What can Math and Psychology teach us about Agile?

who's the girl commenting on real options in the conclusion?

I'm an Agile Coach at Thoughtworks, and fairly new in the role. I have a particular love of spontaneous environments - places where people love to sign up to new work, try new things out, get stuff done. Spontaneity can't happen in a place where people have limited options, and spontaneity is fun!

The technical things that you can do with Real Options, are fairly easy to imagine (write two adapters, of course!) But I've used Real Options when considering whether decisions made now have to be permanent, and under what circumstances we'll revisit them (but not necessarily decide); to stop premature discussions in meetings, and to spot points at which we're shutting down our options unnecessarily, or not taking advantage of one. An example; as Iteration Manager, I'm moving from recording by iteration to recording by date. We don't need it at the moment, but it gives us the option to use that information in the future. Multicoloured finger charts! Cakes whenever a story gets finished in under 3 days! and what's the real impact of that post-release party?

Thanks, Chris; that conversation was fun too. :)

-- Liz

Why is the value of the option not important? Why is it obvious we should not make a decision earlier than the last possible moment?

We know from numerical methods that a series of local optimizations rarely lead to a global optimization. In the end we are looking for global optimizations not local ones.

Last responsible moment seems to me like we are putting blinders on.

Excellent comments Amr.

The value of the option is important, that's why we say that every option has a value. During the decision process you should look at the value of all your options and based on the price you would have to pay to get the value, decide what the best action to take is.

The reason for not making a decision earlier is that you don't gain anything by deciding earlier, but you can make a better informed decision if you wait until the latest responsible moment. If you know you can gain something by making the decision earlier, compare the immediate gain to the value of the options you're not using. And if you think you have to act earlier, do so, that's why the third line states: "Never commit early unless you know why".

Deciding what the best option is, is determined by your own context. If you are looking only for local optimization, that's fine. Deciding what constitutes the last responsible moment (time / circumstance / reaction) is essential and is influenced by many factors. The latest responsible moment is not just a specific time; it can be a specific time, or a response to an event, or a whole complex system of conditions to be met.

For an optimal decision process you should take the whole system into account and base the conditions for the latest responsible moment on the whole system not just the context of the decision alone.

You're only putting blinders on if you choose to, Real Options are not the blinders.

I don't think Chris and Olav are saying the value of an option is not important. In fact, quite the opposite. You absolutely need to understand the value of an option to understand when to exercise it. The value of the real options Chris and Olav are discussing does not always have to be financial, it could be related to some other change in situation. Flexibility within large programmes of work itself is often something very difficult to put a value on.

In terms of deferring a decision, I am fascinated by the human behaviour around uncertainty, and how uncomfortable it makes a lot of people feel.

If you look back over the last 15 years or so, how many people had easy access to email or mobile phones or the internet? I don't have to remember too far back to where video recorders revolutionised peoples behaviour and gave people options on when to watch films or TV progams.

Also, if you wanted to arrange to go for drinks you had to make a decision on where and when in advance. A lot of people who have teenage children today will agree that if they ask their kids at 6pm on a Friday night what they are doing tonight, they'll most likely shrug, grunt and point at their mobile phone. Teenagers have naturally adopted the "defer the decision" mentality, but the parents being of a different generation call it disorganised or lazy. Another example of how we are changing culturally is the popularity of LastMinute.com, TopTable.co.uk or other such sites that
allow you to avoid a lot of the detailed decision making (i.e. commitment) too far ahead of knowing where you feel like going or what you feel like eating, and therefore limit what your options are.

If you think about it, technology is helping us to avoid having to make decisions too far ahead when we don't have all the information we need. People are getting more comfortable with the uncertainty of not planning in advance as they have tools to provide them with options/choices at the time they really need to make a decision. However the older generation and my generation, still struggle with the "uncertainty" as they were not brought up in the "on demand" culture we see growing today. Perhaps that goes towards explaining why senior mgmt tend to not like uncertainty.

The other thing about Senior Executives is that their diaries are normally planned very carefully. Often for months in advance. The idea of an empty diary is scary to them. They like to know what they are doing in advance so that they can plan other things around themselves. They operate a personal optimisation program that may make their organisation less efficient. Say I need the green light on program. It may take several months to get the authorisation which is a delay to the project. The delay is simply about getting a slot in the diary.

