Strategy Through the Option Lens

An Integrated View of Resource Investments and the Incremental-Choice

Process

Edward H. Bowman & Dileep Hurry

Option Theory & Strategy

Options include “Puts” & “Calls”Organizational Resource Investments Analogous to

Options in terms of Investment Behavior Confer preferential access to an opportunity for

investment choicePrior investments necessary preconditions and/or

probability of success increasers for major investments

Resources: Bundle of options for future strategic choice arising from existing investments & environment

Evolved routines & cognitionRight Place & Right Time

The Option Chain

Sense MakingShadow

OptionsSecure

Preferential Access

Strike TypesFlexibility

Strategic Change

Incremental Calls & Puts

Theoretical Propositions

Downside Risk and Optimal InertiaSunk Cost Hysteresis: Hold existing & defer new

investmentsPositive value of waiting to make irreversible

investments to trigger points of minimum profit or maximum loss = zone of optimal inertia

Certainty of option profitability widens zone

Proposition 1: Organizations holding better developed bundles of options will expand more aggressively in growing markets and economic upturns and they will persist longer in difficult markets and economic downturns, than competitors holding less developed option bundles.

Theoretical Propositions (cont.)Perceived Environmental Uncertainty

Option value increases with volatility of asset value High perception of environmental uncertainty incentivizes

management to hold options open, low perception to strikeOpportunity counts shift over time as a function of

environmental volatility and organizational learning Learning provides control over enacting environments and

reduced uncertainty Shifts in and out of exploration and exploitation modes

caused by environmental shiftsP2: Given realistic perceptions of environmental

uncertainty, organizations that hold options during unstable periods and strike options in stable periods will show superior long-term growth and profit performance compared to organizations exhibiting other types of investment behavior

Theoretical Propositions (cont.)The Size of Organizational Investments

Ideal configuration: small option investments, large strike investments

Progression from learning investment to profit generating investment

P3: Organizations that enter new businesses and markets by linking investments, so that small options and followed by large strikes, will perform better than those entering with only discrete small, or large, investments

Theoretical Propositions (cont.)The Timing of Organizational Investments

Optimal to hold a call until expiration if no income yielded Asset yields income: opportunity costs from puts, loss of

dividends from callMarket Strike Signals

Arrival of opportunity: preferential access, incentive to wait remains

Necessary but not sufficient for profitable strike Expiration: Imminent closure through preemptive action of

competitor Sufficient & Perceived more accurately than opportunity

P4: Ranked Performance of timing scenarios Calls struck after both signals received Puts struck after only 1st signal received Calls struck after only 1st signal only received Calls & Puts struck after only 2nd signal received Calls & Puts struck before any signal received

Theoretical Propositions (cont.)The Portfolio of Options

Organization’s structure influences degree to which decision makers can freely strike options

Portfolio of options (division level) vs Option on portfolio of assets (corporate level)

Network & Keiretsu permit division-level option striking Conglomerates can’t strike individually, must separate

options or face hostile bids for undervalued options

P5: Organizations with structures that are capable of holding a portfolio of options will show wider diversification, with fewer divestitures, than organizations with structures that restrict choices to an option on a portfolio of assets

Contributions

Integration of 4 Themes distinguished by temporal orientation & perspective on cognition

Resource allocation: Organizations invest to maximize forecasted operating efficiency

Doesn’t explain choice to select lower NPV projectsSense-making: Organizational investment is the product

of sense making, perceptual biases and intuition Doesn’t explain ability to maintain focus on efficiency

Learning: Organizational investment proceeds incrementally as a result of accumulated learning

Doesn’t connect to strategic choicesStrategic Positioning: Organizations invest to create

new possibilities for future efficiency Doesn’t account for path dependency from past

investments

Contributions (cont.)

Firm Value = Sum of earnings from investments in place + Option Value of Future Strategic Choices

Option Value explains counterintuitive findingsMaintaining Slack Resources & Negative NPV

Investments

Evaluation of Options ≈ Managerial IntuitionAbsorptive Capacity > Recognition & Striking

of OptionsOption chain dependent on prior investments

Path Dependency leading to Inimitable resources > Sustained Competitive Advantage

New Explanation of FindingsStrategy and Selection

Positioning in t for opportunities in t+1

Garbage CanSolutions before problems as Shadow Options waiting

to be struck

Means ConsensusGoals subject to uncertainty, less important to reach

consensus

Risk-Return ParadoxNegative correlation between profitability and

variance of profits Will hold on to underperformers for option value Will seek risk if option to shift risk to debtors is viable

Discussion

Can restart options be used in an R&D context?