Managerial Real Options Practice in Large System Acquisition: Empirical Descriptions and Comparison with Theory

Abstract

Effective and efficient development of large complex acquisition projects requires proactive management of uncertainties to meet performance, schedule, and cost targets. Flexibility in the form of real options can be an effective tool for managing uncertainty and, thereby, adding value to acquisition projects. But, real options can be both difficult to recognize, design and evaluate and expensive to obtain, maintain, and implement. Real options theory suggests a general approach and has developed precise valuation models that demonstrate the potential of options to add value. But, these models of simplified real options (compared to managerial practice) have failed to significantly improve practice, presumably because of a lack of knowledge and understanding of real options use by practicing managers. In contrast, practicing managers identify, design, value, and implement real options as a regular part of acquisition. Understanding the similarities and differences between current practice and theory is critical for developing operational real-option theories that can improve management practice. In the current work, an experiment using a simple uncertain acquisition project and a simulation model is used to capture managers perceptions of real options. Subjects both valued flexibility and conceptually understood the impact of uncertainty on option values. Future needs for expanding real options theory into the operational management of acquisition and management implications are discussed.