Applying real options to IT investment evaluation: The case of radio frequency identification (RFID) technology in the supply chain

Abstract

Due to the high levels of flexibility and uncertainty associated with the deployment of RFID technology in the supply chain (e.g. alternative investment implementations based on the number of RFID-enabled processes or the different supply-chain nodes involved—e.g. stores, warehouses etc.), Real Options analysis becomes strongly suitable. In contrast to the few previous works that demonstrate the suitability of Real Options analysis for RFID investments through hypothetical numerical examples, this paper employs empirical data from a real case firm: 3E Coca-Cola HBC Greece. The proposed model for the case application addresses the simultaneous optimization of RFID investment timing and scale, in the face of (a) substantial uncertainty regarding the products circulated from and among the firm’s premises and (b) largely irreversible investment costs associated with RFID adoption (hardware infrastructure, tags, training and maintenance, etc.). A unique feature of our proposed modelling framework, with implications for a range of other supply chain information technologies with characteristics similar to RFID, is the explicit determination of the volatility of cash flows/revenues that will accrue from adopting the RFID technology from the volatility of RFID tagged items that are circulated from and among the business nodes. This alleviates the need to approximate or estimate the state-variable volatility (undeniably the most difficult parameter to infer in real options applications) through inaccurate or other questionable methods that have been employed in similar case studies in the literature.