The financing rate in the adder matters, but the unit cap and the true-up clause decide most of the money.
Paying for tooling upfront is cheaper whenever the supplier's financing rate built into the piece price is above the buyer's own cost of capital and volumes run to plan. On an illustrative 480,000 mould amortised over 400,000 parts at 9 per cent, the piece price rises by 1.48 a unit, and at a 7 per cent cost of capital the amortised route costs 21,849 more in present value. The bigger risk is volume: without a cap on the amortisation, a programme that runs 30 per cent over plan pays 172,404 more than buying the tool.
Worked in full in Contract Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Suppliers of moulded, cast, stamped or machined parts nearly always need dedicated tooling, and they quote it two ways: a one-off tooling charge, or a higher piece price with the tool paid off inside it. Procurement teams often prefer the second because it keeps the capital budget clean. That preference has a price, and the contract clauses around the amortisation decide most of it.
| Input | Value |
|---|---|
| Tooling cost | 480,000 |
| Piece price, tooling paid upfront | 12.40 |
| Planned volume, a year | 100,000 |
| Programme life, years | 4 |
| Planned units over the programme | 400,000 |
| Supplier's financing rate used to amortise the tool | 9% |
| Buyer's cost of capital | 7% |
Annual recovery = tool × r ÷ (1 − (1 + r)−n) = 480,000 × 9% ÷ (1 − 1.09−4) = 148,161
Excel: =PMT(9%,4,-480000)
Adder = annual recovery ÷ planned annual volume = 148,161 ÷ 100,000 = 1.4816 a unit, so the piece price becomes 13.88, 11.9 per cent higher.
PV of the adders = 148,161 × annuity factor at 7% for 4 years (3.3872) = 501,849
Upfront payment = 480,000. Difference = 21,849 in favour of paying upfront.
Excel: =PV(7%,4,-148161)-480000
In nominal terms the buyer pays 592,640 for a 480,000 tool through the piece price. The gap between that and the 501,849 present value is the buyer's own time value of money; the gap between 501,849 and 480,000 is the price of borrowing from the supplier at 9 per cent rather than funding the tool at 7. If the buyer's cost of capital were 9 per cent, the two routes would break even; at 11 per cent, amortising would be cheaper by 20,342.
The adder is fixed per unit, but the tool cost is fixed in total. Any difference between planned and actual volume turns into a gain for one side.
| Scenario | Paid through piece price | True-up at end | PV cost | Versus upfront |
|---|---|---|---|---|
| Upfront payment | 480,000 | 0 | ||
| Plan, 100,000 a year | 592,640 | 0 | 501,849 | 21,849 |
| 130,000 a year, no cap | 770,432 | 0 | 652,404 | 172,404 |
| 130,000 a year, capped at 400,000 units | 592,640 | 0 | 516,767 | 36,767 |
| Plan, programme extended to year 5, no cap | 740,800 | 0 | 607,485 | 127,485 |
| Plan, extended to year 5, capped | 592,640 | 0 | 501,849 | 21,849 |
| 70,000 a year, no true-up | 414,848 | 0 | 351,294 | −128,706 |
| 70,000 a year, true-up of unamortised balance | 414,848 | 203,271 | 506,369 | 26,369 |
Three things stand out.
Ownership. When the buyer pays upfront, the contract should vest title in the tool in the buyer and require the supplier to mark, insure and release it on demand. When the tool is amortised, the supplier often keeps title until the last unit is paid, which weakens the buyer's position if it wants to move the part to another supplier. The cost of that, alongside notice periods and unamortised tooling, is worked in how much it costs to terminate a supplier contract early.
| Buyer's cost of capital | PV of adders | Amortised minus upfront |
|---|---|---|
| 5% | 525,368 | 45,368 |
| 7% | 501,849 | 21,849 |
| 9% | 479,997 | about nil |
| 11% | 459,658 | −20,342 |
The rule is the usual one for any embedded financing: whichever party funds more cheaply should carry the tool. A buyer with a large balance sheet usually funds more cheaply than a smaller supplier, which is why paying upfront tends to win when volumes are reliable.
Comparing the tooling charge with the adder in nominal terms and stopping there, or worse, comparing 480,000 with 1.48 a unit and calling the adder small. The comparison that matters is the present value of the adder across realistic volumes, under the clauses actually in the draft: is there a unit cap, is there a true-up, who owns the tool. A should-cost model, like the one in how to build a should-cost model, should carry the tooling line separately so the adder can be removed when it has done its job.
Pay upfront when volumes are reliable and your cost of capital is below the supplier's. If you amortise, write a cap at the planned units, a true-up only on the supplier's actual unrecovered cost, and title to the tool on final payment. On this part, a 30 per cent volume overrun without a cap costs 172,404 more than paying upfront, against 21,849 for the financing rate alone. The clause-by-clause pricing of a whole supply agreement is in the free workbook for this case.
Treat the tool as a loan from the supplier: annual recovery equals the tool cost times the rate divided by one minus (1 + rate) to the power minus the years, then divide by annual volume. A 480,000 tool over 4 years at 9 per cent needs 148,161 a year, so 1.4816 a part at 100,000 parts a year. In Excel, =PMT(9%,4,-480000)/100000.
It depends on the true-up clause. Without one, the supplier never recovers the full tool: at 70,000 parts a year instead of 100,000, it collects 414,848 against a 480,000 tool. With a true-up, the buyer pays the unamortised balance at the end, 203,271 in the illustrative case at the supplier's 9 per cent, and ends up paying more than an upfront charge.
Whatever the contract says, and buyers should not assume. When tooling is paid upfront, title usually passes to the buyer on payment. When it is amortised, the supplier often keeps title until the amortisation is complete, which can block a move to another supplier. The clause should state when title passes, who insures and maintains the tool, and how it is released.
This article is one calculation from Contract Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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