See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/236331385

A Real Options Approach For Software Development Projects

Using Fuzzy Electre

Article  in  Journal of Multiple-valued Logic and Soft Computing · January 2012

CITATIONS READS

17 729

1 author:

A. Çağrı Tolga
Galatasaray Üniversitesi
48 PUBLICATIONS   344 CITATIONS   

SEE PROFILE

Some of the authors of this publication are also working on these related projects:

Healthcare View project

Innovation Projects View project

All content following this page was uploaded by A. Çağrı Tolga on 23 May 2014.

The user has requested enhancement of the downloaded file.

 J. of Mult.-Valued Logic & Soft Computing, Vol. 18, pp. 541–560 ©2012 Old City Publishing, Inc.
Reprints available directly from the publisher Published by license under the OCP Science imprint,
Photocopying permitted by license only a member of the Old City Publishing Group

A Real Options Approach For Software

Development Projects Using Fuzzy Electre

A. Çagri Tolga1,*
1
Industrial Engineering Department, Galatasaray University, 34357 Ortaköy, Istanbul, Turkey

Software development project selection decision is a vital process in tech-

nological organizations. These decisions are very important in two ways.
First, in technovation organizations, software development project budget
necessitates huge investment and this project selection decisions should
be thought with the strategic objectives of the firm. Second, multidimen-
sionality of the software development projects’ organizational returns is
naturally risky in terms of expected outcome. Real options approach
helps to calculate this risky side of the selection process. This paper con-
siders the software development project selection process in multi-criteria
thinking. Vagueness is another consideration in the evaluation process.
The fuzzy ELECTRE takes both fuzzy real option value criteria and non-
monetary criteria into account. In this study integration of fuzzy real
options valuation to fuzzy ELECTRE is offered for a selection process
among software development projects.

Keywords: Real Options, Software Development Projects, Multi-Criteria, Fuzzy;

ELECTRE, Black-Scholes Approach.

1. INTRODUCTION

Software development (also known as Software Application Development;

Software Engineering, Software Design) is improving a software product in
a planned and structured process. This software could be generated for the
three most common purposes which are to meet specific needs of a specific
client/business, to meet a perceived need of some set of potential users (the
case with commercial and open source software), or for personal use (e.g. a

*Corresponding author: E-mail: ctolga@gsu.edu.tr; Tel: +90212 2274480 Ext.378

541

MVLSC-226i.indd 541 5/16/2012 11:09:58 AM

 542 A. Çagri Tolga

scientist may write software to automate a mundane task). In this work the
case with commercial use is investigated.
In general, the term software development is used to refer to the activity of
computer programming that means the process of writing and maintaining
the source code, whereas the broader sense of the term includes all that is
involved between the conceptions of the desired software through to the final
display of the software. Therefore, software development may include
research, new development, modification, reuse, re-engineering, mainte-
nance, or any other activities that result in software products. Basically, a
project that searches these activities to present enhanced software for any
purpose to general users would be a software development project (SDP).
Software development process resembles to research and development
(R&D) process according to the stages cited above.
Thinking only cost, revenue or financial base takes just one dimension into
consideration in software development. However any failed SDP make many
contributions to know-how of the experts and to company’s database. Or
expanded hardware for any development project contributes to accumulation
of property. Dynamic nature of the software development projects drives us
to evaluate them with more than one criterion. Technical success probability
or marketing strategy criteria have to assist in evaluation process. In literature
there are few studies about software development projects. Shehabuddeen et.
al. [1] offered a framework for technology selection especially in the applica-
tion of a software tool. Buyukozkan et al. [2] proposed a methodology to
improve the quality of decision-making in the software development project
under uncertain conditions. Multi dimensional side of software development
drives us to use one of useful multi-criteria methods named ELECTRE in this
paper. One of the most important criteria for the evaluation of software devel-
opment projects is the financial attribute. Many researchers handle this attri-
bute with a simple point of view whereas this attribute has a complex dynamic
role in the evaluation process. The dynamic role of this attribute can be han-
dled using a real options valuation (ROV) model.
A financial option is defined as the right to buy (if a call) or sell (if a put)
a nominated asset by paying a preset price on or before a specified date but it
does not contain an obligation. Real options are based on financial options.
However, the nature of real options involves permanent, fixed or immovable
assets. In contrast to financial options, real options are not tradable -e.g. any
retailer cannot sell the right to extend her/his branch against her/his competi-
tor, she/he can only make this decision. The key advantage and value of real
option analysis is to integrate managerial flexibility into the valuation process
and thereby assist in making the best decisions [3]. Real options give a right
but not an obligation to make or not to make an investment for a certain
period. For instance, investing in the expansion of a firm’s software develop-
ment department gives the company right to produce more brilliant output
and more certain products but not the obligation. Real options were first