I like the mention of the "mobile" generation. The mobile phone is possibly the most important tool for a Real Option based approach.

Before the mobile phone, it was necessary for everyone to commit to a meeting place. Now, people can change their mind at any point and chose a new venue.

Amr

Hello again. Will you be in Washington?

As Olav says, the value is important. Unfortunately you cannot use Black Scholes to derive the value. In fact, I am not aware of any model that will give you a reliable price for a Real Option. Quite often the value is not even monetary.

Most of the material I've read on Real Options apply Black Scholes to Investment Decisions without understanding the underlying assumptions (Stated or Unstated). When you investigate those assumptions as they relate to Real Options, it all falls down as a house of cards. In effect, the traditional Real Options approaches offer false accuracy. If you are interested, I can explain what those assumptions (Underlying Market Price, Liquidity, Risk Neutrality) are and why they fail for Real Options.

I agree whole heartedly on your second point. It is about time that IT departments stopped trying to optimise their own through put and costs at the expense of the wider business. When the only thing you can manage is costs, cost optimisation is your goal. Real Options appreciate that there is value in providing options to others and yourself. In effect, it avoids local optimisation. The question is always which level should you optimise? I suggest business unit is a good starting point.

By waiting to the last responsible moment, you give yourself the chance to incorporate late breaking information and consider alternative solutions. The "responsible" means that you need to understand the last point to make a decision without affecting the delivery of the project.

I'm puzzled by the blinker reference. My experience of normal management decision process is a quick brainstorm, big painful meeting to make a decision. Everyone gets behind the solution and runs like crazy. After that intial decision, there WILL be no deviation from the plan. Blinkers? Yes... This is the opposite of Real Options.

The reason for not making a decision earlier is that you don't gain anything by deciding earlier, but you can make a better informed decision if you wait until the latest responsible moment.

As Olav says, the value is important. Unfortunately you cannot use Black Scholes to derive the value. In fact, I am not aware of any model that will give you a reliable price for a Real Option. Quite often the value is not even monetary.

Hi Chris and Olav,

I remember talking to you a couple of years ago, Chris, about real options. I liked your thinking and I later had a chance to use the idea of "keeping your options open" while talking with my parents who were considering selling their farm and retiring.

It turned out that they actually had many options which they could explore and I thought they were prematurely choosing the most expensive one (selling the farm). We discussed the options but in the end they going with their first choice - i.e. they sold the farm. Why? My Dad said that they just felt more comfortable with the decision made and were pleased they no longer had to think about it.

I wonder if you've seen any research, writing or even your own opinions about how different people or personality types cope with the "ambiguity" of keeping their options open?

Amr

We are not saying the "The last responsible moment." We are saying "Options Expire. Do not commit early unless you know why."

Even though we do not know the exact value, we do know an option has a value. Also, we can specify when an option expires.

Let me illustrate with an example.

I was working in an Investment Bank. We were developing a web site to display the results of some funky new analytics (clever maths). We had two choices. One, build on a strategic platform, or two, build a tactical solution that would be migrated to the strategic solution at a later date. The sales team insisted that we get to market asap. A month delay was unacceptable.

Unfortunately the strategic platform was still in development and was not in production. The funky analytics were currently in the hieroglyphics on paper stage. We could not start on the development until the analytics were complete (or at least the API was stable).

In typical fashion we held a meeting of about 20 very very smart business and IT people to decide between the two.

We decided on the tactical solution because we thought it would be quicker.

I was the project manager for the Web site.

I decided not to make a commitment to this decision. We were trying to decide which would finish first... The funky analytics or the strategic platform. We estimated that it would be at least a month for the analytics.
The expiry date for this option was actually the date on which the analytics were complete.

I asked the strategic platform guy to run like hell. I reordered my development plan to push the option expiry date out.

As it transpired, there were issues with the analytics (that were caused by market events outside of the bank) and they were delayed.

The solution was developed using the strategic solution which was quicker to market than the tactical solution would have been. In addition we saved several hundred thousand dollars by not developing the tactical solution. Simply by delaying a decision by a month or so, with no impact on the delivery date.

