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 choice  Prior 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 & cognition  Right Place & Right Time

The Option Chain  Sense Making  Shadow Options  Secure Preferential Access  Strike Types  Flexibility  Strategic Change  Incremental  Calls & Puts

Theoretical Propositions  Downside Risk and Optimal Inertia  Sunk Cost Hysteresis: Hold existing & defer new investments  Positive 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 strike  Opportunity 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 shifts  P2: 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 call  Market 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 1 st signal received  Calls struck after only 1 st signal only received  Calls & Puts struck after only 2 nd 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 projects  Sense-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 choices  Strategic 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 findings  Maintaining Slack Resources & Negative NPV Investments  Evaluation of Options ≈ Managerial Intuition  Absorptive Capacity > Recognition & Striking of Options  Option chain dependent on prior investments  Path Dependency leading to Inimitable resources > Sustained Competitive Advantage

New Explanation of Findings  Strategy and Selection  Positioning in t for opportunities in t+1  Garbage Can  Solutions before problems as Shadow Options waiting to be struck  Means Consensus  Goals subject to uncertainty, less important to reach consensus  Risk-Return Paradox  Negative 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?