MVLSC-226i.indd 542 5/16/2012 11:09:58 AM

 A Real Optıons Approach For Software Development 543

introduced by Trigeorgis [4]. Benaroch and Kauffman [5] applied real options
to information technology investment that is timing of the deployment of
point-of-sale debit services. Huchzermeier and Loch’s [6] model built real
option for R&D managers as to when it is and when it is not worthwhile to
delay commitments.
In workaday life real situations are very often vague and uncertain in sev-
eral ways. When there is a shortfall for information or unwillingness to lead
the financial data out the company, a system might not be known completely.
Zadeh [7] suggested a strict mathematical outline named fuzzy set theory that
overcomes these inadequacies. The fuzzy approach to real option valuation
(FROV) was first studied by Carlsson and Fuller [8]. This work was based on
Black-Scholes’ real option valuation, but under fuzziness. Then, Wang and
Hwang [9] offered fuzzy compound options for R&D project selection based
on the Black-Scholes real option valuation. Another fuzzy real option valua-
tion based on Cox et al.’s [10] method was investigated by Allenotor and
Thulasiram [11]. They modeled pricing of grid/distributed computing
resources as a problem of real option pricing. Tolga et al. [12] studied a com-
parison between fuzzy trinomial lattice and fuzzy compound options applied
to a call center in Turkey.
ELECTRE, an acronym for Elimination Et Choix TRaduisant la REalité in
French, is one of the multi-criteria decision-making (MCDM) methods based
on outranking of alternatives using concordance and discordance indexes.
ELECTRE is an adaptable method that allows combining both qualitative and
quantitative data. This method requires less detailed data, thus careful use of
time and manpower resources is the important factor in the choice of the
method.
The sorts of ELECTRE methods distinguish from each other while the
degree of complexity, or the nature of the main problem, or the richness of the
information required differentiate. There are six main versions of ELECTRE:
1, 2, 3, 4, Tri, and 1S. Roy [13] introduced the first ELECTRE method.
Obtaining a subset or kernel N of project options such that any alternative
which is not in N is outranked by at least one alternative in N was the aim of
that work. ELECTRE 1S method was enhanced by Roy and Skalka [14] to
adopt the ELECTRE 1 into the fuzzy logic. The best option is selected from
other options within the kernel. ELECTRE methods are applied to many
areas since they are stated. For example Raoot and Rakshit [15] used the
method for the multiple criteria evaluation and ranking of efficient layout
alternatives. Montazer et al. [16] discussed the architecture of a fuzzy system
based on ELECTRE III including both modules, utilizing fuzzy concept for
dealing with the uncertainty of the problem. Brito et al. [17] proposed a
multi-criteria model that integrates utility theory and the ELECTRE TRI
method for assessing risk in natural gas pipelines, and for classifying sections
of pipeline into risk categories. In this study; the authority of the firm does not
agree to share the financial data and that was the main reason of fuzzy logic

MVLSC-226i.indd 543 5/16/2012 11:09:58 AM

 544 A. Çagri Tolga

usage. Fuzzy real options integrated ELECTRE 1S method is offered accord-

ing to the structure of the problem. Risky and dynamic side of the problem
will be investigated by fuzzy real options which represent management flex-
ibility.
The rest of the study is organized as follows: The second section includes
the evaluation attributes for software development projects and illustrates the
criteria of the problem. In Section 3, fuzzy real options valuation model is
presented. The preceding section contains an alternative fuzzy ranking
approach integrated fuzzy ELECTRE method. The proposed model’s steps
are given in Section 5. Application of the proposed model is the main subject
of Section 6. And discussions and findings of the study are given in the last
section.

2.  SOFTWARE DEVELOPMENT PROJECTS and SELECTION

CRITERIA

Larger software systems are usually developed by a team of people, some

form of process is typically followed to guide the stages of production of the
software. Therefore, software development project includes stages; research,
new development, modification, reuse, re-engineering, maintenance, and
market introduction that result in software products. Especially the first phase
containing research and new development stages in the software development
process may involve many departments, including marketing, engineering,
research and development and general management. Marketing department
serves to build up the customer needs; engineering and R&D department con-
struct the software data received from the previous department and general
management department organizes the orders of the studies. The second
phase includes modification, reuse, reengineering and maintenance stages. At
that stage only engineering department performs useful studies to present
high quality product. However the last phase i.e. market introduction needs
whole departments.
The financial criteria ranking of the valuation process will be evaluated
by real options approach, however because of the vagueness in data collec-
tion fuzzy form of real options will be utilized. As stated in the introduction
section fuzzy real options valuation will be made according to the phases
cited above. There will be three phases and two options which are shown in
Figure 1.
The rest of the criteria are derived from recent works and they are deter-
mined by departments mentioned above according to these studies. There are
many studies in R&D evaluation using AHP, ANP and ELECTRE. As said
before because of analogy between R&D projects and SDPs the criteria are
derived from these works. Then a DELPHI work with employees is made and
criteria below are derived for the application of ELECTRE 1S method.

MVLSC-226i.indd 544 5/16/2012 11:09:58 AM

 A Real Optıons Approach For Software Development 545

Figure 1
Phases and options of a software development project.

Capacity of employees, resources, and success probability etc. criteria are

determined and explained in Table 1. Experts are asked to make a pair-wise
comparison between alternatives according to the determined criteria. Contri-
bution to firms’ know-how is an obligatory criterion and this criteria needs to
be evaluated in a fuzzy manner because there are no strict expression for that
criterion. Also trends/flexibility criterion necessitates a fuzzy form evaluation
because of its vagueness in future customer needs. Capacity criterion and
marketing potential are also evaluated in fuzzy form. For joining the integrity
fuzzy form will be applied to whole criteria although the other criteria could
be assessed by crisp numbers.

