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Beyond

Valuation:
Options Thinking
in IT Project
Management
Martina Dubey (MS18A018)
Ragavi N (MS18A033)
Shreya Siddhartha (MS18A040)
Smriti Vohra (MS18A045)
What is American Style Calling?
● Options contracts can all be put into one of two distinct categories – American style
and European style. These categories having nothing to do with part of the world the
contracts are bought and sold in, but relate to the actual terms of the contractThe style
or family of an option is the class into which the option falls, usually defined by the
dates on which the option may be exercised.
● An American option on the other hand may be exercised at any time before the
expiration date.
● For both, the payoff when it occurs is:
max{(S-K),0}, for a call option
max{(K-S),0}, for a put option
● The real advantage of American style contracts over European style contracts is the
flexibility that they offer.
● A pilot model in the IT is used similar to the American style in order to implement or
abandon the project.
Connection between stage gate
implementation of different process
models & options thinking
● The model focuses on the innovation process and is also referred to as the
waterfall process. It is a project management technique, in which an initiative or
project takes place, divided over several stages.
● These stages are separated by so-called gates; the decision points for whether or
not to proceed to the next stage. This model can be used when developing new
products, process changes or improvements.
● At each gate, a decision is made whether to continue the process or not.
● The Stage Gate process consists of a number of stages, which are connected to
each other by gates.
● Stage options often overlap with other options, such as abandon, change scale,
and strategic growth.
Connection between stage gate
implementation of different process
models & options thinking
● Stage-abandon options can be created by developing “throw away” prototypes or
following the traditional waterfall SDLC (i.e., analysis, design, construction,
implementation) but with a formal go/no-go decision for each phase, such as in
the spiral model of development.
● The Stage Gate process consists of a number of stages, which are connected to
each other by gates. Each stage is designed to collect specific information:

Stage 0: discovery
Stage 1: scoping
Stage 2: business plan concept
Stage 3: development
Stage 4: testing and validation
Stage 5: launch and implementation
Flexibility in IT project management

● Modern IT systems are highly malleable. Unlike traditional assets that have a fixed set
of potential uses, IT systems can be applied to a variety of business processes and
products.
● Many IT assets can be replicated at low cost, modified and can also be shared or sold.
● Flexibility helps in minimizing the impact of problems on the project and prevent
recurrence.
● Flexibility in project management allows managers to more consistently organize
workloads and resources. They can evenly spread out the peaks and troughs in
demand.
● Flexibility and adaptability in project management helps in dramatically reducing
waste and improving efficiency.
How can Flexibility be improved?
● Planning ahead - A project’s processes should always be mapped thoroughly at the start and
flexibility should be built into this to accommodate late changes. The most important step is to
adopt clear and robust change-control processes so that all parties involved fully understand the
implication of change before it is instructed.
● Breaking the work done into smaller chunks - Smaller deliverables, typically within a week or
even a daily timeframe, is the approach used to counter this issue. Teams can focus on producing
real outputs quickly and efficiently, and any changes that are required can swiftly be incorporated
into the next batch or deliverables.
● Maintain a real-time view of all activity - Using a central dashboard allows project managers and
chief information officers to see when problems are arising and respond. In time, recurring
problems will be easier to identify.
● Creating self motivated teams that can think for themselves - The project manager often feels
the need to micromanage the team to keep them on track. Therefore, creating a team that can
provide its own leadership is vital.
Comparison of estimation process with
no option call and with embedded call

● A firm that is not flexible and uncertain take rigid decisions and hence the expected
outcome will be weighted average of all possible outcomes while it can do better.
● A firm with higher flexibility, can make temporary decisions and make changes with
time based on the outcomes dynamically. Adverse results can be avoided to an extent.
● Hence the probability of getting a better result is higher in a process with embedded
call because the strategy / method can be changed once there is a hint of a flaw in the
existing one.
Comparison of estimation process with
no option call and with embedded call

Estimated value with no option Estimated value


with embedded call
Different ways of implementing
options-thinking

● Stage
○ A project can be divided into distinct stages
● Abandon
○ A project can be terminated midstream
● Defer
○ A decision on whether to invest or not can be deferred for some time
● Strategic Growth
○ An initial investment that opens the door to potential follow-up opportunities
● Change scale
○ Resources allocated to the project can be contracted or expanded
● Switch
○ An IT resource developed can be redeveloped to serve another purpose
How do the six cases mentioned in the article
are related to different option thinking?

