|
Nalin
Kulatilaka
What
motivated you to write the book Real Options?
What
impact did the book have, both in academic and managerial
circles?
What
has changed since you wrote the book?
You
are affiliated with the Boston University Institute
for Leading in a Dynamic Economy (BUILDE). What does
the institute do, and how do companies involved in the
center perceive real options? Do any use the approach?
As
you scan across the corporate environment, what are
some of the least successful applications of real options?
Why?
Did
the demise of Enron change your perspective on the use
of real options?
Tell
us a bit about your own research. (real options flavor?
Risk management flavor?) What's new in academic research
on real options?
Are
there good classroom materials on real options you can
point us to?
Many
students around the world write their thesis on real
options. Any suggestions on topics, methodology or resources?
Martha
Amram
What motivated
you to write the book Real Options?
What
impact did the book have, both in academic and managerial
circles?
What
has changed since you wrote the book?
How
is real options used by companies today?
What
advise do you have for a company interested in starting
a real options program?
You
have been working in the area of patent valuation for
the past year. How does real options apply in that field?
Real
options is an exciting topic in graduate academic programs.
Do you have any suggestions for students looking for
jobs in this area?
Nalin
Kulatilaka
What
motivated you to write the book Real Options?
To make the obscure academic literature more accessible
to managers and students.
>>
back to top
What
impact did the book have, both in academic and managerial
circles?
We wanted to maintain rigor, yet be relevant. We did
so by finding ways to elucidate the intuition behind
real options theory and consider a wide array of applications.
Our book helped kindle the interest of thoughtful executives
who were grappling with complex investment decisions
in tremendously uncertain environments and led the way
in making real options more accessible to practicing
managers.
>>
back to top
What
has changed since you wrote the book?
The study of real options has now reached the main stream
of corporate finance. The idea that capital investments
can be viewed as options has become integral parts of
the finance curriculum in business schools. All major
corporate finance textbooks include several chapters
on real options. With MBAs exposed to real options joining
the management ranks corporations are better equipped
with the skills needed to perform real options analysis.
There has been steady stream of recent publications
that elucidate the intuition without immersing in underlying
mathematics. It is, therefore, not surprising that the
interest from the practice has also been overwhelming.
Senior managers find the idea appealing. This is particularly
so when making strategic investments. Rowing numbers
of corporate strategy academics have embraced the value
of framing strategic decisions as options. Not surprisingly
management consultants have developed practices around
it.
Despite
all this interest, real options have become standard
tools only in a just a few industries (like energy,
mining). The idea seems to have stalled when trying
to reach beyond the handful of obvious applications.
Recent surveys of management practice (Economist…) found
that managers are skeptical about justifying projects
based on their option value. They found several impediments
to widespread adoption. Most have to do with difficulties
encountered in the extension of the applications domain
-- from the well-defined terrain of financial contracts
to the less-precisely defined corporate investments.
Ironically, the most appealing and the most useful application
of the options framework comes arise in these extended
domains.
>>
back to top
You
are affiliated with the Boston University Institute
for Leading in a Dynamic Economy (BUILDE). What does
the institute do, and how do companies involved in the
center perceive real options? Do any use the approach?
BUILDE
is a partnership between Boston University and several
private and public organizations, to explore strategic
investment in the face of uncertainty. Our expertise
lies in the assessment of emerging information and communications
technologies as a source of uncertainty, regarding external
market conditions and internal capabilities of the firm.
As
a method for discovery, the Institute provides a platform
for strategic experimentation where a network of organizations
can co-evolve, innovate, and appropriate decision rights.
The learnings from this process are often proprietary,
leading to the creation of real options and competitive
benefits for the participants.
>>
back to top
As
you scan across the corporate environment, what are
some of the least successful applications of real options?
Why?
The rush of interest has also led to some confusion
about the nature and scope of applicability of real
options. In our book we point out that the real options
valuation consists of several distinct components: frame
the dynamics of uncertainty and understand the decision
flexibilities, seek market discipline to the valuation
of real assets, and use appropriate computation techniques.
There is debate, in my opinion mostly a semantic one,
whether or not all the above components are needed to
make a real option analysis. Instead, I believe that
the appropriate use of real options concepts is determined
by context and complexity of the particular problem.
The
mostly visible success stories of real options applications
are in energy and natural resources industries, where
uncertainty is great, decision flexibility is plentiful,
and where deep markets provide discipline to valuation.
The use of real options valuation is turning out to
be very useful in the design and pricing of technology
licenses and other complex contracts. The management
of technology investments in and R&D programs have also
benefited a lot from real options. Rather than making
investment decisions based on a single scenario or an
expected value and then managing projects towards their
technical success, real options highlight the need to
put in place a value management program. Such a process
provides flexibility to adjust the scale, scope, and
timing of investments, as both technical and commercial
uncertainties are resolved.
The
most daunting challenges are not in the valuation stage
but in the subsequent management. Organizational rigidities
often prevent the correct exercise of real options.
