Real Options at the Interface of Finance and Operations: Exploiting Embedded Supply Chain Real Options to Gain Competitiveness
University of Montreal - Department of Mathematics and Statistics; University of New South Wales (UNSW) - Australian School of Business - School of Risk and Actuarial Studies
École Polytechnique Fédérale de Lausanne
Suzanne De Treville
University of Lausanne - Faculty of Business and Economics
University of Cyprus - Department of Public and Business Administration; Columbia University - Columbia Business School
April 2, 2012
European Journal of Finance, in press
Exploiting embedded supply-chain real options creates powerful opportunities for competitive manufacturing in high-cost environments. Rather than seeking competitiveness through standardization as is common to lean production, real-options reasoning explores opportunities to use supply-chain variability as a strategic weapon. We present an illustrative case study of a Swiss manufacturer of cable extrusion equipment supported by a formal real-options model that aids in valuing the embedded options that make up supply-chain flexibility: postponement, contraction, expansion, switching, and abandonment. Real-options reasoning provides a plausible retrospective rationale for the case firm's use of supply-chain flexibility that provided protection against competition from low-cost but less responsive competitors. Their intuitive real-options reasoning facilitated incorporating fuller information concerning volatility, flexibility, and control into choosing what products to make, in what quantity, and with work allocated to which supplier. The case study also highlights how competing through exploiting embedded real options requires a different managerial skill set than does competing through cost reduction: Skills such as customer communication, supplier management, and ability to ensure a smooth flow of production join the ability to reduce and control lead times as key sources of competitive advantage.
Number of Pages in PDF File: 22
Keywords: real options, supply chain strategy, supply chain risk
JEL Classification: D24, L64Accepted Paper Series
Date posted: December 11, 2010 ; Last revised: April 3, 2012
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