Flexibility, robustness and real options.

Dyson, Robert G.; Oliveira, Fernando S.

Abstract

The importance of flexibility in the strategic development process goes back to the formative days of strategic planning. One of its earliest manifestations was in the guise of contingency planning. For example, Argenti (1974) in his book "Systematic Corporate Planning" defines a contingency plan as "a component of a corporate plan designed as a response to an event E that is thought to be highly improbable (but possible), but of such importance that it must be allowed for in the plan". Such plans are often in place in the event of say fire, computer system failure, bird flue or terrorist attack, but more generally contingency plans can be associated with any flexibility in the planning process aimed at dealing with the uncertainties of the future. This flexibility can often be captured in the form of a decision tree. Gupta and Rosenhead (1968) and Rosenhead (2001) formalized a version of flexibility and robustness as key aspects of the strategic development process, and this approach is discussed in the following section. More recently, the concept of real options has been developed as method of introducing flexibility into strategic decision making. In option theory a call option is the ability to pay a small sum of money now which allows a share to be bought (or not) at some specified time in the future at a pre-determined price. Option theory involves evaluating the price of the option. In real options the focus is on a real asset or strategic initiative (or option) rather than a share and the analysis involves valuing flexibility in strategic decision making. Real options are treated in later sections of the chapter. In this chapter we compare the use of robustness analysis, decision trees and the real options approach as different ways of representing flexibility in strategic decision making: we analyse the advantages and disadvantages of the methods and we identify possible complementarities in these approaches. Finally, we apply the methods to an example in the electricity industry.

Citation

DYSON, R.G. and OLIVEIRA, F.S. 2007. Flexibility, robustness and real options. In Dyson, R.G. and O'Brien, F.A. (eds.) Supporting strategy: frameworks, methods and models. Chichester, Wiley, chapter 13, pages 343-366.

• Publication Date: Apr 30, 2007
• Deposit Date: Nov 21, 2023
• Publicly Available Date: Jul 10, 2024
• Publisher: Wiley
• Pages: 343-366
• Book Title: Supporting strategy: frameworks, methods and models
• Chapter Number: 13
• ISBN: 9780470057179
• Keywords: Decision making; Business planning; Business strategy; Real options
• Public URL: https://rgu-repository.worktribe.com/output/2152543