Making Strategic Investment Decisions - Real Options Theory and Strategic Cost Management: Two Bottles for the Same Wine?
17 Pages Posted: 4 Nov 2010
Date Written: January 1, 2010
Since the end of the ’70s, many researchers have been pointing out some criticisms to the application of advanced financial techniques (e.g. Internal Rate of Return and Net Present Value) for valuing strategic investment decisions: a) their inability to take into account the value of managerial flexibility; b) their poor relationship with strategy.
Real Options Theory (ROT) and Strategic Cost Management (SCM) have been proposed as the solutions for the two criticisms. The purpose of this paper is twofold. Firstly, it offers a fully-comparison between ROT and SCM articulating around a series of differentiating elements: 1) the relationship with the firm strategy; 2) the epistemological models surrounding SCM and ROT; 3) the way they focus on the risk and the uncertainty inherent in the decision; 4) their incentive towards an active management of the strategic investment; 5) the degree of formalisation of the structure of the two approaches; 6) the scope of their applicability; and 7) the most prominent difficulties linked to their implementation. Secondly, the paper examines whether ROT and SCM can be seen merely as two competing methods for firm decision-making, or if some integration between them is also possible. The underlying idea which is here purported is that ROT and SCM can be combined into a unitary and hybrid model for valuing strategic decisions, where the major advantages of the two techniques can be strengthened through their integration.
Keywords: Real Options Theory, Strategic Cost Management
JEL Classification: G31, M21, M4
Suggested Citation: Suggested Citation