Innovator’s Dilemmas: real options in R&D? (2)
“[companies invest] in technologies before they are ready to become revenue-generating products. The investment is small in comparison to production costs and is designed to equip the company with an understanding of the technology, the market, and the infrastructure necessary to create products from it.”
“In each case the company will reach a position in which it must decide that the R&D option is “in-the-money” and should be exercised by going into production, or is “out-of-the-money” and should be terminated. R&D investment positions the company to capture future revenues, but still allows them to abandon the option investment if it will not be profitable.”
Download Roger Smith’s paper, “Applying Options Theories to Technology Management Decisions” from CTO Net.
“Organizational inertia and other sources of resistance to change in plans can make implementation of real options difficult in practice. Because projects often develop their own momentum once they have been set in motion, the exercise of some options - especially those requiring shifts in personnel or downsizing- may demand sustained management attention until fully implemented.”
“Playing it safe has become the norm in many organizations where control systems penalize those whose decisions turn out to be unprofitable, but not those failing to pursue opportunities which might have been great successes.
Read William F. Hamilton’s paper, “Managing Real Options”, in “Wharton on Emerging Technologies” published by Wiley and Sons.
Following up on yesterday’s post, real options happen to be an integral part of R&D investment decisions. For instance, Steve Jobs decided that Apple had to invest their way through the dot-com bubble. As a result the company ended up ahead of competitors when the downturn was over. That decision enabled Apple to eventually exercise its options, which would have been severely constrained otherwise.
In finance options are about getting a future right to buy (call option) or sell (put option) a given stock at a specified price in a defined period of time. The same concept applies to commodities, debt, etc.
Initially, this enables lower investment levels (e.g. the price paid to acquire the option) and, eventually, higher flexibility since there is no obligation to exercise the option.
Most typically, options enable their owners to control equity in a limited capacity for a fraction of what the stock would actually cost. The upside potential is unlimited but a certain investment needs to be made (or granted) to acquire a right which comes with an expiration date. So, if the option is not exercised, the money spent is obviously lost.
The term real option borrows these financially driven concepts to assist corporate managers with investment dilemmas regarding non-financial assets, such as whether to invest in an emerging technology in uncertain market environments.
Investing in proof of concept projects (PoC) helps demonstrate a given technology’s feasibility. Seed money and early stage investments create real options leading to know-how, patents, and platforms for future applications without having initially committed to full blown investments and resources for the launch of a commercial product.
When working on innovation projects, another potential benefit is establishing thought leadership in the industry . This means earning the market’s acknowledgement and customers’ mindshare early enough in the process, as part of a preemptive business development strategy.
In my previous post I talked about decision trees unbundling the actual decision making process. Otherwise, technology and marketing officers would incur the risk of rushing through decisions while unknowingly suffering from tunnel vision. What’s more troublesome is the fact that assessing and managing options might not even be part of the process to begin with.
I will continue to write about real options in my next post.
Picture credits: Digital image content © 1997-2007 Hemera Technologies Inc., a wholly owned subsidiary of Jupiter Images Corporation. All Rights Reserved. Chart Credits: Wikipedia’s article on seed money.
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| Chicago, 30 April 08 |  |
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Innovator’s Dilemmas: real options? (1)
“Real options are created whenever you face a decision that is costly to reverse (…) The solving of real options has two parts. The first part is ’spotting options’ and the second part is ‘valuing options’. To spot options, we need to have a deep understanding of the whole decision landscape.”
Read Andrew Metrick’s book, “Venture Capital and the Finance of Innovation“, published by Wiley & Sons.
“Opportunity cost is the cost (sacrifice) incurred by choosing one option over an alternative one that may be equally desired. Thus, opportunity cost is the cost of pursuing one choice instead of another. Every action has an opportunity cost.”
Wikipedia’s entry for “opportunity cost“
“The primary value of investments in emerging technologies is in the options created through opportunities for future development and profitable commercialization (…) Just how and when (and if) this might happen would depend significantly on the outcome of R&D efforts over the next two or three years, and no one could hope to make credible estimates of of possible payoffs until then.”
Read William F. Hamilton’s paper, “Managing Real Options”, published on “Wharton on Emerging Technologies” by Wiley and Sons. This quote refers to a specific example provided by the author for illustration purposes.
Investing in emerging technologies is a tricky business. In many cases, decisions are made based on ‘high return/high risk’ assumptions or on the theoretical ’strategic value’ of the product, which can dramatically change over the planning horizon.
A decision tree is often depicted as a graph that helps visualize the decision making process by charting decision points, possible paths, outcomes and consequences, resource costs, etc.
When assessing a given R&D investment, it makes sense to develop a decision tree analysis as, often times, we are facing alternative architectures, features, implementations, timelines and market targets, which can yield different results.
This kind of exercise should enable discussions and analysis related to how success is being defined (e.g. qualitative and quantitative targets), impact of ‘what if’ scenarios, and what specific things we could get done in exchange for giving up something else (e.g. trade-offs).
More over, the decision tree analysis can portray contingencies helping the team spot next best alternatives. One of the branches should be about the implications of ‘doing nothing’, clearly showing whether no taking action involves greater risks or it just happens to save us from some kind of unnecessary trouble.
This is my first post on this subject. I will be sharing more insights on the following days. In the meantime, please feel free to leave comments (see link below) or send me an email.
