Bowman and Hurry (1993) Presented by: Zhiling Lin Strategy Through The Option Lens: An Integrated View of Resource Investments and the Incremental-Choice Process Bowman and Hurry (1993) Presented by: Zhiling Lin

Motivation Resource investments and unfolding strategy choices are two related elements Invested resources provide a platform for launching strategies Strategies often generate resources

Option Theory How does an option work? Using option contracts to retain the right to future investment choices without being obliged to invest Hold a choice open at the risk of losing only the (incremental) sunk cost

Option Theory – Strategy through the option lens Resources and the bundle of options: Organization’s resources are a bundle of options for future strategic choice When existing resources and capabilities allow preferential access to future opportunities Firm gains preferential access as a potentially friendly bidder from a joint venture Limiting the Sunk cost of existing assets works like an option contract in limiting downside risk

Option Theory – Strategy through the option lens Shadow Options and Sense Making: Opportunities for strategic choice come into being only when it’s recognized Managers must “make sense” before identifying the potential action Strategy to capture the opportunity will emerge from the bundle of options

Option Theory – Strategy through the option lens Incremental Strategy and the Option Chain Strategies are produced by sequential striking option chain Involves the sequential recognition of shadow options and investments Option has two basic categories: incremental and flexibility Incremental: similar to call and put “Strategies are continued by striking successive calls, but they are reversed by striking puts” “The sale of a call option is equivalent to the creation of a put option”

The Activation of Options A fixed sequence of actions in involved in the activation Managers are motivated to convert the shadow option into a real option Usually make a small investment rather than large Option will be struck when it is ready to exploit Investment is necessary for the option to be fully activated New shadow options arise

Theoretical Refinements and Research Propositions Downside Risk and Optimal Inertia Bundles of options truncate the downside risk Inertia: sunk cost in the past has pressure on organization to defer new investments Optimal inertia is related to industry structure and the option bundle protection against downside risk The more protection an organization has against downside risk, the wider its zone of optimal inertia 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 Refinements and Research Propositions Perceived Environmental Uncertainty Value of option increases as the volatility of underlying asset’s value increase Conversely, as volatility decreases, the organization stands to gain more by striking Managers have motivation to strike options when environmental uncertainty is low Environmental volatility is a function of time for exogenous reason, and endogenous reasons related to the speed of organizational learning Proposition 2: 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 Refinements and Research Propositions The size and timing of organizational investments It is valuable to make small investments in options, followed by large investments in option strikes Large investments such as acquisitions often fail in new areas because of a lack of appropriate management and production operating skills Successful organizations progress from “learning” investments to full operations in a manner resembling an option chain Rival bidder for the company will force the organization to strike its option Proposition 3: Organizations that enter new business and markets by linking investments – so that small options are followed by large strikes – will perform better than those entering with only discrete small, or large, investments.

Theoretical Refinements and Research Propositions The size and timing of organizational investments Two signals to strike: opportunity signal and expiration signal Opportunity signal is a necessary condition and the expiration signal is a sufficient condition Managers tend to perceive threats more accurately than opportunities Proposition 4: The performance of organizational investment in option strikes in related to investment timing as follows – from (a) = high performance to (e) = low performance: (a) Calls struck after receiving both signals. (b) Puts struck after receiving only the opportunity arrival signal. (c) Calls struck after receiving only the opportunity-arrival signal. (d) Calls and puts struck after receiving only the expiration signals. (e) Calls and puts struck before receiving either signal

Theoretical Refinements and Research Propositions The portfolio of options An organization’s ability to strike options effectively is also influenced by its structure If organization allows individual options strike independently, it’s “portfolio of options” If organization allows options to strike in hierarchy, it’s “an option on a portfolio of assets” In general, it is more valuable to hold a portfolio of options Proposition 5: 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

Contribution to strategy and organization theory Experience shapes manager’s cognitive lenses Organizations learn through trial-and-error experimentation Organizational investments provide current returns and cash flow, and they open up options. The value of a firm is the sum of earnings generated by investments plus the option value of future strategic choices The option bundle strengthens the conceptual bridge between strategic action and the value of the firm Organization’s accumulated learning not only provides capabilities that give preferential access to opportunities, but it also influences sense making and the recognition of shadow options

Discussion What are the potential applications of this paper? What can be improved in explaining the concept of options?