I would like to emphasize "Do not commit early UNLESS YOU KNOW WHY." This is the middle ground. It is not a hard rule. It is a principle. Observe people's especially manager's, behaviour. Quite often their default decision process is "NOW!". No middle ground.

Could I value the strategic/tactical option? No. Did I know when the option expired. Yes.

I hope you will be at Agile 2007, because I would love to take you through the full model.

chris

Clarke two points to look at here.

Wherever there are options there will be ambiguity by definition. Beware of using personality typing to predict outcomes such as commitment to a course of action. Commitment to an option is determined by state of mind, not personality type. It's state of mind that determines how one "cope"s with ambiguity and the associated choices present.

All sorts of factors will influence the excitement (or stresses) inherent in holding out for the "best" option because in the end selecting an option denotes commitment. All decisions - or commitments are triggered by feelings - (it's long subject - I'll take it offline if you wish) but in a nutshell the final driver in any decision is "it feels right". No matter how much logic or academic analytical rigour you apply to defining options, in the end commitment boils down to down to a trigger called "it feels right". Basically if one or more options create more "emotional stress" (pain, uncertainty) than others (relief/gain, selling a farm) then the commitment trigger will be driven by the criteria that provide the "best value" in the case above, selling held more "value" than the other options. Hope this helps.

Gary

My understanding of Myers Briggs Type Indicators would suggest that adoption of a Real Option based decision process would cause a migration from J (Judging) towards S (Sensing).

Chris

Oh, like our world NEEDS more P's, lol

Chris
We need to bear in mind that Myers Briggs typing attempts to categorise a complex emergent entity (a person with thoughts and feelings) - with a view to infering that some groups (J or S types) would respond to an emergent environment containing options in a predictable way.

By attempting to classify people into like MBTI style "predictable types" we presuppose each type has a predictable set of limited options. Some may even wish to infer that your "type" could provide insight into the way in which you exploit options. By grouping people into types we are in effect assuming limits to the options available, when exactly the opposite is true.

Options provide choices - time and stress (neediness) regulate the excitement and prioritise the options - and finally commitment to a decision brings closure (gain); everything takes place as complex set of relatively simple interactions - the term for this is emergence. Statistics, Astrology, MBTI, etc assume a reductionist or constructivist approach to determing the probability of a single outcome.

Options are different; options provide true freedom of choice - (free will) - they provide the opportunity for a multiplicity of outcomes.
Options provide a platform for emergence - where anything can or may happen and usually does.

Regards
Gary

If Toyota only builds cars after they have been purchased, what are all the cars doing in their sales lots? I love the concept. The last time I bought a car, I specified my requirements, after which the salesman said "I'll find you your car". I said "I don't want you to find it, I want you to BUILD it". Six weeks later I had the exact car I wanted! Howefver, it was not a Toyota!

Just a couple of thoughts...I've often found that there are many shades between "right decision" and "wrong decision". It is rarely a simple binary outcome.
Secondly (and this might be more related to Agile, in general, than to Real Options), I often encounter projects where functionality cannot be broken down into discrete, deliverable components/features. Oftentimes, a complete, end-to-end process must be delivered in order to have ANY useful funtionality.
Nice article.

One thing that doesn't seem to be covered in the commentary is that most valuations derived in business cases where real options can be used are estimates. Certainly, there are usually some numbers to back up assertions, but at some point, you hit a jumping off point. What the valuation models do is try to average out a range of estimated outcomes. Instead of having a decision tree with two discrete and finite points, you find a range of potential outcomes and probabilities attached with each (e.g. a Poisson distribution). So, while valuing the option is an imperfect science, so is valuing and predicting the outcomes. By utilizing real options, you increase the probability of knowing your outcome because of more information, but it is not a guarantee of any outcomes. Time makes the crystal ball a little less murky, which is valuable in and of itself.

Nice post. I've enjoyed reading it!

So if it is not a Toyota! - is that a good thing or a bad thing?

Hi John

Toyota were the first to cater for two types of buyer. One buyer wanted to buy a car that day. They could choose from anything on the lot. The other buyer was prepared to wait a few weeks for the exact car they wanted.

The Toyota Way has spread throughout the motor industry and on to most manufacturing industries. Womack and Jones's Lean thinking gives a few case studies.

