Competing For Advantage
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Competing For Advantage Part IV – Monitoring and Creating Entrepreneurial Opportunities Chapter 13 – Strategic Flexibility and Real Options Analysis
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Competing For Advantage. Part IV – Monitoring and Creating Entrepreneurial Opportunities Chapter 13 – Strategic Flexibility and Real Options Analysis. The Strategic Management Process. International Strategy. Key Terms - PowerPoint PPT Presentation
Transcript of Competing For Advantage
Competing For Advantage
Part IV – Monitoring and Creating Entrepreneurial Opportunities
Chapter 13 – Strategic Flexibility and Real Options Analysis
The Strategic Management Process
International Strategy
Key Terms
Strategic Flexibility – condition existing when a strategy allows the firm to react to changing uncertainties by quickly changing course or, better still, allows the firm to position itself to take advantage of the resolution of uncertainty
Sources of Enhanced Strategic Flexibility
Organizational structures, systems, or other internal resources
Design of investments and operations
With staging opportunities
With switching opportunities
With follow-on opportunities
Entrepreneurial activities
Real Options Analysis
Key Terms
Real Option – a strategic alternative, with an underlying (real) asset, that provides the firm with the right, but not the obligation, to take some future specified actions which will enable the firm to reduce its downside risk while assessing upside opportunities (a preferential claim to follow up on an investment opportunity)
Real Option Criteria
A right
Not an obligation
Future specified action
Enabling reduction of downside risk
Assessing upside opportunities
Types of Real Options
Key Terms
Growth Options – investments that enable the firm to expand the investment in the future, if that action turns out to be valuable
Abandonment Options – investments that provide the firm flexibility by allowing it to reverse course and exit deteriorating competitive situations
Types of Real Options
Key Terms
Switching Options – investments that combine the features of growth and abandonment options by allowing firms to change the mix of outputs or inputs
Options to Defer – investments that recognize a value in waiting
Compound Options – investments that confer multiple options that are built upon one another
Types of Real Options
Reasons for Positive Effect of Real Options Analysis on Strategic Decision Making
It challenges a conventional perspective on strategic investment based on asset valuation
Shifts attention from possible gains from efficiencies to changes in value chain activities
Moves central focus to operational flexibility rather than operational control
Joint ventures and minority investments have come to be seen as stepping stones (transitional investments) rather than permanent, inflexible investments
Reasons for Positive Effect of Real Options Analysis on Strategic Decision Making
It unites strategic analysis and capital budgeting
Employs the use of tangible cash flows as explicit decision criterion for corporate investment (capital budgeting)
Introduces the flexibility of active management and follow-on opportunities to make resource allocation decisions (strategic analysis)
Reasons for Positive Effect of Real Options Analysis on Strategic Decision Making
It changes go/no-go thresholds for investment decisions by considering embedded growth options
It takes into account the potential for future opportunities that evolve from the project at hand
However, an argument can be made for retaining assets and operations despite expected gains from divestiture
Reasons for Positive Effect of Real Options Analysis on Strategic Decision Making
It becomes a source of value for firms
The present value of a firm’s growth opportunities is its value of growth options because growth in economic profits reflects discretionary future investments by the firm
Despite general tendencies across industries, the degree to which growth options matter within industries varies greatly
Drivers of Call Option Value
Option Value Determinants
Net Present Value (NPV) – the value of the underlying asset divided by the present value of the exercise price
Cumulative Volatility – the time to invest divided by the volatility
Criticisms of Real Options Analysis
It is overly technical
It is beyond the mathematical competence of many managers
It is too complex to implement
Transitional Steps
Conduct one or more experimental pilot projects
Get support from top managers and those involved in the project
Codify the real options technique through expert groups and training materials
Institutionalize real options analysis as a way of thinking as well as an analytical tool
Ethical Questions
What are the ethical implications of making an investment that appears to be a money loser in the short term because of money-making opportunities that may be provided in the longer term? For instance, as a shareholder, would you be comfortable with a firm that routinely supports these types of decisions?
Ethical Questions
How can a firm include human issues (such as the well-being of employees or human risk factors) in a real options analysis?
Ethical Questions
Can real options analysis be used to justify poor decisions? If so, what are the agency implications? What are the legal implications?
Ethical Questions
How can a board of directors ensure that real options analysis does not result in management decisions that hurt shareholders and other important stakeholders?
