Real Options (Luehrman)

Knowledge Center

12manage is looking for students / contributors...


Treating strategic investments as financial options. Explanation of Real Options of Timothy A. Luehrman. ('98)


  1. Summary
  2. Forum
  3. Best Practices
  4. Expert Tips
  5. Resources
  6. Print

What are Real Options? Description

Real Options capture the value of managerial flexibility to adapt strategic decisions in response to unexpected market developments. A company creates shareholder value by identifying Real Options, managing of Real Options, and exercising Real Options, associated with its investment portfolio. The Real Options method applies financial options theory to quantify the value of management flexibility, thus turning uncertainty to its advantage in a changing world.

The idea of treating strategic investments as financial options was conceived by Timothy A. Luehrman in two HBR articles: "Investment Opportunities as Real Options: Getting Started on the Numbers" (July-August 1998) and "Strategy as a Portfolio of Real Options" (September-October 1998). In the last article Luehrman says: "In financial terms, a business strategy is much more like a series of options than a series of static cash flows".

Use of Real Options. Benefits

As a result of the above, when valuations involve significant future flexibility or uncertainty and/or future cash-flows alone are close to break-even, flexibility is a major source of value, and option value must be taken into consideration. Note that the first mentioned circumstance is typical for strategic scenarios. And even for strategic decision-making in general.

Formula of Real Options. Calculation

Formula used is Black-Scholes or other similar. Generally, the following variables determine the value of having (an) option(s) - option value:

  • Time to expiration (duration).

  • Degree of uncertainty.

  • Cost of acquiring the option(s).

  • Potential cash flows lost, compared to full upfront commitment.

  • Risk-free interest rate.

  • Expected present value of future cash flows.

By introducing these factors into business decision-making, the Real Options method has enabled corporate decision-makers to use uncertainty for the advantage of the firm, and to create a limit to downside risk.

Real Options Forum
  Real Options: Measures to Cut Costs
The problem with strategic cost cutting is it is b...
  Real Options Applied to Rapid Labour Mobilization
In some industries, the speed of mobilization of l...
  Applicability of Real Options in Oil and Gas Field Development
How to use the real option technique for the appra...

Real Options Special Interest Group

Special Interest Group

Real Options Education & Events

Find Trainings, Seminars and Events

Best Practices - Real Options Premium

Expert Tips - Real Options Premium

How to Become a Self-tuning Enterprise: Advanced ExperimentersSign up

In an HBR article of June 2015, Reeves, Zeng and V...
Usage (application): Organizational Agility, Strategic Agility, Real Options, Emergent Strategy

How to Design Experiments to Support Decision-making on Strategic InnovationsSign up

The probability of success of a major innovatio...
Usage (application): Strategic Innovation, Strategic Decision-making, Strategic Experimenting, Experiments, Strategic Testing, Innovation Tes

How to Link Risk Management and Strategy?Sign up

Firms practicing strategic risk management:
Usage (application): Strategic Risk Management, Best Practices

Align Strategy and Risk ManagementSign up

In a recent white paper titled "Foundations of GRC...
Usage (application): Performance-Aligned Risk Management

Taking Risk Management from Control and Compliance into a Competitive AdvantageSign up

Since events tend to be repetitive over time, many...
Usage (application): Strategic Risk Management

Why Society is More Risky than BeforeSign up

In his 1992 book "  

Real Options and Brand ValueSign up

A brand can be considered as a feature that allows...
Usage (application): Exploiting Real Options

Resources - Real Options Premium

Scenario Planning and Risk Management in Uncertain Business EnviromentSign up

Extensive and detailed presentation.
Usage (application): Scenario Planning, Risk Management, Strategic Uncertainty

Important Issues Involving Real OptionsSign up

This paper by Gordon Sick and Andrea Gamba provide...
Usage (application): Real Options, Capital Budgeting

The Six Basic Questions of Risk Management: Introduction to Risk ManagementSign up

Managing risk is essentially a process of asking a...
Usage (application): Initial Understanding of Risk Management, Risk Management Introduction

Financial Flexibility OptionSign up

This model estimates the value of financial flexib...
Usage (application): Valuing financial flexibility

Delay OptionSign up

This model estimates the value of the option to de...
Usage (application): Valuing delay option

Expand OptionSign up

This model estimates the value of the option to ex...
Usage (application): Valuing expand option

Rules of Thumb in Real Options AnalysisSign up

In this normative paper, Giuseppe Alesii derives p...
Usage (application): Real Options Analysis

Abandoning OptionSign up

This model estimates the value of the option to ab...
Usage (application): Valuing abandoning option

News about Real OptionsSign up


News about Strategic Decision-makingSign up


Videos about Real OptionsSign up


Videos about Strategic Decision-makingSign up


Presentations about Real OptionsSign up


Presentations about Strategic Decision-makingSign up


Books about Real OptionsSign up


Books about Strategic Decision-makingSign up


More about Real OptionsSign up


More about Strategic Decision-makingSign up


Compare with: Scenario Planning  |  RAROC  |  Strategic Risk Management  |  PEST Analysis  |  Analogical Strategic Reasoning  |  Root Cause Analysis  |  CAPM  |  Dialectical Inquiry  |  Plausibility Theory  |  Theory of Constraints  |  Operations Research

Return to Management Hub: Change & Organization  |  Decision-making & Valuation  |  Finance & Investing  |  Knowledge & Intangibles  |  Strategy

More Management Methods, Models and Theory

Special Interest Group Leader

You here

About 12manage | Advertising | Link to us / Cite us | Privacy | Suggestions | Terms of Service
© 2018 12manage - The Executive Fast Track. V14.1 - Last updated: 19-8-2018. All names ™ of their owners.