“Options

Thinking” in
IT Project
Management
 Content
Options Thinking
01 American Style of
Call
Implementation and 05
six cases

Different process

02 models vs. option-

thinking
Value-eroding with
time and OPM
06

Flexibility in IT
03 project management
Scale-change vs.
Growth vs. Abandon
07
Estimation process
Decision trees vs.
(no-option vs.
04 embedded-call)
options 08
 1. American Style of Call

● American options outline the timeframe when the option holder can exercise their option contract rights.
● These rights allow the holder to buy or sell-depending on if the option is a call or put--the underlying asset,
at the set strike price on or before the predetermined expiration date.
● Investors have the freedom to exercise their options at any point during the life of the contract

Example:

● A common stock of Company A is trading at Rs. 250. Mr. X believes

that the value of Company A is going to increase.
● He buys call options of 100 shares at Rs. 250 ach, expiring in 180
days.
● Over the next 4 months price of Company’s A stock increase to Rs.
280.
● Mr. X exercises his right to purchase 100 shares at Rs. 250 &
immediately selling back in the market at Rs. 280 each.
2. Stage-gate implementation of different process models vs.
option-thinking in IT project management

● In Stage gate implementation a project or an initiative are divided in several

stages called the “gates”At each gate, a decision is made whether to continue the
process or not.
● This decision is based on the prognosis and information available at that moment
and in most cases is made by a manager or steering committee

❖ Similarly, Options thinking has a option of having projects in stages.

❖ At each stage decision is taken about the progress of the project (based on the
ambiguities about net payoffs from subsequent stages i.e the information
available at that time).
2. Stage-gate implementation of different process models vs.
option-thinking in IT project management
● In stage gate implementation after each gate following decisions can be made, GO,
KILL, HOLD, RECYCLE.
❖ Similarly, option thinking gives following types STAGE, ABANDON, DEFER,
STRATEGIC GROWTH, CHANGE SCALE, SWITCH

● Stage gate is a major cultural change, a well thought out & designed
implementation approach along with cross-functional practices.
❖ Similarly using real option will require cultural change in many organisation.
Adoption of new project guidelines to promote flexibility

Both stage-gate model & option thinking is applicable in variety of industries and
projects
 3. What is your understanding about the flexibility in IT
project management? How that can be improved?
Flexibility of It basically relates to two major types:
● Flexibility with respect to the number if uses- An IT project can be put to: If we talk about the assets
that a company owns, IT system is the one which is most flexible in terms of work environments and
functionalities. For example- A traditional equipment will be acquired to perform a specific functionality
and after some time it might turn obsolete. However, an It system is agile, adaptive and can be updated
to suit user needs.
● Flexibility in terms of processes needed to execute a specific function: In case of prototypes, pilots etc
IT projects are not absolutely rigid.
Particularly in case of Options trading, flexibility is really integral because options in itself require user’s
discretion to decide whether to exercise a particular right or not.

Flexibility can be improved by making highly adaptive and far-sighted management systems taking into
considerations the uncertainty and the course of actions that a management would want to integrate.
4. Compare the estimation process that uses no-option with
that of an embedded-call.
Suppose a firm is faced with a large product to implement RFID
tagging across its supply chain. For this the firm has can proceed with
the following ways:

Estimated Value with No Option

● In no option, the firm chooses to implement the project full,
without any pilot initiative
● Traditional tools do not take account of managerial flexibility,
but rather assume equal exposure to both potential losses and
gains.
● Less valuable as only after implementation of whole project we
will know whether it is profitable or not.
● As seen from the image proposed project cost $10 million to
implement, has potential payoff from 0-20m. Average payoff
for the bars is (.02)*(-9)+(.09)*(-7).....(.04)*(+9)= -1.1 million
4. Compare the estimation process that uses no-option with
that of an embedded-call.
Estimated Value with an Embedded Call
● In embedded call, the firm chooses to begin with a smaller project
initiative and expects to proceed with full investment only if pilot
goes favourably.
● Call option on full project will only exercised if information gained
through pilot indicates that payoff for larger project is likely to be
positive.
● Project with embedded call is more valuable as options
acknowledge managerial flexibility to avoid potential loss while
preserving potential gains.
● The figure shows a system which is structured to follow-on project
to be completed later (after pilot). Mostly managers will know true
payoff after pilot so negative net payoff will be avoided. Revised
estimated payoff= (.10)*(1)+(.08)*(3)....+(.04)*(9)= $1.4 million
 5. Option-Thinking Implementation
Stages

● A project can be broken up into different stages, with each stage implemented only after a
independent assessment of financial viability.
● Benefit of this method is it is often hard to predict the results of long complex projects , breaking
them into smaller ones reduces their complexity.
● In the example given the Board of Carlson Hospitality Worldwide rejected the initial bid of 15
million for a Customer Reservation System (CRS) because that was too much of a commitment to
make given the known variables.
● But once broken down into stages , the Board could implement stage 1 of CRS as it wasnt taking as
much of a risk.
● A pitfall of the Stage method is that its not applicable for all kinds of projects.
 5. Option-Thinking Implementation
Abandon
● Abandon is a subset of the Stages process.
● It’s an option to terminate the project if its not economically viable.
● Pitfall of this method is that often times ,it is very costly to terminate a project midway.

