4/5/01 1

Pain Points in Material Procurement

• Price Volatility• Timely Availability• Limited Storage Space• Competitive Bidding

Contractors’

Producers’

• Over capacity due to 9 years of expansions

4/5/01 2

Price Volatility• Steel accounts for 20% and lumber 17% of ENR's

Building Cost Index• Lumber: Hefty quota on Canadian lumber (34%

of U.S. market) raised prices for 33% in 1996 and 20% in early part of 1997. Price then collapsed in summer of 1998, rebounded significantly in 1999 and tumbled again in 2000 due to over capacity.

• Steel: Price peaked in summer 1998 before import drives it down 13% in 1999. Then anti-dumping duties, increase in nickel prices, and strong demand in Asia, Europe and North America drives it back up before diving again due to over capacity

4/5/01 3

Availability• In order to produce more steel, mills who are at

full capacity, adopts longer runs. Lead time is as long as 6 months.

Competitive Bidding• As many as 10 contractors bidding• 5% margin for a big project and 2-2.5% margin for a small one—lower than yield of risk free treasure bonds

4/5/01 4

Options

• Option is the right but not the obligation to do certain things

• Similar to financial options, real options provide a decision maker flexibility to adapt his future actions to market conditions in order to capture upside potential while limit downside loss.

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Potential Types of Real Options

• Options to defer delivery in case weather is bad or there is a delay in obtaining building permits, signing off of a design, the predecessor step, etc.

• Option to alter scale of procurement when market changes

• Option to switch to substitute products in fast-track projects

4/5/01 6

Benefits of Real Options

• Risk sharing similar to insurance. Contractors pay small premium to suppliers minimized risks. Payment is smoothed out, reducing financial distress, and delivery is accurate due to better capacity planning.

• Locking in prices without hassle of inventory due to flexibility of options.

4/5/01 7

Deliverables

• Final CIFE Technical Report on types of materials and types of real options applicable

• One to two journal articles at the conclusion of the research

• Web documentation of the ongoing and finished research

• At least one workshop for CIFE members• Real-life supply contracts if time allows

4/5/01 8

Future Plans

• Seeks further funding from NSF and Sweden