Risk Management in Procurement: A Selection of Sourcing Strategy Based on Real Option

In presence of a high uncertainty level, having the possibility (given by a multiple source strategy) to switch an order to another supplier, already contracted, if the main one has had a default can be very valuable in order to mitigate and manage the risk in purchasing. Nevertheless, multi-source procurement implies a greater cost than single-source one. Thus, a correct evaluation of its (uncertain) benefits is needed to justify the added costs. As traditional "static" techniques often fail in this analysis, this paper uses an approach based on Real Options Theory to value the (supplier switching) option given by multiple sourcing strategy. A quantitative model based on the Monte Carlo simulation was developed. This technique is able to take several uncertainty sources into consideration and, therefore. overcome the limit of traditional methods used in stable and "deterministic" environments.