Harvard Business Review on Managing Supply Chains

It May Be Cheaper to Manufacture at Home

by Suzanne de Treville and Lenos Trigeorgis

WHEN MAKING SUPPLY CHAIN decisions, such as where in the world to locate a new plant or whether to use a foreign or domestic supplier, most managers rely on the discounted cash flow (DCF) model to help them value the alternatives. The trouble with this approach is that DCF typically undervalues flexibility. As a result, companies may end up with supply chains that are lean and low cost as long as everything goes according to plan—but horribly expensive if the unexpected occurs.

You can avoid this trap by complementing a DCF analysis with a real options valuation, which allows you to put a dollar figure on flexibility in the supply chain. This was the tack taken ...