HOW OPTION THINKING CAN IMPROVE SOFTWARE PLATFORM DECISIONS (original) (raw)
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Options Analysis of Software Platform Decisions: A Case Study
Management Information Systems Quarterly, 2000
In recent years, the use of option pricing models to support IT investment decisions has been proposed in the MIS literature. In this paper, we discuss the practical advantages of such techniques for the selection of a software platform. First, we argue that traditional quantitative approaches to a cost-benefit analysis give only a partial picture of such decision situations: due to the long planning horizon required because of the time-consuming and resource-intensive implementation process, it is not possible to exactly predict which applications will, in fact, run on the system over time. Thus, the investor is faced with the problem of valuing "implementation opportunities." We then compare different valuation techniques for this task and discuss their respective advantages and drawbacks. The practical advantages of employing such models are demonstrated by describing a real-life case study where option pricing models were used for deciding whether to continue employing SAP R/2 or to switch to SAP R/3.
Evaluation of Software Development Investments: a Real Options Approach
Software development projects are exposed to multiple sources of uncertainty. This uncertainty has an enormous impact in the investment economic value. The variability of a software development project payoff can be represented by the volatility of the project value over the analyzed period. The aim of this work is to define a framework to estimate the volatility of IT investments that takes into account all relevant information that has impact on project value, and show how to use this volatility estimation in a real options analysis. The suggested method could help IT managers produce a well-structured valuation process in software development investment decision-making, and understand the interactions between software process, market environment, financial issues and options value in a clear way.
A framework for applying real options analysis to information technology investments
International Journal of Industrial and Systems Engineering, 2012
The selection and valuation of information technology (IT) investments are challenging as they usually have long durations and require significant amount of capital expenditure. Given the high uncertainty inherent in these investments, traditional tools are proven insufficient to identify the true values. On the other hand, real options analysis (ROA) is a powerful valuation tool that put emphasis on the 'real options' of projects. However, most IT managers do not have the necessary skills to carry ROA. In this paper, we give introduction of ROA and propose an easy-to-use framework for using ROA to value investment opportunities. In addition, we discuss common types of real options and describe a case study of deferral option in a real-world investment opportunity. This paper should serve as a good starting point for managers who want to put ROA into practice.
The decision processes surrounding investments in innovative IT platform technologies are complicated by uncertainty about expected payoffs and irreversibilities in the costs of implementation. When uncertainty and irreversibility are high this suggests using concepts from real options to properly structure the evaluation and management of investment opportunities-and thereby capture the value of managerial flexibility. However, while innovation researchers have posited that option value can influence the motivations of early adopters, and options researchers have identified emerging IT as a promising area for application of options valuation techniques, there has yet to be a systematic theoretical integration of work on IT innovation and real options.
A Key challenge facing information technology (IT) managers is how to carefully analyze the decision options available to them when considering enterprise software infrastructure upgrades. We present an illustrative case that not only captures the trade-offs involved in retaining an existing software infrastructure as opposed to adopting a new one at an appropriate time, but also demonstrates how the combined application of various analytical tools including real options analysis may provide richer information than a single approach. Our model offers IT managers the potential to arrive at a deeper understanding of software upgrade timing decisions while generating important information relevant to practical decision situations.
Communicating the value of uncertain information technology investments using an options approach
International Journal of Business Information Systems, 2005
Valuing IT investments in hypercompetitive business environments remains an elusive task as traditional valuation tools fail to model inherent uncertainty. Real-options analysis presents a viable alternative to traditional valuation tools in planning and valuing IT investments in uncertain business environments. While much has been written about the quantitative and valuation aspects of real options, we believe that its use as a strategic tool to inculcate broader thinking about IT investment has been understated. Our objective is to illustrate how decision makers can use such thinking to articulate IT value in an environment characterised by high levels of uncertainty. We discuss cumulation, dynamism, and complexity as three major characteristics of uncertain IT-investment decisions and illustrate the use of a strategic real-options framework in each scenario. We hope to stimulate a mode of thinking that can facilitate better communication regarding IT investment and valuation in times of rapid growth and change.
Evaluate IT Investment Opportunities Using Real Options Theory
2002
In this paper, we discuss the real options theory and its applications in IT investment evaluation. We provide a framework within which the appropriateness of using real options theory in strategic IT investment evaluation is systematically justified. In our framework, IT investment opportunities are classified into four categories based on two criteria: the technology switching costs and the nature of competition. We point out that different real options models should be adopted for each category. The electronic brokerage's investment decision in wireless technology is discussed as a real world case within the framework. Our study also provides some insights about the relationship between technology standardization and IT investment decisions.
Option-based management of technology investment risk
IEEE Transactions on Engineering Management, 2001
Real operating (flexibility) options embedded in a technology investment are valuable because they allow management to take rational, value-adding actions that could favorably affect operational traits of the investment (timing, scale, scope, etc.). These options, however, are not inherent in technology investments. Rather, they usually must be carefully planned and designed to fit each investment differently. Building on concepts from the area of financial risk management, this paper presents a methodology for planning the creation of specific operating options designed to maximize the value of a technology investment in light of the risks underlying that investment. The paper also illustrates the use of the methodology in the context of a Web-based information technology investment.