Defer
● Defer is a sort of a waiting game.
● It consists of waiting till more facts become clear and uncertainty diminishes.
● Yankee First a vendor of POS machines worried about the adoption rates of their product ,and also the
future policy regarding such machines, as current policy was not favorable .
● They just waited until they could change the regulations to their favour and more data became
available about adoption patterns
● Defer strategy often lead to the loss of first mover advantage and the erosion of the value of the
project, as sometimes there is a time limit to the effectiveness of the option.
 5. Option-Thinking Implementation
Growth
● A growth option consist of a baseline investment with an imdebbed option for follow up projects.
● This ensures only net positive projects are pursued .
● The ERP upgradation of an european car maker from SAP r2 to SAP r3 , was initially not cost
effective.
● The baseline investment and analysis of embedded options before pursuing them helped them
implement the system.
● Growth strategies are more suited to large innovative projects and not for support projects.
 5. Option-Thinking Implementation

Change Scale

● Changing scale if the option expand the production if conditions are favorable and contract it if
they are unfavorable.
● Cypress communications Authority wanted to update their IS infrastructure , although the net
value of such a project would be negative , the impending inclusion of cypress into the european
union , provided them with an option to scale up afterwards ,which made the net value positive.
● In practice , scaling up or down is a very tedious task in which multiple variables come into
effect and as such cost are hard to predict
 5. Option-Thinking Implementation
Switch

● Switch is an option where an infrastructure or system are used to benefit a goal it was not
designed for .
● Over time it may come to emerge that a certain system is more valuable when attributed to
another task.
● TWA initially created Computer Aided Software Engineering(CASE) template for their own
use ,but they managed to modify the system an sell to Canada airlines , that option made it net
positive.
● Pitfall of this option is that , often the development of multi use softwares are more expensive
and time consuming than single use ones.
5. Option-Thinking Implementation
Combinations of different options

● Combinations of options can be used to value a project.

● Starbucks consumer cards were initially designed just to make
checkout faster(Stage).
● Then they realised that they could grow the platform to
incorporate a rewards system (Growth).
● Later on they implemented co branded cards with credit card
vendors such as visa and mastercard ,which came with all the
normal features of a credit card , plus the incentives at
starbucks(Switch )
 6. Value-eroding with time and OPM
● Deferral options are useful when there’s high uncertainty that can be
resolved over time.
● By waiting, much of the uncertainty about payoffs resolves.
● However, project benefits erode with time when Investment are
decided to be deferred.
● In case of characteristics of first mover advantages or when other
firms are expected to follow quickly, value eroding over time
becomes a reality.
● .But, OPM suggests otherwise:
Longer Deferral periods increase the value of options
● An example is Yankee 24’s implementation of a network
infrastructure to support point of sale (POS) debit cards for New
England merchants.
 6. Value-eroding with time and OPM
● The uncertainty related to the decision included:
○ How fast would retailers adopt POS debit cards as a payment
option?
○ Would Massachusetts (50% of the New England market) revise
banking regulations that currently discouraged POS debit
adoption among smaller businesses?
○ Would consumers in New England take up POS debit cards at the
same rate as other markets?
○ Would a competing network signal an intent to enter the POS
debit arena?
● Yankee understood, correctly, that by simply waiting, much of the
uncertainty about payoffs could be resolved.
● Yankee deferred entry for three years, as was the optimal time for
Yankee to defer investment.
 7. Scale-change vs. Growth vs. Abandon
Definition How Value is Created Pitfalls

Resources can be contracted or Scale up or down: can add to

Increase the scale of a project
expanded, or the operational project costs.
Scale Change system enabled by a project can
(potential benefits):
Abandon: intangible costs related to
circumstances are favorable; or
be scaled up or down more easily. credibility and morale.
can reduce the scale (potential
losses): circumstances are
unfavorable.

Opens the door to pursue a Value of follow-on investments Difficult to value due to higher
Growth variety of potential follow-on more apparent over time. Only ambiguity and the longer time
opportunities. investments with positive payoffs frames often involved.
are pursued.

Projects tend to take on a life of their

A project can be terminated
As a project unfolds actual costs own and are difficult to terminate.
Abandon midstream and remaining project
and benefits become more clear, Abandoning projects can carry
resources relatively easily
and losses can be curtailed by intangible costs related to
redeployed.
terminating the project. credibility and morale.
Resources can’t always be
productively redeployed.
8. How do decision trees compare with options?
● If it is expected that senior managers will resist OPM then decision
trees provide viable alternatives.
● When transparency is important decision trees can be used. In most
of the cases framing proposed investments in form of decision tree
can convince management easily.
● As value of flexibility is not zero in decision trees, they are better
than conventional approaches.
● Limitations of Decision Trees:
○ The tree becomes more complex as more alternative scenarios
are incorporated.
○ There is no straightforward way to determine what correct risk
adjusted discount rate for whole tree should be.
○ If managers rely on intuition they must be on guard again
systematic biases.
Decision Tree