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IT Services: A Real Options Thinking Approach

2. VITAL/design. 3. VITAL. VITAL/maturity. 1. VITAL/services. Value-based business-IT ALignment . http://www.vital-project.org. IT Services: A Real Options Thinking Approach. Koen Voermans & Pascal van Eck Value modeling workshop, Tilburg, Jan. 18-19, 2007.

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IT Services: A Real Options Thinking Approach

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  1. 2 VITAL/design 3 VITAL VITAL/maturity 1 VITAL/services Value-based business-IT ALignment http://www.vital-project.org IT Services: A Real Options Thinking Approach Koen Voermans & Pascal van Eck Value modeling workshop, Tilburg, Jan. 18-19, 2007

  2. “Option” according to Merriam-Webster’s • … • something that may be chosen: as a : an alternative course of action <didn't have many options open> b : an item that is offered in addition to or in place of standard equipment • a contract conveying a right to buy or sell designated securities, commodities, or property interest at a specified price during a stipulated period • … Value Modeling workshop, Tilburg

  3. Goal of this presentation Way to value e-services • Really? • Does this have practical value? + = Real Options Analysis (ROA) Service bundling Value objects in e3value Value Modeling workshop, Tilburg

  4. Choice points: managerial flexibility Positive influence on business case NPV: neglects managerial flexibility ROA: takes choice points into account Use ROA to value this Overview ‘Building’ services out of components Service marketing risk management Introduce enh./supp. services later Value Modeling workshop, Tilburg

  5. NPV: dominant approach • NPV = Net Present Value in: 20 30 40 1 2 3 year out: 65 17.5 20 sum of discounted net cashflows (NPV) = -14.5 Value Modeling workshop, Tilburg

  6. Configuration of Service • Core service: describes value from customer perspective • Supporting services: needed to enable consumption of core service • Enhancing services: can be added to core service to increase value • Service bundle: set of core services Baida, Z. (2006). Software-aided Service Bundling - Intelligent Methods & Tools for Graphical Service Modeling. PhD thesis, Vrije Universiteit Amsterdam, The Netherlands, 2006 Value Modeling workshop, Tilburg

  7. Value Modeling workshop, Tilburg

  8. Service marketing risks • Three types of risk (Benaroch, 2002): • Firm-specific risks: ability of investing business to realize the investment • Competition risks: less payoff due to competition • Market risks: less payoff due to lack of demand Benaroch, M. (2002). Managing Information Technology Investment Risk: A Real Options Perspective. J. Mngt. IS, 19(2):43-84. Value Modeling workshop, Tilburg

  9. IT options Managerial flexibility in IT according to Benaroch Defer Stage (Stop-resume) Explore (Pilot/ Prototype) Scale up/down Abandon (switch usage) Compound Ability to have these choices in the investment are the real options Value Modeling workshop, Tilburg

  10. Service options Value Modeling workshop, Tilburg

  11. The question How to quantify the value of these options? Value Modeling workshop, Tilburg

  12. A mobile phone service bundle • Bundle components: • Connectivity (voice+SMS, SMS €0.17 per message) • Optional SMS package: 25 messages for €3 (= €0.12 per message) • What to do? Take optional SMS package or not? Value Modeling workshop, Tilburg

  13. What is the value (provider persp.)? SMS costs without bundle valueBun(#SMS) = € 3 - 0.17*#SMS, if #SMS < 25 - 1.25, if #SMS ≥ 25 SMS costs with bundle 3 valueBun= (SMS costs with bundle) – (SMS costs without bundle) 1.25 0 #SMS 18 25 E(valueBun)=Σ(P(#SMS=i)*valueBun(i)) -3 expected value probability distribution Value Modeling workshop, Tilburg

  14. A put option unprotected position • Put option: • Right to sell (put) stock at price S at some point in the future € protected position S price paid for option 0 S € (protected position) – (unprotected position) = put value Value Modeling workshop, Tilburg

  15. Options valuation (European) • Black-Scholes formula input: • Current stock price S • Std. dev. σ of the above (= volatility) • Strike price K • Risk-free interest rate r • Remaining time until expiration T • Output: price of European call C (= premium) Value Modeling workshop, Tilburg

  16. Black-Scholes formula where Value Modeling workshop, Tilburg

  17. Service options Value Modeling workshop, Tilburg

  18. Koen’s example, revisited • Service is designed such that two options are created • Growth option: picture service • Scale-up option • Original business case: -14.5 • With options: -14.5+16.5+12.6 = +14.6 Value Modeling workshop, Tilburg

  19. Discussion • Fundamental validity of the options metaphor (the liquidity issue) • We’re designing a service (= future-oriented). But volatility needs historical data! • We need very complex maths • Are decision makers willing to trust that? Value Modeling workshop, Tilburg

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