Towards improved port capacity investment decisions under uncertainty: a real options approach

ABSTRACT

Port activity plays an important role in facilitating international trade. Sufficient capacity is indispensable for a port to attract flows to a region and retain them. The capacity decision is the result of a trade-off between investment and waiting costs. Traditional methods to value expansion projects do not deal adequately with managerial flexibility in the face of uncertainty from different sources in the complex port environment. In this paper, real options (RO) models are identified as an alternative method to making project valuations and investment decisions, as they attribute the correct value to managerial flexibility under uncertainty. In order to be able to build and use such RO models for port capacity investment decisions, the sources and implications of uncertainty in the port and the different RO model specifications need to be understood. To this end, both the literature about uncertainty in the port context and the literature about real options models are reviewed in order to provide researchers who want to build their own decision-making models, with the necessary knowledge of both fields. The review makes clear that the complex interactions in and competition between the logistics chains and their actors coming together in ports have significant impacts on port capacity. Uncertainty is also caused by uncertain international trade flows and changes in legislation following new technologies and environmental impacts. An analysis of the components of some general RO models shows how the options of flexible output, investment size and timing are valued by RO models in a setting with demand uncertainty. Moreover, the review presents researchers with insights in how to deal with cooperative and competitive interactions in the chain, time to build, cyclical markets and legislation changes. It also shows how to value the expansion and the phased investment options. The new insights resulting from this review are subsequently combined in a framework that serves as a guideline to build RO models for port capacity investments. Finally, an exemplifying application of the framework is used to build an actual port capacity investment decision model.

KEYWORDS:

• Port capacity
• investment
• valuation
• decision making
• real options
• uncertainty

Acknowledgments

The authors would like to thank Trevor Heaver, Siri Pettersen Strandenes, Peter Kort, Anming Zhang, Michele Acciaro and the participants of various conferences for their valuable comments to previous versions of this paper. All remaining errors are ours.

Disclosure statement

No potential conflict of interest was reported by the authors.

ORCID

Matteo Balliauw http://orcid.org/0000-0003-1008-8109

Hilde Meersman http://orcid.org/0000-0002-1806-8965

Eddy Van de Voorde http://orcid.org/0000-0002-1868-2332

Thierry Vanelslander http://orcid.org/0000-0001-5213-3444

Additional information

Funding

This work was supported by the Research Foundation Flanders (FWO) under a PhD grant.