Still concerned about the risk in Problem S11.2, suppose that Phillip is willing to use one local supplier and up to two more located in other territories within the country. This would reduce the probability of a “super-event” to 0.5%, but due to increased distance the annual costs for managing each of the distant suppliers would be $25,000 (still $15,000 for the local supplier). Assuming that the local supplier would be the first one chosen, how many suppliers should Witt Input Devices use now?

Problem S11.2

Phillip Witt, president of Witt Input Devices, wishes to create a portfolio of local suppliers for his new line of keyboards. As the suppliers all reside in a location prone to hurricanes, tornadoes, flooding, and earthquakes, Phillip believes that the probability in any year of a “super-event” that might shut down all suppliers at the same time for at least 2 weeks is 3%. Such a total shutdown would cost the company approximately $400,000. He estimates the “unique-event” risk for any of the suppliers to be 5%. Assuming that the marginal cost of managing an additional supplier is $15,000 per year, how many suppliers should Witt Input Devices use? Assume that up to three nearly identical local suppliers are available.