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Real Options Analysis and Strategic Decision Making

Author

Listed:
  • Edward H. Bowman

    (formerly at The Wharton School, University of Pennsylvania)

  • Gary T. Moskowitz

    (Edwin L. Cox School of Business, Southern Methodist University, P.O. Box 750333, Dallas, Texas 75275-0333)

Abstract
The real options approach is frequently advocated as an approach that offers a positive and radical reassessment of the value of risk and exploration. We examine a recent case where Merck used the real options approach to justify an investment in an R&D project. This case is used to highlight some of the problems associated with using real options. We note that the assumptions incorporated in most standard option valuation models can conflict with the conclusions reached by strategic analysis. As a result, users of real options models should understand the quantitative aspects of these models, and may often need to create a customized model for each situation. The difficulty of developing customized models may explain, in part, the limited use of the real options approach in strategic analysis.

Suggested Citation

  • Edward H. Bowman & Gary T. Moskowitz, 2001. "Real Options Analysis and Strategic Decision Making," Organization Science, INFORMS, vol. 12(6), pages 772-777, December.
    • Handle: RePEc:inm:ororsc:v:12:y:2001:i:6:p:772-777
    DOI: 10.1287/orsc.12.6.772.10080
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    References listed on IDEAS

    as
    1. Bruce Kogut & Nalin Kulatilaka, 2001. "Capabilities as Real Options," Organization Science, INFORMS, vol. 12(6), pages 744-758, December.
    2. Lander, Diane M. & Pinches, George E., 1998. "Challenges to the Practical Implementation of Modeling and Valuing Real Options," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 2), pages 537-567.
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    7. Bruce Kogut & Nalin Kulatilaka, 1994. "Operating Flexibility, Global Manufacturing, and the Option Value of a Multinational Network," Management Science, INFORMS, vol. 40(1), pages 123-139, January.
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    Full references (including those not matched with items on IDEAS)

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