HOW MANY SUPPLIERS ARE BEST FOR MANAGING RISK? Xiaotian Geng, president of Shanghai Manufacturing Corp., wants to create a portfolio of suppliersfor the motors used in her company’s products that will represent a reasonable balance between costsand risks. While she knows that the single-supplier approach has many potential benefits with respectto quality management and just-in-time production, she also worries about the risk of fires, natural disasters, or other catastrophes at supplier plants disrupting her firm’s performance. Based on histori-cal data and climate and geological forecasts, Xiaotian estimates the probability of a “super-event” that would negatively impact all suppliers simultaneously to be 0.5% (i.e., probability 5 0.005) during thesupply cycle. She further estimates the “unique-event” risk for any of the potential suppliers to be 4%(probability 5 .04). Assuming that the marginal cost of managing an additional supplier is $10,000, andthe financial loss incurred if a disaster caused all suppliers to be down simultaneously is $10,000,000,how many suppliers should Xiaotian use? Assume that up to three nearly identical suppliers areavailable.APPROACH c Use of a decision tree seems appropriate, as Shanghai Manufacturing Corp. has thebasic data: a choice of decisions, probabilities, and payoffs (costs).

HOW MANY SUPPLIERS ARE BEST FOR MANAGING RISK?

Xiaotian Geng, president of Shanghai Manufacturing Corp., wants to create a portfolio of suppliers
for the motors used in her company’s products that will represent a reasonable balance between costs
and risks. While she knows that the single-supplier approach has many potential benefits with respect
to quality management and just-in-time production, she also worries about the risk of fires, natural

disasters, or other catastrophes at supplier plants disrupting her firm’s performance. Based on histori-
cal data and climate and geological forecasts, Xiaotian estimates the probability of a “super-event” that

would negatively impact all suppliers simultaneously to be 0.5% (i.e., probability 5 0.005) during the
supply cycle. She further estimates the “unique-event” risk for any of the potential suppliers to be 4%
(probability 5 .04). Assuming that the marginal cost of managing an additional supplier is $10,000, and
the financial loss incurred if a disaster caused all suppliers to be down simultaneously is $10,000,000,
how many suppliers should Xiaotian use? Assume that up to three nearly identical suppliers are
available.
APPROACH c Use of a decision tree seems appropriate, as Shanghai Manufacturing Corp. has the
basic data: a choice of decisions, probabilities, and payoffs (costs).