Criteria
Capacity (C1)
Resources (C2)
Expandability (C3)
Quality (C4)
Reliability (C5)
Success Probability (C6)
Technical Contribution (C7)
Performance (C8)
Marketing Potential (C9)
Distribution Capacity (C10)
Trends/Flexibility (C11)
FROV (C12)
Explanation
Staff numbers and skills dedicated to any SDP in software
development process
Requirements for additional equipment and facilities
Enhancing current functions or adding new functionality
capability
Correctness and verifiability of the project
The certain performance of a software for a specified period
of time
Probability of technical success
Contribution to Firm’s know-how
Efficiency and usability of the software
Probability of commercial success against competitors, cus-
tomer acceptance
Likely sales volume and market share
Adequacy for customer future preferences
Fuzzy real option value of software development projects

Table 2-1
Explanation of Criteria

MVLSC-226i.indd 545 5/16/2012 11:09:59 AM

 546 A. Çagri Tolga

3.  REAL OPTIONS APPROACH

There are mostly more than two stages in software development project as
stated in Section 1 and the decision maker (DM) has to determine whether to
exercise or to carry on the option (which means to stop or to defer the proj-
ect). Technically, if any stage of the project is succeeded option to expand
should be made real and more investment is needed. However, adversely if
there is no success in any stage, no need to continue the investment more and
thereby that means downside risk limit of the software development project
is reached. Expenses up to that point correspond to option premium in finan-
cial options. Stages of the SDP were investigated deeply in Section 2 and they
will be used hereafter.
In this study, we use Wang and Hwang’s [9] fuzzy real option valuation
method which is based on Geske compound options model for the evaluation
of financial attribute in fuzzy ELECTRE.
A SDP project containing three phases as shown in Figure 1 will be exam-
ined. Let K be the present value of investment cost for stages i = 1, 2, 3, and G
i
be the present value of the project return after market introduction.
K i (i = 1, 2, 3) and G should be fuzzy numbers. Time to maturities of first and
second options for the project are T1 and T2, respectively. Fuzzy real option
value of the SDP project is:

 - ∆T2 M (u ; z ; T / T ) - K e-η T2 M (u ; z ; T / T ) - K e-ηηT1 N (u ) (1)

Z = Ge 1 1 1 2 3 2 2 1 2 2 2

where

ln[ E (G ) / G c ] + (η − ∆ + σ 2 / 2)T1

u1 = , (2)
σ T1

u2 = u1 − σ T1 , (3)

ln[ E (G ) / E ( K 3 )] + (η − ∆ + σσ2 / 2)T2

z1 = , (4)
σ T2

z2 = z1 − σ T2 , (5)

Here, D is the dividend yield; η is the interest rate; σ is the volatility of the
project return; N is the cumulative normal distribution; and M (u, z, ρ) is the

MVLSC-226i.indd 546 5/16/2012 11:10:00 AM

 A Real Optıons Approach For Software Development 547

Figure 2
A trapezoidal fuzzy number, Ã = (a1, a2, a3, a4)

bivariate cumulative normal distribution function with u and z that are upper
and lower integral limits and correlation coefficient ρ.
Risk neutral expectation of the project return is given at the first term of
Eq. (1), the second term is the expected investment at T2, and the last term gives
the expected investment at T1. We can calculate the volatility (σ) of the rate
of the change of the project return as Var(G ) / E (G ) and the dividend yield
(D) is calculated as E ( K 1 ) / E (G ). Possibilistic mean (E ( A )) and variance (
Var( A )) of fuzzy number A (shown in Figure 2) which could de denoted as
(a1, a2, a3, a4) are calculated from Eqs. (6) and (7) [8]:

a2 + a3 a1 − a2 − a3 + a4 (6)
E ( A ) = + ,
2 6

(a3 − a2 )2 (a3 − a2 )(a2 + a4 − a1 − a3 ) (a2 + a4 − a1 − a3 )2

Var( A ) = + + , (7)
4 6 24

We obtain the critical value Gc from the equation below with interpolation.

G c e- ∆ (T2 −T1 ) N (c1 ) - E ( K 3 )e-η (T2 −T1 ) N (c2 ) - E ( K 2 ) = 0 (8)

where

ln[G c / E ( K 3 )] + (η − ∆ + σ 2 / 2)(T2 − T1 )
c1 = , (9)
σ T2 − T1

c2 = c1 − σ T2 − T1 . (10)

MVLSC-226i.indd 547 5/16/2012 11:10:01 AM

 548 A. Çagri Tolga

For simplifying the calculation of the project value, investment costs

 defined in Eqs.
( K 2 and K 3 ) of stages 2 and 3 and future project return (G)
(2), (3), (8), and (9) are replaced by their possibilistic mean and variance
values [8].

