Question

Suppose that the manager of a company has estimated the probability of a super-event sometime during the next three years that will disrupt all suppliers as 2%. In addition, the firm currently uses four suppliers for its main component, and the manager estimates the probability of a unique-event that would disrupt one of them sometime during the next three years to be 20%. Supplier management costs during this period are $50,000 per supplier. The financial cost incurred if all four suppliers are disrupted at the same time is estimated to be $10,000,000. What is the expected monetary value (cost) of the current supplier diversification arrangement? Show results by drawing a decision tree.

Answer 1

The probability of disruption of all suppliers = 2%

The probability of disruption of one of the suppliers = 20%

Probability of total disruptions:

• One Supplier , P1 = 2% + (1-2%) * 20% = 0.02 + (1-0.02)*0.2 = 0.216
• Two suppliers, P2 = 0.02 + (1-0.02)*0.2^2 = 0.0592
• Three suplliers, P3 = 0.02 + (1-0.02)*0.2^3 = 0.0278

Please find below associated cost in image for management of suppliers.