On the Value of Flexibility in R&D Projects

Abstract

In this paper, we consider whether an increase in uncertainty increases the value of a research and development (R&D) project. We also consider the related question of the impact of increased project uncertainty on the value of management flexibility, defined as the difference in value when the project is managed "actively" versus when it is under "passive" management. These questions have already been formulated in an insightful paper in the literature, where different sources of variability and uncertainty in R&D projects are identified and abandonment and improvement at interim stages are considered as options that provide management flexibility. We follow the same formulation. We derive a set of negative results that are contrary to the results of the above-mentioned paper and a set of positive results that are different from those presented. Our negative results indicate that when the source of variability is development uncertainty or market requirement uncertainty, one cannot make a general statement about the impact of increased uncertainty. In some cases, the value of flexibility (and project value) increases and in others it decreases. On the other hand, if the source of variability is market payoff, we show that increased variability increases either the overall project value or the project option value. If the increased variability of market payoff increases the "passive" value of the project, the overall project value also increases; and if it decreases the "passive" value, the value of flexibility, i.e., the project option value, increases.R&D projects, managerial flexibility, real options, option valuation, project management, dynamic programming

A Multi-stages Decision Approach for Managerial Flexibility of Energy R&D Project under Fuzzy Environment

“…In this study, we adopt the real option structure in accordance with Huchzermeier & Loch (2001) and Santiago & Vakili (2005). The interested readers may consult the detail modelling methods in these literature.…”

“…Krishnan and Bhattacharya (Krishnan & Bhattacharya, 2002) proposed that the "pizza-bin" method of abandoning potential technologies could not efficiently provide firms with profits, while the challenges to various products are huge. Santiago and Vakili (Santiago & Vakili, 2005) considered the situation that whether the uncertainty increases the flexible value of R&D project, which can be seen as the ability to carry new products into market with the least variabilities. They found the negative conclusions in contrast to Huchzermeier & Loch (2001).…”

“…Therefore, simplicity should be taken into consideration for striving to maintain distinction to the greatest extent. Dynamic programming model, which is composed of uncertain R&D information and described as more realistic formulation of investment planing by mathematical equations, is proposed to analyze crucial development risks methodically and determine proper decision operations ahead of increasing managerial flexibility based on real option analysis in accordance with Santiago and Vakili (2005). Since managerial flexibility is not the internal attribute of energy R&D project, the presented method can recognize the potential risky factors, develops a serious of real options to capture the risky factors, afterwards the fuzzy decision model is used to evaluate the value of opportunity and take the decision options, which can maximize the market payoff of R&D project.…”

New product development projects evaluation under time uncertainty

“…Santiago & Bifano (2005) used the methodology proposed by Huchzermeier & Loch (2001) and further developed by Santiago & Vakili (2005), to evaluate the development project of an Adaptive Optics Scanning Laser Ophthalmoscope (AOSLO). Such innovative project of a laser ophthalmoscope differed from the ones available in the market especially due to the high resolution of the images produced by it.…”

New product development flexibility in a competitive environment

“…Many have explored how this impact depends on the characteristics of the development process (Huchzermeier and Loch 2001, Wilhelm and Xu 2002, Santiago and Vakili 2005, Cui et al 2011. What is not yet fully known, however, is how the value of flexibility in NPD is influenced by the competitive environment in which a firm operates.…”