Innovator dilemmas: modeling real options
“The solving of real options problems 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 (…) when a decision maker is considering all possibilities, it is helpful to sketch [them]”
Adrew Metrick’s Venture Capital and the Finance of Innovation.
Understanding one’s options is key to modeling and, therefore, business case development. Most of the literature on real options discusses decision tree charts, which entrepreneurs can use to assess alternative paths and outcomes.
I crafted the above picture just to illustrate some of the basic decisions worth considering. Let’s start figuring out whether your business will deliver point or end to end solutions. Most typically, a point solution can be a single product or service, while and end to end solution involves systems integration, this means the seamless assembly of a number of products or services which, in turn, enables the supplier to become a one stop shop. Example:
- Point solution: a software application
- End to end solution: turnkey solutions encompassing servers, applications and networks
In today’s high-tech industry, whether your business delivers products or services has more to do with your choice of business model than with the actual technology. In general terms: products happen to be sold and, as result, the title of that asset is legally transferred from the supplier to the buyer, who becomes the new owner; a service model can enable the supplier to retain the title to that asset, while the costumer pays for the right to use the product within a given timeframe; the concept of multi-tenancy is often part of this picture since more than one customer would be leveraging the same asset. Example:
- Product: servers and data centers (capex play)
- Service: shared cloud computing infrastructure (opex play)
Just based on the above, the chart’s quadrants get you to discuss four different business models:
- The inner spheres help visualize and compare the revenue forecast for these different options.
- The outer circle portrays the size of the revenue opportunity in any subsequent years or at the end of the planning horizon.
- Needless to say that just discussing revenue alone would not do the job, so I have also added a couple of other metrics such as % of market share and growth (i.e. CAGR)
- The clocks should be set to clearly show the time that it would take to launch the product or service (time to market) or to acquire the first customer, how long it would take your venture to reach: a given share of the market, the breakeven point, specific profitability metrics and/or any other time related benchmark.
The intent of this one chart is just to help entrepreneurs visualize, brainstorm and work with others on how to go over figuring out high level business models. By the way, if you think your business is limited to selling products, you might like to think twice: Rolls Royce, a leading supplier of jet engines, is succeeding by charging airlines for the amount of hours an engine is in service (cost per flying hour).
“Rolls got there in part by creating what BusinessWeek called "one of the world’s most sophisticated help desks," which "continuously monitors the health of some 3,000 engines for 45 airline customers." In addition, because its service guarantee is so comprehensive, Rolls is now more focused than ever on making sure the engines don’t fail in the first place”.
Tim Manners’ Dare to be Different.
*In case you wondered: the size of the spheres and circles as well as the clock’s arrows are provided just for illustration purposes and, therefore, they are neither related to a specific business case nor representative of a specific business model.
J. de Francisco blogging from Chicago on Oct 7
