Lecture 5: Choosing Innovation Projects Flashcards
The Development Budget - Capital Rotating
= firms set a fixed R&D budget and rank order projects to support
= R&D intensity varies across and within organizations
-> Most: Pharma
-> Less: Machinery Industry
Financing Projects
= Big firms can often finance projects internally
= small firms/ start-ups:
-> rely on family, friends, and credit cards
-> Funding from government grants and loans
-> Promising projects: Angel investors
Quantitive Methods for Choosing Projects
- Discounted Cash Flow (DCF)
-> and internal rate of return - Real options
What is the Discounted Cashflow and the Internal Rate of Return
- Equation: see summary
Internal Rate of Return
= The discount rate that makes the net present value of investment zero
= calculated by trial and error
Strengths of Discounted Cash Flow
= Provide concrete financial estimates
= Considers timing of investment and time value of the money
Weaknesses of the Discounted Csh Flow
= May be deceptive -> only as accurate as original estimates of CF
= May fail to capture the strategic importance of the project
What are real options?
= Applies stock option market to nonfinancial resource investments
-> The cost of R&D program can be considered the price of the call option
-> The cost of future investments required can be the exercise price
=> The returns to the R&D investment are analogous to the value of a stock purchased with a CALL OPTION
When should the method of real options be used?
= valuable when there is uncertainty
Limitations of the real option method
= many innovation projects do not conform to the same capital market assumptions underlying the option market
-> may not be able to acquire option at a small price
–> full investment before knowing success of technology
-> The value of stock options is independent of call holder’s behavior
–> BUT: the value of R&D investment is shaped by its capabilities
Why Qualitative Methods for Choosing a Project?
= Many factors in the choice of projects are extremely difficult or misleading to quantify -> therefore qualification of projects
Screening Questions which are used to assess different dimensions of the project decisions…
- Role of customer
-> market, use, compatibility, ease of use, distribution & pricing - Role of Capabilities
-> existing capabilities, competitors’ capabilities, future capabilities - Project timing and cost
What are Qualitative Methods?
- The Aggregate Project Planning Framework
- Types of Projects
- Q-Sort
The Aggregate Project Planning Framework
= Managers map their R&D projects according to levels of risk, resource commitment, and timing of cashflows
Types of Projects
- Advanced R&D Projects
-> Develop cutting-edge technologies, often with no immediate commercial application
-> take longer to pay off
-> Potential to become technological leadership - Breakthrough Projects
-> Incorporate revolutionary new technologies into commercial application - Platform projects
-> not revolutionary, but offer fundamental improvements over proceeding generations of products - Devirate Projects
-> pay off the quickest
-> help service the firm’s short-term cash-flow needs
Q-Sort
= Simple method for ranking ides on different dimensions
-> Ideas are put on cards
-> For each dimension being considered, the cards are stacked in order of their performance in that dimension
-> several rounds of sorting and debate are used to achieve consensus about the projects
