10 Juin (Cercle de discussion) - Real Options

DDjian a écrit:... I encourage everyone to correct and challenge my perception
...
The paradigm shift behind real options consists in accepting the uncertainty associated with risks, ... example of an expedition which might encounter tigers. Usually we would try to reduce the probability of such encounters, for instance by getting local information on tigers' general habits and recent sightings in order to optimize our route. Claus made us research ways to build flexibility for the future, in this case by assuming that we would encounter tigers. Taking shotguns for the expedition was one way of creating such flexibility (in addition to legal advice on the local fine for killing members of endangered species...)

Putting on my "discussion" hat, it seems to me that "building flexibility" is already covered in our risk management, specifically "mitigating impact", at least the way I practice this. projecting myself in the future, facing a tiger, I try to imagine what would make this encounter less dangerous for my project.

Any thoughts anyone?

Dear all,

Thanks again for your attendance, and thank you to David for the summary. Here are just a few additional points from the cocktail discussions:

* Real Options are already largely applied in the pharmaceutical and raw material industry. A more recent and spectacular example in innovative industries is the Airbus A380: The NPV was negative, but the Real Options value resulted into an overall positive Adjusted NPV, and the project was launched; Real Options made the A380 fly !

* Project Managers and Business Owners should work jointly to identify uncertainties and suitable flexibilities. As you remember, Real Options enable us to quantify the value of flexibility it in a fair way.

* Again, the broader perspective of Real Options is that they are very useful for innovative projects, as they typically comprise lots of uncertainty, and the NPV may be negative. In this case, you may
(a) either drop the innovative project (sub-optimal !),
(b) or just accept the uncertainty and take a bet (still sub-optimal !),
(c) or take the Real Options approach to progress (!) with your innovative project at the right (!) investment level.

If course, choice (c) is most suitable when supporting significant innovative projects while striving for best investment efficiency. And Project Managers have one of the key roles to make that happen.

I hope the Real Options approach will bring you the expected usefulness and advantages, best regards,

Claus.

It was a pleasure to have Claus Hirzmann (Amadeus) introduce us to the concept of "real options". I will try to summarize the talk below, and I encourage everyone to correct and challenge my perception

Claus presented the key advantage of real options as to provide a model to compute a fair financial value for flexibility (real options are derived from models of financial options). This financial value yields less conservative results than Net Present Value (NPV) calculations on the uncertainty of cashflow.

The paradigm shift behind real options consists in accepting the uncertainty associated with risks, instead of trying to reduce or control this uncertainty. He gave, among others, one example of an expedition which might encounter tigers. Usually we would try to reduce the probability of such encounters, for instance by getting local information on tigers' general habits and recent sightings in order to optimize our route. Claus made us research ways to build flexibility for the future, in this case by assuming that we would encounter tigers. Taking shotguns for the expedition was one way of creating such flexibility (in addition to legal advice on the local fine for killing members of endangered species...)

The associated mathematical model uses decision trees, it seems with the possibility of walking "backwards" from leaf to root. Claus also mentioned uncertainty relationships being represented by arrows between decision tree nodes. In one example, NPV was negative, which would usually lead to a project No-Go, but building flexibility via real options provided some positive valuations, thus showing that this project could in fact bring positive financial gains.

Claus finally recommended for further reading: Real Options: A Practitioner's Guide (Hardcover) by Thomas E. Copeland (Author), Vladimir Antikarov (Author)

To conclude, I enjoyed this stimulating and very interative session. I had trouble following the mechanics of the examples, which I suspect is due to the challenge of presenting such a complex subject in a short time, so again, a discussion follow-up here is in order!


David