● Carlson Hospitality
○ When that proposal was soundly rejected, the IS team reconceptualized the project as a set of
nine separately implementable “chunks,” each of which had to produce a direct business benefit
beyond simply enabling subsequent stages.
● Yankee 24
○ They could observe debit card adoption rates in other more mature markets and lobby the
Massachusetts government for favorable legislation. Meanwhile, the upside opportunity was not
in serious peril for at least three years, because this was how long Yankee thought the most
likely competitor would need to establish the necessary infrastructure.
● A European Automaker
○ The project team simply expanded the bounds of the initial must do project to include these
elements, the project would have remained unjustified, with a negative NPV. The resulting Black-
Scholes estimate for the add-on projects was enough to make the overall project worth
undertaking—and based on this expanded estimate of value managers did proceed with the
implementation.
How do the six cases mentioned in the article
are related to different option thinking?

● Cypress Communications Authority


○ In 1992, CYTA anticipated that Cypress’s eventual entry into the European Union would warrant
a significant expansion of its telecommunication network. Yet, they determined that this
expansion would only be feasible if a complementary investment was made in upgrading the
information system used to support the daily operations of the authority
● TWA
○ Trans World Airlines’ (TWA) development of a computer-aided software engineering (CASE)
“template” for their Frequent Flyer Benefits (FFB) shows how to create a switch-use option.
● Starbucks Coffee Company
○ Starbucks managers realized that the card could do much more than simply speed check out, so
a third stage, the card was enhanced to support loyalty points redeemable at Starbucks based
on purchase volume, entry in occasional sweepstakes, and e-mail notification of instore
promotions and new products. Since this add-on project created a new asset (e.g., a loyalty
program) rather than changing the value of an existing asset (as with online registration for the
initial pre-paid card), it represented a growth option rather than a scale-up option.
How does value-eroding with time fit
with OPM?

● If an organization chooses the option to defer investments, there is a risk for


erosion of project benefits with time.This occurs when first movers advantage
exists and there is a danger of preemption by another firm or when it can be
expected that other firms will quickly follow.
● The behavior of prices over time may not conform to the price path assumed by
the option pricing models. For instance, a sudden technological change may
dramatically change the value of a project. This will also lead to value- erosion of
the project.
How does scale change differ with
growth or abandon?

● Change of scale exists when the resources allocated to a project can be


contracted or expanded in response to future conditions, or when the production
system enabled by a project can be scaled up or down with comparative ease.
● If unexpected technical barriers are encountered—or a change in business
conditions reduces the value of the intended system—a project with an
embedded scale-down option can be reduced in scope, and some project
resources can be reassigned. Thus the scale-down option may be viewed as a
milder form of an abandon option.
● A project structured to increase the scope of the resulting system in the event of
favorable future conditions has a scale-up option that is similar to a growth
option.
Comparison of decision trees with
options
● A decision tree is a graphical representation of possible solutions to a decision based
on certain conditions. Calculating the Expected Monetary Value of each possible
decision path is a way to quantify each decision in monetary terms.
● Decision trees, unlike options, are highly transparent.
● They are easy to understand and interpret, perfect for visual representation.
● Some limitations of Decision Trees as compared with Options:
● The complexity of the tree can increase rapidly, as more alternative scenarios are
incorporated.
● There is no straightforward way to determine what the correct risk adjusted discount
rate for the whole tree should be.