A Real Options Approach to Quantity and Cost Optimization for Lifetime and Bridge Buys of Parts

Abstract

Mismatches between part procurement life cycles (especially for electronic parts) and the life cycles of the systems that parts are used in cause systems with long manufacturing and/or support lives to incur significant obsolescence management costs. While lifetime and bridge buys, which are used to manage part discontinuance (i.e., obsolescence) during the support of critical systems are simple in concept, the challenge is determining the optimum number of parts to buy and understanding their true cost. This report presents a real options approach to valuate lifetime and bridge buys and to determine the optimum part quantity for a lifetime or bridge buy. The approach accommodates uncertainties in demand, holding costs and end of support dates.