Option-Based Risk Management: A Field Study of Sequential Information Technology Investment Decisions

  • Authors:

  • Michel Benaroch;Mark Jeffery;Robert Kauffman;Sandeep Shah

  • Affiliations:

  • The Martin J. Whitman School of Management, Syracuse University;The Kellogg Graduate School of Management, Northwestern University;The W.P. Carey School of Business, Arizona State University;Sapient Corporation, and was previously a Research Fellow in the Center for Research on Technology and Innovation, The Kellogg School of Management

  • Venue:
  • Journal of Management Information Systems
  • Year:
  • 2007

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Abstract

This field study research evaluates the viability of applying an option-based risk management (OBRiM) framework, and its accompanying theoretical perspective and methodology, to real-world sequential information technology (IT) investment problems. These problems involve alternative investment structures that bear different risk profiles for the firm, and also may improve the payoffs of the associated projects and the organization's performance. We sought to surface the costs, benefits, and risks associated with a complex sequential investment setting that has the key features that OBRiM treats. We combine traditional, purchased real options that subsequently create strategic flexibility for the decision maker, with implicit or embedded real options that are available with no specific investment required provided the decision maker recognizes them. This combination helps the decision maker to both (1) explicitly surface all of his or her strategic choices and (2) accurately value those choices, including ones that require prior enabling investments. The latter permits senior managers to adjust a project's investment trajectory in the face of revealed risk. This normally is important when there are uncertain organizational, technological, competitive, and market conditions. The context of our research is a data mart consolidation project, which was conducted by a major airline firm in association with a data warehousing systems vendor. Field study inquiry and data collection were essential elements in the retrospective analysis of the efficacy of OBRiM as a means to control risk in a large-scale project. We learned that OBRiM's main benefits are (1) the ability to generate meaningful option-bearing investment structures, (2) simplification of the complexities of real options for the business context, (3) accuracy in analyzing the risks of IT investments, and (4) support for more proactive planning. These issues, which we show are more effectively addressed by OBRiM than the other methods, have become crucial as more corporate finance-style approaches are applied to IT investment and IT services problems. Our evaluative study shows that OBRiM has the potential to add value for managers looking to structure risky IT investments, although some aspects still require refinements.