Dual Sourcing Decision at Vantage Medical
Vantage Medical assembles patient monitors. A proprietary power module is bought from a single supplier at $42.00 per unit; annual volume is 60,000 units. The supplier's lead time is 16 weeks with a quoted 98.5% on-time rate. Two quality escapes in the last year caused line stoppages totalling nine days. A qualified alternate offers $46.50 per unit, a 6-week lead time, and 99.6% on-time, but requires a $180,000 tooling investment and a 3-year commitment of at least 30,000 units per year. The incumbent has offered a 3% price reduction if Vantage commits to 100% volume for two years. Carrying cost is 24% per year; a line-stoppage day costs about $28,000 in lost margin. Vantage holds 4 weeks of safety stock. Finance wants the lowest piece price; operations wants resilience.
1. Compare the annual total cost of the incumbent's 100% volume offer with a 50/50 dual-source arrangement over three years, including tooling amortization. Use carrying-cost data where it is relevant.
Read the worked answer
Incumbent 100% with 3% reduction: price = $42.00 x 0.97 = $40.74. Annual spend = 60,000 x $40.74 = $2,444,400.
Dual 50/50:
- Incumbent 30,000 x $42.00 = $1,260,000.
- Alternate 30,000 x $46.50 = $1,395,000.
- Annual purchase total = $2,655,000.
- Tooling amortized over 3 years = $180,000 / 3 = $60,000 per year.
- Annual dual-source cost = $2,715,000.
Incremental cost = $2,715,000 - $2,444,400 = $270,600 per year, or about 11% above the discounted incumbent option.
Carrying cost: 4 weeks of total demand is 60,000 / 52 x 4 = 4,615 units. At $42, 24% carrying cost is about $46,500 per year. A 6-week alternate may allow two weeks less safety stock on half the volume, saving only about $11,600 per year at $42 x 24%. That does not close the gap.
The TCO comparison therefore favours the incumbent on stated costs alone. The missing item is expected stoppage cost: nine days at $28,000 is $252,000 in the past year. Dual sourcing is an insurance premium, not a piece-price decision.
2. How should Vantage respond to the incumbent's 3% offer? Evaluate the commitment and propose negotiation terms.
Read the worked answer
The 3% offer saves 60,000 x $42.00 x 0.03 = $75,600 per year. That is real, but it requires 100% volume for two years, which removes the alternate as a credible option and leaves Vantage exposed to the same 16-week lead time and quality record.
Do not accept 100% exclusivity. Counter with a volume-band commitment, for example 70% of annual volume, conditional on:
- Lead time reduced from 16 weeks toward 8-10 weeks, or consignment safety stock held at the supplier.
- A quality penalty tied to line-stoppage days, not just a replacement-parts credit.
- Capacity reservation evidence for peak quarters.
- Price reduction maintained, but applied to the committed band rather than all-or-nothing exclusivity.
The 3% saving is worth about $75,600; the annual dual-source premium is about $270,600. The incumbent would need to improve lead time and quality enough to reduce safety stock and stoppage risk before Vantage gives up the alternate. If the incumbent refuses, keep the alternate qualified even at a lower share, because the qualification itself is an option.
3. Recommend a sourcing decision and the risk mitigations that should accompany it. Justify the premium or reject it.
Read the worked answer
Recommendation: dual-source 50/50 for three years, using the alternate for 30,000 units and the incumbent for 30,000 units. Reject the 100% incumbent commitment unless the incumbent accepts a shorter lead time, consignment buffer, and quality penalty.
Justification: the premium is about $270,600 per year. That is substantial against a $2.44 million spend, but one avoided nine-day stoppage is $252,000, and the past year actually had two quality escapes. The premium buys a second qualified source, a 6-week lead time, and a 99.6% on-time record. Finance should treat part of the premium as risk mitigation rather than pure purchase price.
Mitigations:
- Negotiate tooling cost sharing or a phase-in so the $180,000 is not all sunk before the alternate proves volume.
- Require lot-level traceability and incoming inspection for the first six months.
- Hold a joint safety stock or consignment buffer for the power module.
- Set a quarterly scorecard with on-time, defect ppm, and stoppage hours.
- Define an exit or volume-shift clause if either supplier misses two consecutive scorecards.
- Reassess after 12 months using actual stoppage and lead-time data.