For more info on a specific newsletter, click the title. Details will be displayed in a new window.
Subscribe to
Computerworld 40 years of the most authoritative source of news and information for IT leaders.
Tapping Into Real Options
or
Other Computerworld Stories
|
|
|
|
January 07, 2002 (Computerworld) -- Even before the jolt of the Sept. 11 terrorist attacks, the U.S. economy was on shaky ground. An impending recession and rigorous budgeting led many IT managers to seek focused IT projects offering quick returns on investment. Was that a reasonable strategy? Not necessarily.
We live in a world of uncertainty. IT professionals have been living facing quandaries for some time. What e-business initiatives should be pursued? What's the next killer app? The answers to such questions are anything but sure bets.
Oil and gas developers also routinely make multimillion-dollar decisions in a fog of ambiguity. In an effort to make the best choices possible under the circumstances, energy analysts often use a methodology called real options reasoning. They advise, for example, on the value of alternatives to drilling whole hog into an oil reservoir of unknown capacity by evaluating options such as spending more on preliminary seismic studies.
Some experts say the same approach should be applied to IT investments.
"In the old world, IT investments improved existing operations, and its success was tied to achieving a particular business outcome," says Martha Amram, interim CEO of Vocomo Software Corp. in Cupertino, Calif., and a writer on the subject of real options. "ROI and other traditional valuation approaches did just fine back then."
But ROI can be misleading when IT is being implemented strategically, rather than for incremental improvement. Sam Israelit, manager at consultancy Bain & Co.'s Boston office, tells of a client in the energy sector that balked at a major enterprise software investment when it appeared that the anticipated benefits were far off. The client used real options to break the project down into three phases.
"That way, they were able to learn about the application and give some thought about how to use it more effectively," he says. "This approach brought about benefits early on in the project."
For instance, end users at the energy firm had to determine the likelihood of achieving the benefits they expected from the application. "Going through this process forced them to think specifically about what they have to do to reach those benefits," says Israelit. "The net result was that they were better prepared to implement the change management needed for a successful implementation."
Through real options, Israelit's client was also able to identify the riskiest aspects of the project. "They put additional emphasis on mitigating the risks in those areas," he explains. "They also thought through the phasing of different project components so that they could start to achieve the lower-risk returns earlier in the project and smooth the overall risk over the life of the project."
The real options response to uncertainty, then, is flexibility. Just as financial options seek to hedge the risk associated with trading securities, real options attempt to mitigate the risk associated with deploying business assets.
The trick is not to bet the company on a risky strategy nor to walk away from uncertain opportunities that could pay big dividends. "The first principle is to postpone any investment that would expose the company to an irreversible downside," says Rita McGrath, an associate professor at Columbia Business School in New York. "Break the project up into milestones and commit resources sequentially."
DEFINITION
REAL OPTIONS is a systematic and integrated decision analysis process that centers on real (nonfinancial) assets: Make a capital investment today to create an opportunity in the future. Real options enable the owner to benefit from the upside potential of an opportunity while controlling the downside risk. It's "real" because you're investing in operating capital instead of financial capital. It's an "option" because you're investing in the right, but not the obligation, to invest. Much like IT infrastructure investments, a real options opportunity will pay off if market conditions are favorable. If the investment results in a loss, the loss is limited to the initial investment.
Step by Step
Characteristic of real options strategies is a step-by-step approach, in which small investments are made for specific purposes. If the desired outcome is achieved, the project manager has the option of going forward. If the results are disappointing, the manager walks away, having lost only the initial investment. Either way, the lessons drawn from the project are a win for the company.
Take, for example, an investment in a new IT architecture. The CIO will doubtless have to explain to the chief financial officer how the benefits outweigh the costs. "Traditional analyses often break down when the return is cashless," says Johnathan Mun, director of corporate finance at Decisioneering Inc., a Denver-based software development firm that's working on incorporating real options into its decision analysis packages.
"Increased efficiency and lowered costs in office operations or the IT department can be debatable," says Mun. "The real value may come down the road if the company exercises options to implement collaboration or e-commerce modules. The strategic value is likely to be high and the costs to deploy those latter phases relatively low."
Under a real options approach, it wouldn't make much sense to develop a full-blown IT architecture that couldn't be tested until the whole thing was built. On the other hand, it might be wise to pay more upfront for a reusable modular platform as opposed to paying less for a system that would benefit from just one business process.
"You need to plan for a passing lane, in case you need to speed things up, and an exit ramp, in case you need to get off," says Adam Borison, who until recently ran the real options practice at PricewaterhouseCoopers in New York. "And you also need a process on the back end to enforce this discipline."
Practitioners manage bundles of options like investment portfolios. "The question is, how is the value of the portfolio influenced by the staging and sequencing of projects?," says McGrath.
Israelit says he believes that CIOs should learn to present their proposals in just such a light. "Rigorous analytical thinking is more critical than ever to get through these turbulent times," he says.
Buxbaum is a freelance writer in Elizabeth, N.J. Contact him at Pab001@aol.com.
Tapping Into Real Options:
Potential Applications For Real Options
Bibliography
The Accidental Real Optionist
Tapping Into Real Options
|
Print this Story |
|
Send Us Feedback |
|
E-mail this Story |
|
Digg this Story |
|
Slashdot this Story |
|
|
|
|
 |
|
All Zones Application Performance Zone Business Continuity Zone Data Center Management Zone Enterprise-Class Security Zone The File Data Management Zone Grid Computing on Windows Zone Security Management Zone ITIL Best Practices Zone The SAS Zone Storage Virtualization Zone Business Intelligence and Analytics Zone |
 See your link here
|
 |
||||||||
| ||||||||
| ||||||||
| ||||||||
|
Enabling Data Centers that Are Both Automated and Dynamic 
Download this Technology Briefing now!
Download this special report now!
Read up on the latest ideas and technologies from companies that sell hardware, software and services.
- Google gives away home-cooked Web application security scanner
- HP eyes move of support facilities out of Colorado Springs
- Microsoft trumpets security additions in upcoming IE8
- More top stories
 LIVE - June 24th @ 11am ET
|
Provide a Better Customer Experience
Register now for "Provide a Better Customer Experience," a live TechWise TV broadcast. This webcast is free to view, compliments of Cisco. Click here to watch now
|
 |
 Virtualized iSCSI SANs: Flexible, Scalable, Enterprise Storage for Virtual InfrastructuresDownload this white paper |
 Case Study: Simplified DR Planning and ImplementationDownload this case study |
 Webcast: Disaster Recovery Simplified – iSCSI and VMware Site Recovery Manager Deliver ResultsView this webcast |
 Webcast: Data Protection and Disaster Recovery with iSCSI and VMwareView this webcast |
