Business Engineering: A Practical Approach to Valuing High-Risk, High-Return Projects Using Real Options
Abstract
Technologists and engineers endeavor to design and propose leading edge concepts, but the development of these concepts ultimately depends on obtaining funds justified by a business case. Most existing business case tools and methods, which have their origins in the conservative banking industry, tend to favor those project concepts that have secure annuity-like returns such as extensions of existing product lines. This tutorial provides engineers with the business case methods and tools to calculate the value of smaller, more risky projects where new technology or markets are involved, and which potentially offer higher returns in the long run. These straightforward methods and tools have been adopted from sophisticated techniques used in the options markets, where investments in risky securities are routinely traded. We first present an example scenario for a new product and review a typical business case using net present value analysis. Next we develop a “what-if” multi-scenario business case model using Monte Carlo simulation. Then we examine an investment decision using a decision tree to capture scenario flexibility. Finally, we determine a risk-averse investment decision using real options calculated with an intuitive and transparent algorithmic tool. In conclusion we show business engineering as a new approach that provides engineers with investment and risk modeling tools and methods that can be incorporated alongside standard systems engineering design modeling techniques to justify the targeting of project investment dollars to manage risk, shape value outcomes, and make better strategic decisions.
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