Abstract
Purpose Firms can choose from an array of approaches for reducing the detrimental financial effects caused by unfavorable fluctuations in commodity prices. The purpose of this paper is to provide guidance for effectively estimating the financial effects of mitigating commodity price risk volatility (CPV) in supply chain management decisions. Design/methodology/approach This paper adopts two prominent and complementary methodologies, namely, total cost of ownership (TCO and real options valuation (ROV), to illustrate how commodity price risk mitigation strategies can be analyzed with respect to their effect on costs and performance. The paper provides insights through a case study to demonstrate the application of these methods together and establish the benefits and challenges associated with their implementation. Findings The paper illustrates advantages and disadvantages of TCO and ROV and how these approaches can be adopted together to contribute to effective purchasing decisions. Supply chain flexibility is a key capability but requires investments. Holistically measuring the financial effects of flexibility investments is imperative for gaining executive management support in mitigating commodity price volatility. Research limitations/implications This study can provide supply chain professionals with useful guidance for measuring the costs and benefits related to developing strategies for mitigating commodity price volatility. TCO provides a focus on the costs associated with the commodity purchasing process, and ROV enables the aggregation of all the costs and benefits associated with the use of the strategy and synthesizes them into the net value estimate. Originality/value The paper provides a comparison of different but complementary approaches, specifically TCO and ROV, for analyzing the effectiveness of CPV risk mitigation decisions. In addition, these two methods allow supply chain professionals to evaluate and control the financial effects of CPV risk, particularly the impact of mitigation on firm’s cash flows.
Highlights
Most organizations purchase commodities in some form as part of its firm’s operations
The findings and their discussion highlight how the two approaches do not seem to be alternative or mutually exclusive, but instead we discovered that real options valuation (ROV) can serve as an extension of total cost of ownership (TCO) because of its ability to calculate the net value of the strategy and its impact on the firm’s bottom line
With regard to contributions to practice, we believe this study can provide supply chain professionals useful guidance for measuring the costs and benefits related to developing strategies for mitigating commodity price volatility
Summary
Most organizations purchase commodities in some form as part of its firm’s operations. Several risk mitigation strategies have been identified from the financial perspective, namely, financial hedging (Sun et al, 2017; Caniato et al, 2016), and from the SCRM perspective, sourcing approaches (forward buying, switching supplier, substituting commodities, vertical integration) (Manikas and Kroes, 2016) and contracting strategies (escalator clauses, staggering contracts, passing price increase to customers) (Gaudenzi et al, 2018; Zsidisin et al, 2013; Wakolbinger and Cruz, 2011) All of these strategies are characterized by different thresholds between costs and benefits, which need to be carefully evaluated by supply management professionals before implementing measures to mitigate this form of risk. The second reason for combining these two approaches is their practicality, which fits to the aim of the paper to provide guidance for effectively estimating the financial effects of mitigating CPV in supply chain management decisions, as discussed
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