I agree on the right/wrong decision thing. When you force yourself to make a decision NOW, you often end up with a polarised decision. Giving yourself time allows you to come up with other options, often combining more than one. This is the subject of Roger Martin's "How successful leaders think" article in the June 2007 of HBR.

I agree on the functionality point. We tend to deliver Minimum Marketable Feature sets (or MMFs), the concept originated in "Software by Numbers" by Denne and Cleland Huang.

Hi Jason

Thank you for your comment.

I'm with you here. I started out trying to value the optionality in Agile... And failed. Then I tried to use Real Options to generate business cases... And failed. Then I realised pretty much all business cases using ROI were Crystal Ball gazing as well. What is most important is that people actually put together a business case in the first case. This means people think about how they are going to generate business value.

As I've tried to develop business cases over the years I have found that the business often push back on ROI based business cases. This feature will mean we will process 1000 trades, with $1000 profit on each... Instead, a Real Option approach, we say This feature will give us the Option to process 1000 trades. Then we can guess probabilities for each trading volume which should generate ranges rather than a single value.

ROI and Black Scholes based analysis can give a false sense of accuracy. As you say, Business cases are crystal ball based estimates, and waiting gives you a better insight into the future.

Chris, Olav,

an interesting aspect of the delayed exercise of real options is to look at the already known properties of normal (financial, or commodity) options.
It is well known that the so called american call option should be never exercised early (prior to expiry), however the opposite is true for the so called american put option. (there is an easy mathematicall proof of this in John Hull's book).
Is it possible that your statement about no early exercise applies only to certain class of real options but for some other classes there is more optimal exercise point of time prior to expiry?

One case where you would exercise early is when there is an additional dividend declared with an ex div date prior to expiration that was not known at the time of the purchase of the call option (which has known dividends priced into the option price, presumedly). I would imagine that the same would apply here; exercise the option early when the underlying assumptions change or when there accrues an additional dividend (so to speak) that was not previously known or incorporated. Another possibility is when taking a path frees up resources which can then be applied to a higher ROI activity. This doesn't address "classes" per se, but situations.

Hi Plamen,

you are right. The optimal exercise point of time can be very dependend on the context in which it resides. Therefore it is important to stress the 'unless you know why' of the third rule. With the american put option you know why you want to exercise early and there are even situations where it actually makes sense to execute a call option.

One other point to make here is that options expire, which means that at that point in time they no longer have any value (or significantly less). Waiting till the expiry time may be very risky as circumstances may change and expire your option even earlier than you anticipated. This also is part of the knowing why.

Turned out to be a GREAT thing. The car was an Oldsmobile (in 1990, long before they went out of business). That was not GM's 'preferred' sales methodology (there were incentives for moving cars off the lot). However, American consumers had leverage as car buyers long before the internet exposed the MSRP myth! You could order a car at invoice price, specify exactly what you wanted, and add $100 for the salesman's efforts.

Sorry, Chris. I know none of this has anything to do with Real Options!

Chris/Olav - got a "dirty dozen" question for you.....

So where would you NOT want to use real options, and where would they fail to be effective?

Given that this is about behaviours, and not Black-Scholes, the question is how we can get people to let go of the spurious feeling on control they get from a big plan up front and have them realize the real control that they can get from making decisions when they're needed. As mentioned in the thread this is probably about personality types - some people are uncomfortable with the idea of ending up where it takes you rather than having the defined end point. This is especially true if people with that personality type have been more effective at getting to influential positions in your organization.
What can be done to win them over?

Tim - Your first question:

"how we can get people to let go of the spurious feeling on control they get from a big plan up front and have them realize the real control that they can get from making decisions when they're needed"

"ending up where it takes you rather than having the defined end point"

At a very high level, I think that real options in Agile are your stories. Your stories are your options. Iteration planning meetings let you decide what goes into this iteration (where this iteration is the last possible moment).

At a level a bit closer to the ground, the details of an individual story can be left until the last minute (e.g. a quick discussion with the customer as you launch into a new story). They tell you what they need to see before the story could be considered 'complete'

At the ground level, BDD and TDD give us the ability to specify what the facets of that story are. We write the specification for the story, as code-but we don't implement it until the very last moment. By which stage the decision on HOW to implement the story (or that single specification) becomes a no-brainer. Using true BDD and TDD approaches, the actual implementation of the code is a lot easier that the decision of what to implement (or how to implement it). BDD/TDD is the thought process-the discovery process. It allows developers to discover the options that are available.

