Summary by Eileen Fried Master of Accountancy Program University of South Florida, Summer A strategy is generally comprised of a sequence of major decisions or options. Luehrman suggests that a company can more effectively execute their strategies through active management of these options by evaluating them not only on the basis of discounted cash flows, but also by giving strong consideration to the timing of their investments.

Value-to-cost metric — the value of the underlying assets we intend to build or acquire divided by the present value of the expenditure required to build or buy them This is the horizontal axis.

Strategy as a Portfolio of Real Options

If the value-to-cost ratio is between zero and one, it means the cost of this option is more than the value we will generate from it. If the value-to-cost ratio is greater than one, it means the value generated is greater than the cost.

Volatility metric — measures how much things can change before an investment decision must finally be made This is the vertical axis. The same holds true for evaluating your investments.

See the chart below:. Regions 6 and 1 — These two regions are the now or never areas, where either all the unknowns about an investment have been determined or your time to decide is up. If the investment has a value-to-cost greater than one, you should invest, if below one, no. The dave leaver forex dividing region 2 and 3 equates to the net present value NPV of the option. In region 2, the NPV is greater than 0, in region 3 the NPV is less than zero.

This line would normally be curved strategy as a portfolio of real options harvard business review you were to plug in actual strategy as a portfolio of real options harvard business review the curves have been removed to simplify the chart.

Regions 4 and 5 — Are less promising, because they have a value-to-cost ratio of less than one. Unless this can be improved upon before time runs out, they would not be pursued.

The natural movement of an option within the Option Space over time with no other change is upward i. Managers should nurture the investments in regions 3 and 4 to attempt to increase their value or reduce their cost, thus improving their locations within the Option Space.

As stated earlier, a business strategy is like a series of options or major business decisions. Plotting related options within the Option Space will help managers understand where they need to focus their attention to continue to optimize a particular strategy.

Strategy as a Portfolio of Real Options - Article - Harvard Business School

This technique includes more analysis than the conventional NPV evaluation. It also requires attention. Just like a tomato garden, for the best results, you need to be constantly monitoring and re-evaluating where your options are in the Option Space for the best harvest. Harvard Business Review November-December: Strategic analysis over the entire product life cycle.

Harvard Business Review March-April: Management Accounting Quarterly Fall: The effect of strategy and organizational structure on the adoption and implementation of activity-based costing. Accounting, Organizations and Society 22 2: Harvard Business Review March: Using the balanced scorecard as a strategic management system.

Investment Opportunities as Real Options: Getting Started on the Numbers

Harvard Business Review January-February: Having trouble with your strategy? Harvard Business Review September-October: Transforming the balanced scorecard from performance measurement to strategic management: Measuring the strategic readiness of intangible assets.

Harvard Business Review February: The strategic logic of high growth. Creating new market space: A systematic approach to value innovation can help companies break free from the competitive pack.

Charting your company's future. Harvard Business Review June: Management control systems and strategy: The role of strategy and culture in the performance evaluation of international strategic business units. Management Accounting Quarterly Winter: Techniques for Analyzing Industries and Competitors. From competitive advantage to corporate strategy. Harvard Business Review May-June: What is a strategy? Strategy and the internet. Control in an age of empowerment. Strategy as a portfolio of real options.