>>
back to top
Did
the demise of Enron change your perspective on the use
of real options?
Execution of real options based strategy poses new organizational
risks. (Download
my note on Enron)
>>
back to top
Tell
us a bit about your own research. (real options flavor?
Risk management flavor?) What's new in academic research
on real options?
My own research is addressing several strategic aspects
of real options. In some of my more theoretical work,
I examine the implications of real options in imperfectly
competitive settings. For instance, the exercise of
an investment options by one firm may affect behavior
of competitors. It is also the case that multiple firms
often own real options, so the exercise decision requires
actions by multiple firms. (Download
note on 3G options)
>>
back to top
Are
there good classroom materials on real options you can
point us to?
This still a problem. I think Alex Triantis' web site
is a good source.
>>
back to top
Many
students around the world write their thesis on real
options. Any suggestions on topics, methodology or resources?
See
my own research. There is also a scarcity of good
empirical work on real options.
>>
back to top
Martha
Amram
What
motivated you to write the book Real Options?
At the time Nalin and I started the book, I had just
left academia. I felt like a human bridge between academic
and business life, and wanted my business colleagues
to see the power of the real options ideas Nalin and
I had worked on in academia.
>>
back to top
What
impact did the book have, both in academic and managerial
circles?
I often think of Innovator's Dilemma, a book that languished
for the first 18 months after publication until the
Internet emerged as business problem for established
companies, and gave them a dilemma. After that, sales
zoomed.
Real
Options had a similar story. Our book arrived with the
dot.com frenzy and was used and abused to explain high
stock prices. Further, established corporations felt
they were navigating a very uncertain economic environment,
and so our book helped then think through the signals.
For
academics, we brought in some business perspectives
that provided classroom teaching material. And, because
we used a non-mathematical approach, our book has had
wide adoption in the academic strategy departments.
>>
back to top
What
has changed since you wrote the book?
Well, real options doesn't help cut costs, so there
has been a hiatus in the area as companies slimmed down
and conserved cash. But, as the economy picks up, so
have our book sales and phone calls. I am surprised
how quickly managers are returning to keen interest
in the real options approach for managing R&D, growth
projects and strategy.
>>
back to top
How
is real options used by companies today?
There have been two excellent reviews of this topic
by CFO magazine, and one in the Journal of Applied Corporate
Finance. (See Recent Articles.) All of these conclude
that there is not widespread adoption by companies.
Two reasons stand out: Real options is too complex;
corporate incentives are not supportive of risk taking
and triage.
Two
industries facing a lot of risk, pharmaceutical drug
development and oil exploration, are heavy users of
decision analysis. I think this alternate tool serves
these companies well, and internal staff has strong
skills in these areas. Real option advocates have to
ask themselves: What is the incremental value of real
options over these well-established practices? In other
industries, a good decision tree might be an easier
starting point as well.
>>
back to top
What
advise do you have for a company interested in starting
a real options program?
That question prompted me to write a follow-on book,
Value Sweep. Value Sweep makes two points that are relevant
for those just starting: Keep it simple; Make apples-to-apples
comparisons. Any change in valuation and strategy analysis
will need buy-in from a range of managers, few with
training in finance. So simplicity is key for them to
understand the tools and to match it to their experienced
intuition.
The
title of Value Sweep addresses the problem I saw, that
innovative tools were selectively applied, and it became
difficult for CFOs and other gatekeepers to adopt new
practices when they were presented with a confusing
array of models. I argue that simple frameworks are
needed across the sweep of growth opportunities.
>>
back to top
You
have been working in the area of patent valuation for
the past year. How does real options apply in that field?
There is growing interest in applying real options to
patent valuation. But, I don't see the fit. Patents
represent technologies that are years away from being
a product, so the cone of uncertainty is necessarily
wide. This means patent valuations are inherently point
estimates surrounded by large confidence intervals -
some would argue they are simply guess-estimates. Why
invest in heavy-duty valuation technology when you will
drive to the same degree of uncertainty about value?
Second,
patents have an extremely low probability of creating
business value. It's a numerical fact. Most valuation
techniques, including real options, neglect this fact
in their framework and hence overestimate patent value.
>>
back to top
Real
options is an exciting topic in graduate academic programs.
Do you have any suggestions for students looking for
jobs in this area?
Tools are very interesting, and my next sentence may
seem unfair, something like "you can't do what I do".
However, let me say it: "There is no career in being
an expert in the real options technique." The reason
is that the tool is always in search of an application.
Application expertise dominates tool expertise in the
hiring market.
However,
digesting the frameworks and insights of real options
will definitely make you a better manager. In one of
my jobs I was the CEO of a software startup. I found
myself searching for options, questioning their value,
and easily talking with investors - all because I could
clearly frame the key growth issues using my real options
perspective. The investors never heard the word real
options from me, but it sure helped to crystallize my
thinking.
>>
back to top
|