4.  FUZZY ELECTRE

This work is based on selection procedure and though only vague data can be
taken out from the company, fuzzy logic will be used. As stated in Section 1,
ELECTRE 1S is selected for modification by using alternative ranking method
because of its appropriateness to that selection procedure. The basic steps of
proposed fuzzy ELECTRE method can be viewed as follows:
Suppose a MCDM problem has m decision criteria (C1, C2, …, Cm) and n
alternatives (A1, A2,…, An). Alternatives are evaluated by m criteria sepa-
rately. The decision matrix is formed by the fuzzy ratings assigned to the
alternatives w.r.t. each criterion denoted by T = (tij )n×m . The relative fuzzy
weight vector about criteria is displayed by W = (w 1 , w 2 ,..., w m ).
Step 1: Constitute the decision matrix from the decision maker’s thoughts
as below:

 t11 t12  t1m 

 
t t22  t2 m 
T =  21 (11)
    
 
 tn1 tn 2  tnm 

Step 2: If the objective is a minimization like cost criteria, apply the normal-
ization procedure as seen in Eq. (12), otherwise like benefit criteria apply the
normalization in Eq. (13):

∑ 1/ tij
n
rij = 1 / tij (12)
i =1

2
∑ tij
n
rij = tij (13)
i =1

where i = 1, 2 ,…,n and j = 1, 2 ,…,m. At that point division of fuzzy numbers

(shown in Section 3) has to be explained that one can easily calculate with
Eq. (14)

1 / A = (1 / a4 ,1 / a3 ,1 / a2 ,1 / a1 ) (14)

MVLSC-226i.indd 548 5/16/2012 11:10:02 AM

 A Real Optıons Approach For Software Development 549

Step 3: Calculate the weighted fuzzy normalized decision matrix V = (vij )n×m
for i = 1,2 ,…, n and j = 1,2 ,…, m, where vij = w j × rij .
Step 4: Designate the fuzzy concordance and discordance sets. The fuzzy
concordance set, which is formed by all criteria for which alternative Ap is
preferred to alternative Aq, can be written as

{ }
O( p, q ) = j v pj ≥ vqj (15)

The discordance set, the complement of O( p, q ) which includes all criteria for
which Ap, is worse than Aq, can be written as

{ }
D( p, q ) = j v pj < vqj (16)

Here, the alternative fuzzy ranking method offered by Kahraman and Tolga
[18] is going to be used. For detailed information see the said study. All the
fuzzy comparisons in Eqs. (15) and (16) are made with the conclusion of
Eq. (18).
An index that measures the possibility of one fuzzy number being greater
than another will be determined in said method. That preference index will be
illustrated by I(ω) ∈ [0,1] and it is determined by Eq. (17):

 0 , b1 ≥ a4

 (a4 − b1 )2
 (b2 − b1 − a3 + a4 )
 , b2 ≥ a3 , b1 < a4
 (a4 + a3 − a2 − a1 ) + (b4 + b3 − b2 − b1 )
 a4 + a3 − b2 − b1
 , b3 ≥ a2 , b2 < a3 (17)
I (ω) = 
 4( a + a3 − a 2 − a1 ) + (b4 + b3 − b2 − b1 )
 (a2 − b3 )2
 (a4 + a3 − b2 − b1 ) −
 (b4 − b3 + a2 − a1 )
 ( a + a − a − a ) + (b + b − b − b ) , b3 < a2 , b4 > a1
 4 3 2 1 4 3 2 1
 1 , b4 ≤ a1

The fuzzy preference relation (PKT ) of the fuzzy numbers will be determined
as following:

 A  B if I (w) ∈ (0.5,1]

PKT ( A, B) =  A = B
  if I (w) = 0.5 (18)
 B  A if I (w) ∈ [0, 0.5)


MVLSC-226i.indd 549 5/16/2012 11:10:02 AM

 550 A. Çagri Tolga

From fuzzy preference relation one can easily deduce that if the outcome of
Eq. (17) is larger than 0.5, this means that the fuzzy number à is preferred
to B.
Step 4: Calculate the concordance and discordance indexes. The degree of
confidence in the pair-wise judgments of (Ap→Aq) is represented by Opq and
it is calculated by Eq. (19)

O pq = ∑ j*
w j* (19)

where j* are criteria contained in the concordance set O (p, q).

The discordance index of D (p, q) can be defined as

D pq = ( ∑ j0
v pj 0 − vqj 0 ) ( ∑ j
v pj − vqj ) (20)

where j0 are criteria contained in the discordance set D (p, q). Though the
absolute value clause in Eq. (20), all the compared values in Eqs. (15) and
(16) should be defuzzified by equation below and these values should be used
in Eqs. (19) and (20).

a2 a3 a4
 x − a1   a −x 
∫
a4
x ⋅ µ A ( x )dx ∫
a1
 x ⋅ a − a  dx +
2 1
∫ ∫
x.1dx +  x ⋅ 4
 a4 − a3 
a3
dx

d ( A i ) =
a1 a2
a4
= a2 a3 a4
∫a1
µ A ( x )dx
∫
 x − a1 
∫
 a3 − x 
∫
 a − a  dx + 1.dx +  a − a  dx
(21)
a1 2 1 3 2a3
a2

(a + 2 a2 + 2 a3 + a4 )
= 1
6

Step 5: Outrank the relationships. A higher concordance index Opq and a

lower discordance index Dpq means the dominance relationship of alternative
Ap becomes stronger over alternative Aq. When the Opq ≥ O and Dpq < D, that
represents Ap outranks Aq. Here, O and D are the averages of Opq and Dpq,
respectively.

