A real options model for remanufacturing facility installation decisions

In this paper, we consider a company that can satisfy customers’ demands for a product using two alternative sourcing strategies: (1) purchasing new products from outside sources (such as an international partner) or (2) collecting cores (used products) and remanufacturing them. As the purchase price from outside sources is subject to noticeable volatility (e.g., exchange rate volatility, raw material price volatility, etc.), we assume it is characterized by a geometric Brownian motion (gBm) with positive drift and volatility. Assuming the quality of the new and the remanufactured products are similar, and the customer’s demand is within the capacity of the remanufacturing facility, we show how a company utilizing the first alternative sourcing can optimally switch to the second alternative sourcing. We consider the profit maximization criterion and utilize the theory of real options to determine the optimal threshold of the outside purchasing price and the corresponding expected time to install the remanufacturing facility. We present a comprehensive numerical example of installing a Laser-Directed Energy Deposition (L-DED) system for remanufacturing gas turbine blades to demonstrate the model’s key features. We also perform analytical and numerical sensitivity analysis to examine how the purchasing price uncertainty and other factors influence the aforementioned threshold. Managerial insights and policy implications are also provided.