Monday, November 17, 2008

Real Options Process.

Last Tuesday I met with David Peterson at XTC. David asked me about a comment I had apprently made along the lines of "Real Options are a process". ( I trust David, but not my memory ).

Real Options are based on the three statements...

1. Options have value.
2. Options expire.
3. Never commit early unless you know why.

1. and 3. tell us we should defer our commitment until the last responsible moment. But what is the "last responsible moment"? To answer this, we look at statement 2. "Options expire ( or mature )"........ But what does that mean?

To illustrate this, we discussed getting home from XTC. Immediately we run straight into the another question. "What is the deadline or target?".... "We want to get home by XXX time, or by YYY condition." In fact, do we need to get home?

Often we discover that we do not NEED to get home or some other intermediate step, but rather the commitment is to be at work in a fit state by 9am the following day.

By pushing the commitment back and trying to identify the real commitment, we end up with a better understanding of our true goal. This is the first part of the process. Identify the true goal or commitment. In software development, this is often "Deliver the software AS SOON AS POSSIBLE.". More later on that

Lets assume that our goal is "Home by 1am to relieve the baby sitter." Now we know where and when we need to be. ( In production by December 1st )

For this we need to identify our options. For this, we start with the destination and work towards the origin ( City Pub ). This way we only consider valid options. Invalid options (that take too long) drop out as part of the process.

The last train (free as we have a travelcard) we can get leaves Waterloo at 12:00. A taxi from Waterloo takes 40 minutes costing £50, and from the City pub takes 35 minutes costing £55.

A train from Waterloo to "Town near home" leaves at 12:15 and takes 40 minutes followed by a 10 minute taxi ride costing £20.

To get to Waterloo from "City Pub", We can get the bus ( 30 minutes, £2 ), Taxi ( 5 minutes at £10 ), or Northern Line/Jubilee Line ( 15-20 minutes, Free! ), Waterloo and City Line ( 8 minutes ), etc., etc..

Traditional project management would identify that the cheapest, quickest route is Waterloo and City Line ( 8 minutes ) followed by train from Waterloo to home.

So the second step is identify the options and their costs. Note that this is an information hungry process. You will need to do more research, but we normally do this well away from the expiry date in what we call "slow time". Once we exercise the option, we are normally in "fast time" and go as fast as possible. The time to seek out and gather new information is very expensive during "fast time" and cheap in "slow time".

A Real Options process leaves that decision until the "last responsible moment." What does that mean? Well, obviously we do not want to pay more than we have to. Also, we want to hit our deadline.

First a word on costs. We should consider costs in two ways. In traditional "Cash out the door" cost management way, but also time. We should consider time as "fast time" (on the critical path ) and "slow time" ( off the critical path ).

We record the time and cost of each option, and work backwards to establish the possible routes. Then on the evening, we can decide on the best route. The best route will depend on a number of factors....

More later. I've done a spreadsheet for this example, just need to display the results.

36 comments:

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