5.  STEPS of THE FUZZY REAL OPTIONS VALUE INTEGRATED

ELECTRE 1S MODEL

In selection procedure, this study argues risky side of the software develop-
ment projects by fuzzy real options, and this evaluation method for economi-
cal side is integrated to ELECTRE 1S method which is called fuzzy

MVLSC-226i.indd 550 5/16/2012 11:10:03 AM

 A Real Optıons Approach For Software Development 551

ELECTRE. This proposed method finds the solution with more realistic way
however it does not disregard the dynamic environment of SDPs and it dis-
solves the problem at a quick pace. The steps of the offered method are as
below:
Step 1. Determine the weights of criteria. Experts have to determine the
importance levels of criteria.
Step 2. Construct the decision matrix. For criteria from 1 to 11 shown in
Table 2-1 utilize the experts’ opinions derived from fuzzy conversion scale
and initialize them to Eq. (11) like below.

 t11 t12  t111 

 
t t22  t211 
T =  21
    
 
 tn1 tn 2  tn11 

Step 3. Compute the economic criteria. Economic side -fuzzy real options
value- of the selection process is calculated in this step with sub steps below.
Step 3.1. For fuzzy real options value, calculate E (G ), E ( K 1 ), E ( K 2 ) ,
E ( K 3 ), and Var(G ) values at first for each alternative separately via Eqs. (6)
and (7). Then find Gc with interpolation.
Step 3.2. Calculate u1, u2, u3, and, z1 values respectively by Eqs. (2), (3),
(4), and (5).
Step 3.3. Find Z values for each alternative by Eq. (1) which might become
input values for the next step.
T
Step 4. Integration. Integrate the t112  tn12
n   values found in Step 3.3 to
the decision matrix as the twelfth criteria.
Step 5. Normalization. Normalize tij values for criteria 1 to 12 by applying
Eq. (13).
Step 6: Calculate the weighted fuzzy normalized decision matrix
V = (vij )n × m for i = 1,2 ,…, n and j = 1,2 ,…, m, where vij = w j × rij .
Step 7. Designate the fuzzy concordance and discordance sets. Calculate
the concordance sets by using Eq. (15) and applying the fuzzy number rank-
ing procedure explained in Section 4. Then compute the discordance sets by
using Eq. (16) and also apply the ranking procedure given in Eqs. (17) and
(18).
Step 8: Calculate the concordance and discordance indexes. Concordance
index is calculated by Eq. (19) and discordance index is calculated by Eq. (20).
Defuzzify (by using Eq. (21)) all discordance values because of the absolute
value clause in Eq. (20).
Step 9. Outrank the relationships. When the Opq ≥ O and Dpq < D, that
represents Ap outranks Aq. Here, O and D are the averages of Opq and Dpq,
respectively.

MVLSC-226i.indd 551 5/16/2012 11:10:04 AM

 552 A. Çagri Tolga

6.  AN APPLICATION to MID-SIZE SDP FIRM in TURKEY

A mid-size software development company in Turkey wants to make outrank-

ing among three of their future software development project. This company
has determined its targets strategically by courtesy of its boss with great
vision –being a leader company in five 5 years- and it has also very talented
employees. Though the company has great goals and it situates in develop-
ment phase hereafter it will called ABC Software Company.
The ABC Co. desires to choose most suitable one among three different
commercial software development projects those take place in the strategic
goals of the firm: SDP 1 is commercial software that directs human resources
planning, recruitment and placement processes of any firm. SDP 2 is com-
mercial software that undertakes production planning control. Then the SDP
3 is software that applies activity based costing/managing in a commercial
worried firm.
The application is performed in two stages. At the first stage, the finan-
cial data is taken out from the company. Though some part of the data is
insufficient and the authority of the company does not want to take out the
other part of the data crisply, financial info is utilized in a trapezoidal fuzzy
numbers manner. At the second stage, a survey work is evaluated. Pair-wise
comparisons of criteria of the projects are asked to an expert from the com-
pany. After then, non monetary and monetary criteria are consolidated in a
sole table to select the most suitable software development project for the
company.
At the first stage, obtained financial data with trapezoidal fuzzy numbers
is given in Table 6-1. The values are in thousand TL and interest rate is taken
from the Central Bank of the Republic of Turkey’s (CBRT) rate (η = 5.25 %).
Option value reducing dividend rate which represents downturn in profitabil-
ity in real options and shown by δ is calculated by the formula E ( K 1 ) / E (G ).
At the first column; mutually exclusive projects’ codes, at the second col-
umn; estimated returns of each projects after market introduction separately,
at the third column; expected value of estimated returns calculated by Eq. (6),
at the fourth column; present value of costs of discovery phase means costs of
generation of software with all functions, at the fifth column; expected value
of this cost, at the sixth column; present value of costs of testing phase for
determination of the deficiencies and errors, at the seventh stage; expected
value of this cost, at the eighth stage; present value of marketing costs while
market introduction of the projects, at the ninth stage, expected value of this
cost, at the tenth stage; first option’s maturity date, at the eleventh stage; sec-
ond option’s maturity date with year rate, are given.
Steps of the offered approach were given in Section 5. According to this
methodology; at first we asked the experts the weights of the criteria. They
evaluated the criteria by fuzzy scale shown in Figure 3. The scale is in trian-