Picture credits: Digital image content © 1997-2007 Hemera Technologies Inc., a wholly owned subsidiary of Jupiter Images Corporation. All Rights Reserved.
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| Chicago, 29 April 08 | |
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What happened to the Internet?
The following content is intended for mature audiences:
http://www.southparkstudios.com/clips/166182/
“Over Logging” is South Park’s episode #1206:
“One day the citizens of South Park wake up and find the Internet is gone.”
“When Randy hears there may still be some Internet out in California, he packs up his family and heads west.”
http://www.southparkstudios.com/
Picture credits: Comedy Central, South Park and all related titles, logos and characters are trademarks of Comedy Partners.
Innovator’s Dilemmas: business vs. technology innovation?
“I’ve spent most of my life thinking that value was generally created by technical innovation (…) I’m not talking about ‘financial engineering’ here, but plain old business model and revenue model. (…) many companies have come to dominate their space simply by reworking the way they make money (…) model innovation is particularly effective when attacking an existing industry because the incumbents often cannot match the change because doing so would require massive organizational changes.”
Read Adam Messinger’s post, “Innovation in Business Models” , on O’Reilly Radar.
“Over the years, entrepreneurs have been mostly known for technical innovations. And there are many great companies that have been built on top of technical innovations like Intel, Cisco, Oracle, Apple, and arguably Microsoft (…) I wonder if business model innovation isn’t as powerful, maybe a more powerful opportunity to build a new business. If you think of Federal Express, Google, Netflix, these companies were built on business model innovations.”
Read Fred Wilson’s post, “Technical Innovation vs. Business Model Innovation“, on A VC.
Some new technologies drive business model innovation…
Most of us can talk about new technologies which happen to be game changers by enabling business model innovation. Amazon has pioneered quite a few initiatives of this kind. Just recently, the company launched the Kindle, an electronic book reader which retrieves content wirelessly over a cellular network without users receiving a monthly bill from a phone company.
While some other do not…
It should be noted that the rollout of a new technology does not necessarily imply the need for a new business model. As an example, a bit more than a year ago I bought a Toyota Prius, a hybrid car which most regard as an engineering innovation. There was nothing different about my buying experience (e.g. same sales and pricing tactics) when compared with other cars I purchased years ago. The only remarkable exception would be the tax rebate granted to the purchase of an energy efficient car.
And there are new business models which are not necessarily born from breakthrough technologies…
There are innovative business models and marketing practices which are not strictly related to engineering breakthroughs. In quite a few cases, new business models involve existing products which leverage innovative processes (not necessarily new technologies) and more cost effective ways of managing the value chain. Business model innovation can be about new ways of reaching customers, distribution channels, partnerships, and pricing strategies for all kinds of products and services. It so happens that technology has become pervasive to a point at which both conventional and innovative business models happen to rely on it.
The following is a presentation from Cap Gemini which I have come across on SlideShare:
Picture credits: Digital image content © 1997-2007 Hemera Technologies Inc., a wholly owned subsidiary of Jupiter Images Corporation. All Rights Reserved.
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| New York, 22 April 08 | |
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Mobile Mediascapes enabled by HP
“mediascapes are mobile, location-based experiences that incorporate digital media with the sights, sounds, and textures of the world around you. A mediascape blends digital images, video, audio and interactions with the physical landscape. Games, guided walks, tours, and destinations are among the mediascapes created to date.”
http://www.hpl.hp.com/mediascapes/
“You can make a mediascape right now in about five minutes. It’s as simple as pointing to a few spots on a map. And the best part is that you can try it out in a flash demo when you’re done (…). So make your own mediascape anytime you like, then save it to your account. It’ll be there waiting for you to download it or share it with your friends.”
“The software only runs on phones with Windows Mobile 5.0 (or later versions) and is limited to the resolution of the GPS sensor (…) many of the gadgets available operate consistently within about a 10-meter radius (…) a person must keep this limitation in mind when developing her mscape application.”
Read Kate Greene’s article, “Your Phone as a Virtual Tour Guide“, on Technology Review.
I’m following up on a post on augmented and virtual reality for mobile users, which I uploaded back in July. The below chart was presented at mScpaeFest took place just a few months ago, in December of 2007 to be precise, and was hosted by Hewlett-Packard Laboratories, Bristol (UK).
Basically the intent is to deliver a mushup based on a mixture of physical and digital content. This means delivering context relevant media based on information provided by sensors (e.g. GPS’ location information) and end user input. As an example, different locations will trigger different applications, media and interactions, making both professionally crafted as well user generated content available.
Other applications would eventually leverage Bluetooth, infrared sensor data, information from in-phone accelerometers, and biometrics. Mobile users would benefit from digital media delivered over 3G wireless networks (e.g. downloads, uploads and streaming). If interested, watch the following video:
Speaking of sensor networks, here is the link to my previous post on Mobile Ad-hoc Networks. I would also suggest retrieving the one on “grocery shopping” as it links location based and web applications with retailers and online commerce. Interestingly enough, that is one of the most visited posts of this blog. By the way, what follows is just a quick note to share the link to “itsnearme“, a blog of recent creation exploring geo-targeted applications (GTA) and location based services (LBS), which happens to be run by a buddy.
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| Chicago, 20 April 08 | |
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