Real options at the interface of finance and operations: exploiting embedded supply-chain real options to gain competitiveness

Abstract

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.

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