MVLSC-226i.indd 552 5/16/2012 11:10:04 AM



MVLSC-226i.indd 553
PV of
PV of project return after PV of investment investment PV of investment
market introduction cost for Stage 1 cost for Stage 2 cost for Stage 3
T1 T2
Projects G 
E(G) K1 E(K1) K 2 E( K 2 ) K 3 E(K 3) (yr.) (yr.)
SDP 1 (60, 65, 70, 75) 67.50 (13, 15, 18, 21) 16.67 (1, 3, 5, 7) 4.00 (3, 4, 5, 6) 4.50 1 2
SDP 2 (51, 52, 55, 57) 53.67 (9, 10, 12, 13) 11.00 (1.5, 2, 3, 3.5) 2.50 (3, 6, 8, 11) 7.00 1 1.5
SDP 3 (85, 87, 90, 92) 88.50 (23, 25, 30, 32) 27.50 (3, 4, 5, 6) 4.50 (8, 10, 15, 17) 12.50 1.5 2

Table 6-1
Financial data of software development project alternatives (Thousand TL).
A Real Optıons Approach For Software Development
553

5/16/2012 11:10:05 AM
 554 A. Çagri Tolga

Figure 3
Fuzzy weight scale.

gular shape but it is written in trapezoidal form and it covers all details to
express the exact weights in mind of experts.
Then experts are questioned to compare the criteria pair-wisely according
to alternatives by scale given in Table 6-2 and visualized in Figure 4.
The weights of the criteria determined by expert are shown in Table 6-3.
Decision matrix except economic criteria is constructed by these evaluations
as determined in Step 2 and the decision matrix can be seen in Table A-1.
Then computing the economic criteria in Step 3 is applied as below.
In light of foregoing data in Table 6-1 values in request are calculated by
Eqs. (2)-(10) among and as denoted in Steps 3.1 and 3.2. All the alternative
projects’ fuzzy real option values are calculated by Eq. (1) separately and
they are given in Table 6-4.
These found values are integrated to the decision matrix as benefit criteria
because of the nature of real options. And the last integrated decision matrix
is shown in Appendix. As denoted in Step 5 normalization is applied to this

Linguistic statement Trapezoidal fuzzy statement

Least important (0, 10, 10, 20)
Much less important (10, 20, 20, 30)
Less important (20, 30, 30, 40)
Not so important (30, 40, 40, 50)
Equal (40, 50, 50, 60)
Important (50, 60, 60, 70)
More Important (60, 70, 70, 80)
Much more important (70, 80, 80, 90)
Most important (80, 90, 90, 100)

Table 6-2
Fuzzy Linguistic Scale

MVLSC-226i.indd 554 5/16/2012 11:10:05 AM

 A Real Optıons Approach For Software Development 555

Figure 4
Graphical expression of fuzzy scale.

Criteria Fuzzy Weight Criteria Fuzzy Weight

C1 (0.45, 0.50, 0.50, 0.55) C7 (0.50, 0.55, 0.55, 0.60)
C2 (0.25, 0.30, 0.30, 0.35) C8 (0.35, 0.40, 0.40, 0.45)
C3 (0.20, 0.25, 0.25, 0.30) C9 (0.60, 0.65, 0.65, 0.70)
C4 (0.60, 0.65, 0.65, 0.70) C10 (0.40, 0.45, 0.45, 0.50)
C5 (0.25, 0.30, 0.30, 0.35) C11 (0.50, 0.55, 0.55, 0.60)
C6 (0.30, 0.35, 0.35, 0.40) C12 (0.80, 0.85, 0.85, 0.90)

Table 6-3
The weights of criteria

SDP Project Fuzzy Real Options Values

Human Resources Management V = (24.8, 28.6, 35.6, 39.4)
SDP1

Production Planning and Control VSDP = (24.0, 28.0, 33.0, 37.7)

2

Activity Based Cost Managing VSDP = (24.6, 30.4, 36.3, 42.1)

3

Table 6-4
Computed Fuzzy Real Options Values

decision matrix. Then the weighted fuzzy normalized decision matrix is com-
puted as depicted in Step 6 of the offered method and this matrix is also
shown in Table A-2.
Fuzzy concordance and discordance sets are computed by Eqs. (15) and
(16) as remarked in Step 7 and shown in Table 6-5. And also concordance and
discordance indexes calculated with Eqs. (19) and (20) in accordance with
Step 8 are denoted in Table 6-5.
Let us investigate an example from Table 6-5 that how a preference index is
computed for instance O(1,2) for criteria 12. From the weighted fuzzy normalized

MVLSC-226i.indd 555 5/16/2012 11:10:06 AM

 556 A. Çagri Tolga

Concordance Sets Concordance Discordance Sets Discordance

Indexes Indexes
O(1,2)= 2,3,4,6,7,9,10,11,12 O12= 4.600 D(1,2)= 1,5,8 D12= 0.234
O(1,3)= 2,6,7,11 O13= 1.750 D(1,3)= 1,3,4,5,8,9,10,12 D13= 0.775
O(2,1)= 1,4,5,8 O21= 1.850 D(2,1)= 2,3,6,7,9,10,11,12 D21= 0.720
O(2,3)= 2,6,7,11 O23= 1.750 D(2,3)= 1,3,4,5,8,9,10,12 D23= 0.906
O(3,1)= 1,3,4,5,8,9,10,12 O31= 4.050 D(3,1)= 2,6,7,11 D31= 0.225
O(3,2)= 1,3,4,5,7,8,9,10,12 O32= 4.600 D(3,2)= 2,6,11 D32= 0.075

