Evaluating Product Plans Using Real Options

Abstract

Product planning helps a company to strategically plan its current and future product platforms and offer product variants in the marketplace. Product platforming is widely touted as a successful strategy for mass customization. However, due diligence should be exercised before implementing any product platform strategy. The product planning exercise should account for future uncertainties. Traditional financial tools such as the net present value (NPV) are static since they do not compensate for any exogenous and endogenous uncertainties during the course of the project. The crux of the problem lies in the evaluation model that is used for evaluating the product planning projects. While many view uncertainties in a product planning project as problematic, it can also be viewed as a source of new opportunities. We argue that uncertainties should be an integral part of the evaluation model. If the future possibilities (or strategic options) are not considered in the evaluation model, a corporation may face a “myopic syndrome”. In this article, we consider two important product planning decisions—platform decisions and product variant decisions. The platform decision involves strategic selection of a concept product platform from various possible alternative concept product platforms. The product variant decision involves deciding how long a company should continue to offer its current product variant in the marketplace and whether the existing product variant should be discontinued, scaled down, or scaled up with additional product features. To address the two aforementioned decisions, we developed a real options-based methodology that considers technical, project implementation, and market-related uncertainties. The proposed methodology uses a binomial and quadranomial lattice approach to build a decision tree. Product planning decisions at various decision tree nodes are evaluated using a risk-neutral option valuation methodology. We demonstrate the working of the proposed methodology using an illustrative example.

Department(s)

Engineering Management and Systems Engineering

Keywords and Phrases

Development Economics; Economic Theory & Philosophy; Engineering Economics; Industrial Economics; Industrial Engineering & Manufacturing

International Standard Serial Number (ISSN)

0013-791X

Document Type

Article - Journal

Document Version

Citation

File Type

text

Language(s)

English

Rights

© 2007 Taylor & Francis, All rights reserved.

Publication Date

01 Jul 2007

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