Archive for April 30th, 2008
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.
| J. de Francisco |  |
|
| Chicago, 30 April 08 |  |
 |
|
