Hidden Discount in Sourcing

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.