If you cannot specify the functionality as a coded spec, then you obviously do not have enough information to make that decision-a great time to make no decision, go back to the customer and flesh out the detail some more.

What's I like about real options is that it is all-pervasive. A methodology that can be applied at the coarse grained as well as the fine grained is great! It gives members of the team, at all levels (customers, management, code-monkeys etc) a common understanding of how to approach an option, and when to make that decision.


BTW...Great article guys! ;)

Great question Iain.

I apologise for the delay answering the question. I was in a bar last night watching "Shaun the Sheep" with a friend. An option to consider if you get the chance.

There are two situations where you should ignore the Real Option approach.

1. When your gut screams at you to get out of a situation. Get out! Get out fast!

Malcolm Gladwell's "Blink" contains a story (pg 122 on Amazon.com ) of a fire lieutenant who orders his team out of a seemingly routine kitchen fire... moments before the floor collapses.

Real Options are a conscious mind tool. Your conscious mind can only process information is it consciously aware of. The sub-conscious mind is aware of other information that a person's conscious mind might not be focused on. When the sub-conscious mind becomes aware of a threat, it will communicate through the body creating a sense of foreboding or unease. If this sense is acute... move fast. Any direction you can.

By conscious / sub-conscious, I mean the things you are focused on as opposed to your mindful peripheral vision (senses).

2. Sometimes other organisations are using utility and option based pricing models. This means the longer you wait, the more it will cost. This is not a problem when people say "Buy before 20th June and get 10% discount." In this case you know when the option expires. The problem is when the price changes based on unseen stimli to the system. The classic example is airline flight prices. The price goes up as more seats are sold and as it gets closer to the flight time.

Last year I decided to go to Agile 2006. I looked at flight prices on Wednesday and discovered it would be cheaper to do a stop off in Toronto. About $1000 in total. I e:mailed some friends in Toronto to see if they were free. On Friday I got the replies and tried to book the flight via Toronto. It had gone up to $3000. In the time it took me to check out expedia (ten minutes), the price went up to $4000. Someone else had obviously bought a ticket and sent the price up. Options are worth more when there are fewer of them. Supply and demand.

This year rather than wait until I knew for certain that I was going, I booked a suite in the conference hotel (free option that can be cancelled up to the day of stay) and bought a flight well in advance. It was likely I would go and the earlier I booked the cheaper the flight. I bought a flight ticket for $1000. The airlines reward you for removing their uncertainty.

Real options are about knowledge. Knowledge allows us to make better decisions. Two colleagues in New York were thinking of attending Agile 2007. They were getting the company authorisation when the "Nearly sold out" sign went up. I told them to buy immediately. They were worried they were commiting to the approx $1000 conference price. In actual fact they were committing to $100 which is the admin charge for a cancellation. They bought the option to attend for $100. A few days later it sold out.

Finally. On eBay, experienced bidder wait for the last minute to bid. They do not commit too early. They might decide weeks in advance to buy that rare signed edition of the white book. But they wait to the last minute to bid (commit) to get the chance to read chapter 3 (plus the other stuff on coding).

Night night.

Raymond

Thank you.

Yep. Real Options are for everyone. Inside and outside the community or organisation. CxO down to Lawyer.

I agree on the story point.

Andy Pols and I are working on a Real Option, TOC based software investment, project management and community coordination tool. The metaphor we are using is a dream. A dream is a story that does not exist. Once a dream is implemented, it becomes reality.

demo.pols.co.uk/dream/world/available

We even realised a dream for Ward. Check out the bad patents.

Chris,

I have to disagree with you here.

I agree on the first example. In his book 'Blink' Malcolm Gladwell explains very well how our subconcious works and how we should listen to it and improve it. There are circumstances where something just doesn't feel right and you don't know why. There are many examples of this in the book and I can highly recommend it.

The second example is actually an example of Real Option theory. The third 'rule' of Real Option theory says to not commit early unless you know why. In the flight tickets situation you actually know why you want to commit early. If you don't commit early the prices go up dramatically over time. Therefore you commit early.

