A methodological approach to evaluate supplier development based on real options

Abstract In the last three decades, companies have intensified their global business activities with suppliers and thereby were able to focus on their core competencies. Today, supplier development in low cost countries is of increasing strategic importance due to its high cost-cutting potential; however, especially low cost country sourcing features high decision complexity and challenges due to changing corporate environment. This paper presents a three step approach to include uncertainty and flexibility into the decision making process on supplier development, using real options valuation. First, the procurement object is analysed followed by an analysis of the corporate environment in which dynamic environmental factors and risks are evaluated. In the final step, the real options value of the supplier development project is determined, including market risks and flexibility of action. The methodology of real options valuation is a useful tool for supplier evaluation in a low cost country environment since it provides a gradual increase in prediction quality through a project-accompanying evaluation and therefore allows for more reliable planning.