Hidden Discount in Sourcing
Posted: 27 Mar 2014 Last revised: 4 May 2016
Date Written: June 27, 2015
We introduce "indifference price" as the risk-adjusted unit price a supplier should charge for its customer’s random demand, given its flexible but limited capacity. The gap between this indifference price and the unit price used in practice, which is not adjusted for risk, then gives a hidden discount received by the supplier’s customers. Calibrating our model using a data set of a Norwegian bumper beam supplier, we show that this hidden discount rises in the customer’s order size. Further, customers with more volatile orders receive higher discount.
Keywords: Order quantity risk, flexible capacity, indifference price, just-in-time sourcing
JEL Classification: L11, L62
Suggested Citation: Suggested Citation