If a supplier actually fails, the CPO has to explain a risk that was already known internally. The solution has often been readily available for some time: a second supplier or a higher safety stock. Nevertheless, implementation frequently fails due to internal approval issues, because the unit price is higher than that of the existing supplier. This leads to structural risks remaining in the portfolio even though a solution already exists, and to CPOs having to regularly hold the same discussions with finance and management without a shared basis for assessment.

This article will tell you:

• Why simply comparing unit prices structurally disadvantages resilience measures in purchasing

• What behavioral economic bias lies behind it?

• How to economically model the expected damage of a supply interruption

• How this approach can be applied to a concrete numerical example

• What needs to change for procurement teams, CPOs, and management to create a common basis for evaluation.

  
  

Why Purchase Price Variance ignores resilience

Procurement decisions in many companies are still primarily driven by Purchase Price Variance (PPI), i.e., the comparison between the actual price paid and a reference value. This metric rewards the cheapest available supplier while ignoring the likelihood of that specific supplier failing at a given time.

Resilience measures such as a second supplier, a higher safety stock, or a more flexible contract clause therefore generally incur immediate additional costs, the benefits of which only become apparent when a disruption actually occurs. If these benefits are not factored into the evaluation, the measure appears in every single decision as a pure cost driver, even if it avoids significant costs over several years.

If this blind spot remains unaddressed, the same pattern repeats itself with every future resilience decision: measures with high risk mitigation potential are regularly rejected, while structural weaknesses in the portfolio continue to accumulate unnoticed. The procurement teams themselves feel this most acutely, as their technically sound proposals repeatedly fail due to the same price argument. However, as soon as a disruption actually occurs, the responsibility falls to the CPO, who must explain themselves to the board and supervisory bodies. Ultimately, management bears the consequences of this gap, usually without realizing it: the actual risk level of the portfolio deviates from internal reporting, without this being reflected at the capital allocation level.

The behavioral economic explanation for this blind spot

This approach is based on established concepts from risk management and decision theory. The underlying bias can also be explained from a behavioral economics perspective: Certain, immediate additional costs tend to be weighted more heavily in decision-making processes than uncertain losses further in the future, even if their expected value is objectively higher. This pattern is well-documented in decision research as the bias between certain and uncertain outcomes and explains why resilience measures are structurally disadvantaged even in well-managed organizations. The valuation approach described here is already being used in numerous manufacturing companies to counteract this bias with an explicit calculation.

How to calculate the economic value of resilience

What a risk-based cost analysis can achieve

A risk-adjusted cost analysis is a method that incorporates the expected damage from a disruption into a decision, in addition to the pure purchase price. The expected damage is calculated using the formula probability of occurrence multiplied by the severity of the damage, thus adhering to the same principle used in enterprise risk management for assessing individual risks. Unlike a classic total cost of ownership calculation, which primarily captures known, ongoing costs such as transportation or warehousing, this method also includes uncertain, potentially rare events with a high impact.

Two objections to the risk-based approach, and why they are not convincing

This blind spot stems from a widespread assumption: that the cheapest available supplier is automatically the most economical choice. In practice, two main objections to this assumption warrant a factual response. The first is that probabilities and damage levels cannot be determined precisely enough to be incorporated into a reliable calculation. This objection is valid, but it doesn't change the conclusion, because a rough, conservatively estimated range still provides more guidance than an analysis that sets the expected damage to zero entirely. The second objection concerns finance departments, which primarily accept reliable, verifiable figures. This objection is best addressed by presenting estimates from the outset as a range with clearly stated assumptions, rather than feigning a false degree of precision.

The calculation in four steps: from probability to expected value

The first step involves estimating a range for the probability of a disruption with the existing supplier, based on supplier history, risk indicators, and expert assessment. The second step involves estimating the potential damage such a disruption would cause, for example, through production downtime, express freight charges, or lost revenue, ideally in coordination with production, sales, and controlling. Multiplying the lower and upper ends of both ranges yields two expected values that can be directly compared with the additional costs of the planned resilience measures. Finally, it is worthwhile to examine how sensitive this result is to individual assumptions to determine whether the conclusion remains stable even under more conservative assumptions.

A numerical example: Second supplier versus default risk

An example illustrates how this works in practice: A company sources a critical component exclusively from a single supplier. A second, slightly more expensive supplier would increase the annual procurement costs for this component by €150,000. The probability of a delivery disruption lasting several weeks from the existing supplier is estimated at 10 to 20 percent per year; such a disruption would, according to production and sales, incur costs between €1.5 and €2.5 million. The expected value of this risk, therefore, lies between €150,000 and €500,000 per year, depending on the assumptions. Even at the lower end of this range, the expected damage already reaches the amount of the additional costs for the second supplier; at any other point in the range, it significantly exceeds them, so the conclusion remains valid even under conservative assumptions.

What changes for Procurement, CPO and Management

All three levels within the company work with the same invoice, but ask different follow-up questions. For procurement teams, it starts with a repeatable methodology: designated contacts in risk management, production, and controlling; a standardized format for assumptions and ranges; and a fixed point in the sourcing process at which this invoice is generated as a matter of course.

Once this calculation is regularly available, the CPO can aggregate it at the portfolio level. A single resilience measure is easily justified once its expected damage is apparent, but only the sum of the expected damage across the entire supplier portfolio reveals the total amount of uncovered risk in the procurement volume and what proportion of it could be reduced through targeted, comparatively small additional costs.

It is precisely this aggregated figure that becomes truly relevant for management, as individual supplier decisions are usually too granular for them. What matters to them is how much of the expected damage in the procurement portfolio corresponds to the company's risk appetite and how much of it currently remains uncovered. This question can be answered using the same methodology as the individual supplier decision, only at an aggregated level, thus linking an operational key performance indicator from procurement with a strategic decision regarding capital allocation and risk-bearing capacity.

The real bottleneck is the internal coordination between purchasing, risk management, and finance, which is necessary for a reliable estimate. Many companies already have the required figures individually; they are simply never brought together in one place and never translated into a language that describes the same situation at every decision-making level, from category managers to the executive board.

The most important points in brief

The unit price alone is not a reliable indicator for resilience decisions because it systematically ignores the expected damage from a disruption. A risk-adjusted analysis using ranges makes this expected damage, and thus the benefit of a resilience measure, visible, and remains robust even with rough estimates. Procurement teams need a repeatable methodology, CPOs need portfolio-level aggregation, and management needs a connection to the company-wide risk appetite so that, ultimately, procurement performance indicators reflect this expected benefit and not just the pure price.

If you would like to calculate the economic value of your own resilience measures and present your case jointly at the purchasing, CPO and management levels, please feel free to contact us for an initial consultation.