Application of Real Options to the Risk Management of Supply Chain

Risk management is very important to supply chain management. Managers can reduce supply chain risk by operations management and financial management. Many researchers studied the supply chain risk by using operations management, but only a few authors analyzed financial management applied to risk management of supply chain. Few researchers use the real options as a tool to study supply chain risk. In a supply chain, the right to return the unsalable products to the suppliers is a kind of option which is valuable. In this study, we add option to the normal order and try to manage the relationship between distributors and manufacturers with more flexibility. The rights of purchasing and the rights of returning the unsalable products to the supplier are two kinds of options. We choose a one-manufacturer n-distributor supply chain with a short life-cycle product to study. A mathematical model is developed for the manufacturer and distributor to make decision. Monte Carlo simulation is used to simulate the decision. Numerical results are given. The novelty of the paper is that two kinds of options (call option of ordering products and put option of returning the unsalable products) are added to the model and Monte Carlo simulation are applied to simulate the order policy. The research will do some help to the manufacturer and the distributors for their production and distribution.