Table 6-5
Concordance and Discordance Sets and Indexes

matrix denoted in Table A-2, one can easily found v112 equals (0.273, 0.476,
0.498, 0.866). With the same logic v212 = (0.260, 0.461, 0.462, 0.830) value
could be found. The preference index is found by Eq. (17) and it is equal to
I(ω ) = 0.542 which means from Eq. (18) PKT (v112 , v212 ) = 0.542 → v112  v212 .
The other ranking of fuzzy numbers are made with the same method.
Finally an outranking represented in Step 9 is made and the results of
interrogations are given in Table 6-6. The relationship SDP3 → SDP1 → SDP2
can be easily inferred from the last Table.
At the first order activity based cost managing software is selected to be
developed by the reason of fuzzy real options integrated fuzzy ELECTRE
method. SDP3’s fuzzy real option value is slightly bigger than SDP1’s fuzzy
real option value; the decision maker can have conflict about to choose which
one. However with help of a decision making method called fuzzy ELEC-
TRE selection of SDP3 is more believed and more valuable in rationalist
mind.

Opq Is (Opq ≥O)? Dpq Is (Dpq <D)? Is (Ap→Aq)?

O12 Yes D12 Yes Yes
O13 No D13 No No
O21 No D21 No No
O23 No D23 No No
O31 Yes D31 Yes Yes
O32 Yes D32 Yes Yes

Table 6-6
Outranking relationships.

MVLSC-226i.indd 556 5/16/2012 11:10:07 AM

 A Real Optıons Approach For Software Development 557

CONCLUSION

One of the most value creating working areas is software development

projects for developing countries. Evaluation of these SDPs is a vital process
because of the time and cost resource restrictions. Selection of the right soft-
ware development project is inevitable for growing companies in developing
countries.
Risky and dynamic side of the selection process is evaluated by real
options. Real options give the management flexibility about making an invest-
ment. ELECTRE is a multi-criteria evaluation method for choosing proce-
dure and it is little bit more easily applicable than the other methods. This
property saves time, workload and money because of the application time of
the problem. Beneath its saving resources the method produces the right deci-
sion to the problem.
In case of lack of information and vague data situations fuzzy logic is
offered. In this application fuzzy form is used because of the company does
not want to take out the other part of the data crisply. Fuzzy logic overcomes
these difficulties. Though these deficiencies fuzzy real options integrated
fuzzy ELECTRE method is offered in this work to choose the right software
development projects among them. Activity based costing software alterna-
tive is selected by the help of this offered method. Though there are less
companies working on this topic and there are many opportunities, this solu-
tion is sensible and it seems more applicable.
For future studies, criteria offered in this work could be enhanced and may
be more criteria added. A different multi-criteria method like fuzzy MAC-
BETH or fuzzy VIKOR could be offered by integrating the real options.

MVLSC-226i.indd 557 5/16/2012 11:10:07 AM

MVLSC-226i.indd 558
Appendix A
558

C1 C2 C3 C4 C5 C6
SDP1 (30, 40, 40, 50) (70, 80, 80, 90) (30, 40, 40, 50) (30, 40, 40, 50) (50, 60, 60, 70) (70, 80, 80, 90)
SDP2 (40, 50, 50, 60) (60, 70, 70, 80) (10, 20, 20, 30) (30, 40, 40, 50) (60, 70, 70, 80) (50, 60, 60, 70)
SDP3 (60, 70, 70, 80) (40, 50, 50, 60) (40, 50, 50, 60) (60, 70, 70, 80) (70, 80, 80, 90) (40, 50, 50, 60)
C7 C8 C9 C10 C11 C12
SDP1 (80, 90, 90, 100) (20, 30, 30, 40) (30, 40, 40, 50) (30, 40, 40, 50) (70, 80, 80, 90) (24.807, 28.606,
35.644, 39.443)
SDP2 (60, 70, 70, 80) (40, 50, 50, 60) (20, 30, 30, 40) (20, 30, 30, 40) (60, 70, 70, 80) (24.013, 27.996,
32.999, 37.717)
SDP3 (60, 70, 70, 80) (60, 70, 70, 80) (80, 90, 90, 100) (70, 80, 80, 90) (50, 60, 60, 70) (24.573, 30.423,
36.272, 42.122)

Table A-1
A. Çagri Tolga

Real Options integrated decision matrix.

