IT Services: A Real Options Thinking Approach

1
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-Websters

• something that may be chosen as a an
  alternative course of action ltdidn't have many
  options opengt 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

3
Goal of this presentation
Way to value e-services


Real Options Analysis (ROA)
Service bundling
Value objects in e3value

• Really?
• Does this have practical value?

4
Overview
Building services out of components
Service marketing risk management
Introduce enh./supp. services later
5
NPV dominant approach

• NPV Net Present Value

20
30
40
in
1
2
3
year
65
17.5
20
out
sum of discounted net cashflows (NPV)
-14.5
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
7
(No Transcript)
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.
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
10
Service options
11
The question
How to quantify the value of these options?
12
A mobile phone service bundle

• Bundle components
• Connectivity (voiceSMS, 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?

13
What is the value (provider persp.)?
SMS costs without bundle
valueBun(SMS)

3 - 0.17SMS, if SMS lt 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)S(P(SMSi)valueBun(i))
-3
expected value
probability distribution
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
15
Options valuation (European)

• Black-Scholes formula input
• Current stock price S
• Std. dev. s of the above ( volatility)
• Strike price K
• Risk-free interest rate r
• Remaining time until expiration T
• Output price of European call C ( premium)

16
Black-Scholes formula
where
17
Service options
18
Koens 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 -14.516.512.6 14.6

19
Discussion

• Fundamental validity of the options metaphor (the
  liquidity issue)
• Were designing a service ( future-oriented).
  But volatility needs historical data!
• We need very complex maths
• Are decision makers willing to trust that?