Flexibilty and real options Flashcards
Strategic flexibility
A firm has strategic flexibility when it can choose among several different strategic options.
An example of this is, a firm may choose to implement a product differentiation strategy, but not completely commit to a single basis for differentiating its product.
Real options
A real option exists when a firm has the ability, but not the obligation to invest in real assets of some type.
Option to defer
A strategic option that enhance its ability to defer additional investment in a strategy until some later period.
An oil company leases land for potential exploration instead of buying it.
Option to grow
The ability to “grow” an investment in the future, should that option turn out to be valuable.
A firm builds a plant with the ability to add capacity at low cost.
Option to contract
Enhance the ability to get smaller and reduce investment in a strategy.
A firm hires contract and temporary employees instead of full-time employees.
Option to shut down and restart
Shut down business A and restart business A in the future, when strategic advantage is bigger.
A firm outsources distribution to a firm that distributes the products of many firms instead of outsourcing distribution to a firm that distributes only its production.
Option to abandon
Abandoning the current strategy and increasing the flexibility by investing in a new strategy.
A firm builds a manufacturing plant that employs only general-purpose machinery
Option to expand
The strategy is expanded beyond the current boundaries.
A firm invests to create one product because that investment could lead to the development of other products in the future.
The value of strategic flexibility
Strategic flexibility is most likely to be valuable under conditions of uncertainty. So, in this context concepts of risk and uncertainty need to be distinguished. A decision-making setting is said to be risky when the outcome of that decision is not known with certainty.
Net present value (NPV)
The most common way risk is introduced to strategic analyses is through present value analysis. The net present value (NPV) of the cash flows generated by choosing and implementing a particular strategy is equal to the sum of those cash flows.
NPV = net cash flow of firm j and time t/(1+discountrate)^t
Black-Scholes formula
The model for valuing financial options suggests that the value of these options depends on the previously named five variables.
Positioning options
Technical uncertainty is high: take multiple small positions in alternative technologies and wait until technological uncertainty resolves, then invest.
Scouting options
Market uncertainty is high: put several new offerings in consumer hands to gauge their reactions; once consumer preferences are clear, then invest.
Stepping-stone options
Both technical uncertainty and market uncertainty are high: avoid fixing on a particular design or set of features early; fail fast, fail cheap & learn fast, and try again.