5/16/2012 11:10:08 AM


MVLSC-226i.indd 559
C1 C2 C3 C4 C5 C6

SDP1 (0.120, 0.211, 0.211, (0.130, 0.204, 0.204, (0.072, 0.149, 0.149, (0.169, 0.289, 0.289, (0.090, 0.147, 0.147, (0.163, 0.250, 0.250,
0.352) 0.313) 0.294) 0.476) 0.234) 0.379)
SDP2 (0.161, 0.264, 0.264, (0.111, 0.179, 0.179, (0.024, 0.075, 0.075, (0.169, 0.289, 0.289, (0.108, 0.172, 0.172, (0.116, 0.188, 0.188,
0.422) 0.279) 0.177) 0.476) 0.267) 0.295)
SDP3 (0.241, 0.369, 0.369, (0.074, 0.128, 0.128, (0.096, 0.186, 0.186, (0.337, 0.506, 0.506, (0.126, 0.197, 0.197, (0.093, 0.157, 0.157,
0.563) 0.209) 0.353) 0.762) 0.300) 0.253)
C7 C8 C9 C10 C11 C12

SDP1 (0.265, 0.370, 0.370, (0.065, 0.132, 0.132, (0.152, 0.253, 0.253, (0.109, 0.191, 0.191, (0.251, 0.360, 0.360, (0.288, 0.401, 0.603,
0.514) 0.241) 0.399) 0.318) 0.515) 0.838)
SDP2 (0.199, 0.288, 0.288, (0.130, 0.220, 0.220, (0.101, 0.189, 0.189, (0.072, 0.143, 0.143, (0.215, 0.315, 0.315, (0.279, 0.393, 0.558,
0.412) 0.361) 0.319) 0.254) 0.458) 0.801)
SDP3 (0.199, 0.288, 0.288, (0.195, 0.307, 0.307, (0.404, 0.568, 0.568, (0.254, 0.382, 0.382, (0.179, 0.270, 0.270, (0.285, 0.427, 0.613,
0.412) 0.481) 0.798) 0.572) 0.400) 0.895)

Table A-2
The weighted fuzzy normalized decision matrix.
A Real Optıons Approach For Software Development
559

5/16/2012 11:10:08 AM
 560 A. Çagri Tolga

REFERENCES

 [1] Shehabuddeen, N., Probert, D., Phaal, R. (2006). From theory to practice: challenges in
operationalising a technology selection framework. Technovation, 26, 324-335.
 [2] Buyukozkan, G., Kahraman, C., Ruan, D. (2003). A Fuzzy Multi-criteria Decision
Approach for Software Development Strategy Selection. International Journal of General
Systems, 33 (2-3), 259-280.
 [3] Brach, M. A. (2003). Real Options in practice. Hoboken, New Jersey: John Wiley & Sons,
Inc.
 [4] Trigeorgis, L., (1986). Valuing real investment opportunities: an options approach to stra-
tegic capital budgeting. Ph. D. Thesis, Graduate School of Business Administration, Har-
vard University.
 [5] Benaroch, M., Kauffman, R. J. (1999). A case for using real options pricing analysis to
evaluate information technology project investments. Information systems research, 10, 1,
70-86.
 [6] Huchzermeier, A., Loch, C. H. (2001). Project management under risk: Using the real
options approach to evaluate flexibility in R&D. Management Science, 47, 1, 85-101.
 [7] Zadeh L. (1965). Fuzzy sets. Inform Control, 8, 338–353.
 [8] Carlsson, C., Fullér, R. (2003). A fuzzy approach to real option valuation. Fuzzy Sets and
Systems, 139, 297-312.
 [9] Wang, J., Hwang, W. L. (2007). A fuzzy set approach for R&D portfolio selection using a
real options valuation model. Omega, 35, 247-257.
[10] Cox, J. C., Ross, S. A., Rubinstein, M. (1979). Option pricing: a simplified approach.
Journal of Financial Economics, 7, 229-263.
[11] Allenotor, D., Thulasiram, R. K. (2007). A grid resources valuation model using fuzzy real
option. Lecture notes in Computer Science, 4742, 622-632.
[12] Tolga, A. C., Kahraman, C., Demircan, M. L. (2010). A Comparative Fuzzy Real Options
Valuation Model using Trinomial Lattice and Black-Scholes Approaches: A Call Center
Application. International Journal Of Multiple-Valued Logic And Soft Computing, 16
(1-2), 135-154.
[13] Roy, B. (1968). Classement et choix en présence de points de vue multiples (la méthode
ELECTRE). Revue Informatique et Recherche Opérationnelle, 2, 8, 57-75.
[14] Roy, B., Skalka, J. M. (1985). ELECTRE 1S: Aspects méthodologiques et guide
d’utilisation. Document de LAMSADE, 30, 1-125.
[15] Raoot A. D., Rakshit, A. (1993). A Linguistic Pattern Approach for Multiple Criteria Facil-
ity Layout Problems. International Journal of Production Research, 31, 1, 203-222.
[16] Montazer, G. A., Saremi, H. Q., Ramezani, M. (2009). Design a new mixed expert deci-
sion aiding system using fuzzy ELECTRE III method for vendor selection. Expert Systems
with Applications, 36, 10837-10847.
[17] Brito, A. J., Almeida, A. T., Mota, C. M. M. (2010). A multi-criteria model for risk sorting
of natural gas pipelines based on ELECTRE TRI integrating Utility Theory. European
Journal of Operational Research, 200, 812-821.
[18] Kahraman, C., Tolga, A. C. (2009). An Alternative Ranking Approach and Its Usage in
Multi-Criteria Decision-Making. International Journal Of Computational Intelligence
Systems, 3, 2, 219-235.

MVLSC-226i.indd 560
View publication stats 5/16/2012 11:10:08 AM