ROI Guide: Real Options

Steve Ulfelder   Today’s Top Stories   or  Other ROI Stories  

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February 17, 2003 (Computerworld) -- Champion: Collaborative Consulting, Woburn, Mass.

One innovative IT return-on-investment model is the Real Options approach—although one of its prime champions, Walter Kuketz, chief technology officer at Collaborative Consulting, says Real Options is "not a methodology yet, but a set of guidelines." Perhaps, but those "guidelines" have won many fans among pharmaceutical companies, energy traders and other organizations that routinely finance capital-intensive projects. And a broad range of experts, including academics and analysts, say Real Options may also be the best way to assign a value to IT-related risk.

Real Options lingo may not be familiar to all IT executives. In finance, a "call-option contract" on a given stock allows (but doesn't force) the holder of the contract to buy a fixed number of shares of the stock at a specified date for a specified price. Real Options simply substitutes nonfinancial, or real, assets for financial ones.

The goal is to create a situation in which your company can benefit from the upside potential of, for instance, an enterprise resource planning (ERP) system while controlling its downside risks. In practice, Kuketz says, this tends to mean incremental IT investment. If you spend a relatively small amount on a thorough study of that ERP system and the results look promising, the investment in that study gains value; if the results aren't promising, your losses are minimal, compared with a full-blown ERP project.

Real Options has detractors, to be sure. Critics say the practice looks good in theory (not surprising, since it was developed by academics) but is effective only if a company is genuinely prepared to cancel projects after their initial investment. And anybody who's spent any time in the corporate world knows that projects tend to acquire invisible momentum that's hard to stop.

In a 2001 Bain & Co. study of more than 5,600 companies, Real Options earned mixed reviews. Only 8% of companies using the methodology said they were "extremely satisfied" with it, but Real Options' overall satisfaction score ranked fourth out of 25 methodologies studied.

Nevertheless, Real Options may be a helpful way "to guide IT's thinking," Kuketz says. "It forces you to put investments in terms of risk premium and options—and these are terms the CFO understands."

Ulfelder is a freelance writer in Southboro, Mass. Contact him at sulfelder@charter.net.

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ROI Guide: The Consultants' Offerings Real Options Where ROI Models Fail ROI Guide: Internal Rate of Return ROI Guide: Payback Period

Three Problems ROI Guide: Balanced Scorecard ROI Guide: Economic Value Added ROI Guide: Net Present Value Outsourcing's Payoff

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• ROI Guide: The Consultants' Offerings
• Three Problems
• Real Options
• ROI Guide: Balanced Scorecard
• Where ROI Models Fail
• ROI Guide: Economic Value Added
• ROI Guide: Internal Rate of Return
• ROI Guide: Net Present Value
• ROI Guide: Payback Period
• Outsourcing's Payoff

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• More top stories 

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