. Above roughly 2.03% rejected units per year, A becomes cheaper. The gap between the observed rate and the break-even rate is only about half a percentage point, which is well inside sampling noise for a few consignments. A single bad quarter, or a rate of 3%, costs B the contract: at 3% (144 units) the extra Rs 80,640 wipes out the advantage and leaves A ahead by about Rs 26,000.
Drafting implications.
- Fix a contractual rejection ceiling at or below 2%, with a credit note issued within 7 days rather than quarterly, since the quarterly delay makes the hospital finance Rs 40,320 of returns.
- Price the replacement obligation into the contract, requiring B to replace rejects at its own cost, which raises the per-rejection penalty above Rs 560 and widens the safety margin.
- Monitor the rate monthly. Because the decision hinges on a parameter estimated from past consignments, the committee should treat the award as provisional and review after two quarters.
3. Beyond the arithmetic, what non-price factors could reverse this recommendation? Give the MSMED Act point specific weight.
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The Rs 14,255 margin is small enough that any one of the following can decide the contract.
The MSMED Act point, which is the most serious. Vendor B is a registered micro enterprise, so the statutory payment period under the MSMED Act is 45 days, with compound interest at three times the bank rate if payment is delayed. B's quoted 45-day credit is therefore not a concession the hospital can bank on; it is the legal maximum, and the credit benefit of Rs 34,442 evaporates entirely if the hospital pays late. Take a bank rate of about 6.5%, giving roughly 19.5% compounded monthly: a 30-day overrun on about Rs 23 lakh costs in the region of Rs 37,000, which is larger than the whole advantage. Public-sector payment cycles commonly exceed 45 days, so the risk is not hypothetical. The recommendation should be conditioned on a written assurance that payment will be released by day 40.
Other factors.
- Quality risk in a clinical setting. A 1.5% rejection rate on a consumable used for patient care carries clinical and reputational cost that the Rs 560 replacement price does not capture.
- Working capital. A's 2% discount requires payment in 5 days, which demands a standing facility; if the hospital cannot fund it, the discount is illusory.
- Supply continuity. A single-vendor award to a micro enterprise with a documented rejection problem concentrates risk; the forfeiture of both offers from splitting should be weighed against that.
Conclusion. B remains the better choice on the numbers, but the award should carry a rejection ceiling, a 7-day credit note, and a payment-timeline condition. If those cannot be secured, A is the safer purchase at a premium of about Rs 14,000.