research@hec - Issue #16 - (Page II)

Bertrand Quélin research Charlotte Krychowski Real Options for Optimal Investment Strategies Corporate finance professionals have wondered how to optimize investment strategies for a long time, and the increasingly uncertain economic environment has made this issue even more critical. The combination of monetary crises, rapid technological change, and difficulties in anticipating demand has created an economic context where companies often have to invest a great deal to seize new opportunities. However, they are not always able to determine the conditions required to achieve ROI. BIOGRAPHIES Bertrand Quélin is professor of strategic management and industrial economics at HEC Paris. He also directs the strategic management master’s degree program. Charlotte Krychowski is professor in strategic management at Telecom & Management SudParis engineering and business school. A graduate of ESCP Europe (1995), she also holds a Kaufman diploma from Technische Universität Berlin. She earned her PhD at HEC (2007) and wrote her thesis under the supervision of Bertrand Quélin. REAL OPTIONS AND FUTURE CASH FLOW In corporate finance, ROI is predominately anticipated through analysis of future cash flow. “This is a solid approach,” says Quélin, “but it is not always reliable, because it is based on the principle of definitive, non-modifiable investment decisions.” To deal with this problem, researchers have drawn on finance theory and adapted the principle of real options to apply it to material investments. Quélin explains, “As with financial options, taking out a real option on a new activity consists of making a test investment to find out whether it is worth investing further.” Keeping track of the initial consequences of an operation should reveal whether it would be wise to continue. The method involves separating investments into two parts: an observation phase and a phase during which an option How can companies optimize their long-term investment decisions? To answer this question, Bertrand Quélin and Charlotte Krychowski have studied the use of real options. Drawing on the case of a cell phone provider, have shown that by making experimentation possible, this method often proves more effective than future cash flow analysis. hec APPLICATION OF THE THEORY To validate this approach, the researchers examined the case of Mobitel, a cell phone provider (see “Methodology”) hesitating to invest in 3G technology. The technology seemed promising, but it would be a risky investment choice because of high uncertainty in the following three areas. • Potential success of the technology: This question is related to the presence of another technology, EDGE, which, while less powerful, might win over consumers. • Investment timing: Should investments be made all at once or should they be segmented and spread out over a period of time? • The competition: What are competitors planning to do? How risky would it be for Mobitel to postpone this investment for a year? Mobitel decided to delay total investments, while nonetheless developing 3G technology in key cities to assess demand. A year later, the investment had proven profitable, so Mobitel extended the network throughout the country. If this had not been the case, Mobitel would have instead invested in EDGE technology, which is less powerful than 3G but also significantly less costly to deploy. is either exercised (investment continued) or not (investments stopped). II research@hec • August-September 2010

Table of Contents for the Digital Edition of research@hec - Issue #16

Cover & Contents
Real Options for Optimal Investment Strategies
Social Construction of Identity among Poor Consumers
Promoting Creativity Same-Discipline vs Cross-Discipline Interactions
Launch of the AXA – HEC Paris Chair

research@hec - Issue #16