So Chris - your airline example is perhaps a 'Real Future'?

Olav

OK.

You have me here. Next time I'll reply before the glass of wine instead of after.

Chris

Hi,

In my role as project manager, I prefer early decisions, instead of having them as late as possible.

Early decisions reduce the complexity and gives direction to the team, and clarity for the customer what we are really doing. Have a clear goal for the team increases motivation, while being vague because several options are still open can lead to misunderstanding/miscommunication.

Early decisions also reduces time(money) spent in (re-)discussing options and trying to have a good overview on them all.

I'm not saying that decisions are final. Let's see them as working assumption. When the need arises (especially brought up by the customer), most decisions can be debated again.

Making a decision sometimes takes into account several stakeholders in a complex project. So when an 'option expires' one may find out that a decision is not made fast enough because of the involvement of several people in the decision itself.

Jan Willem

Hi Jan

Thank you for your comment. It is a question that often arises. In fact I was discussing this issue with a friend of mine over curry a couple of weeks ago. He also had a go at Real Options with Game Theory. Poor old Game Thoery ;-)

Are you going to Agile 2007. I would love to discuss this further.

My response...

In my role as project manager, I prefer early decisions, instead of having them as late as possible.

Early decisions reduce the complexity and gives direction to the team, and clarity for the customer what we are really doing. Have a clear goal for the team increases motivation, while being vague because several options are still open can lead to misunderstanding/miscommunication.

Early decisions also reduces time(money) spent in (re-)discussing options and trying to have a good overview on them all.

Early decisions also reduces time(money) spent in (re-)discussing options and trying to have a good overview on them all.

Making a decision sometimes takes into account several stakeholders in a complex project. So when an 'option expires' one may find out that a decision is not made fast enough because of the involvement of several people in the decision itself.

So when an 'option expires' one may find out that a decision is not made fast enough because of the involvement of several people in the decision itself.

Quick q on real options - How do you deal with cost of creating the option in the first place ? Would it be a wasteful cost if that option is not really exercised ?

I know you speak about cost optimisation. But it should not really become an excuse to pre-build stuff e.g. "Frameworks would give you more options in the future to quickly deploy business applications"

Great questions Prashant, one that gets to the heart of the problem in IT. IT departments try to optimise the cost of software development. They do not optimise the delivery of business value.

Consider the situation where a client will chose "A" or "B". Say the profit is $1Million, solution "A" costs £100K and solution "B" costs £100K. Now say the client will chose the provider that delivers the quickest solution. Which do you build? Well, it could be that you build both options at a cost of £200K. Traditional IT wisdom is to chose which one to build which optimises IT costs but not business value. i.e., you take the risk you make the wrong decision. building both is exactly what Microsoft did in the early 1990s.

As for building options... We know they have value. You can estimate the value (but do not use Black Scholes) and then compare to the cost. The key thing is to know when you have to start. The cost of the option is subjective. If everyone is flat out on building a feature for a client, then the cost of time is high. If people are between features, then the cost is effectively free. Do not associate cost with man days. Unutilised resource is free. Do not let the accountants mess you up.

Analysis is a knowledge option. We use analysis as an information discovery process. The key thing we are interested in is not the detailed analysis but how long it will take to build the feature. What is the takt time? We may never use the analysis but its value in "sizing" the effort is very valuable. We would not use an analyst to do this if they are working on something else, only if they are free (in more ways than one). The same with developer frameworks. You should not be building them on the critical path. They should be developed when the developer time is free.

At the moment, there is a LOT of low hanging fruit. Most Real Options you build are effectively free. Developers on the beach building frameworks are building free options.

Accountants would say that you used the developers and should assign their costs to an option. In actual fact the developers on the beach are an option. The option to deploy a developer quickly...

It is worth distinguishing between the (Theoretical) Value and the Cost of Real Options. The Value is the “fair value” of the option; the price at which you would be 50:50 on having it or not. The Cost is how expensive it would be for you to set up. If the Cost to you is less than the Value then you should buy/build it. If it is more then don’t bother.

One thing for sure about options is that they cannot have a negative Value.
However their Value can drop from whatever it was originally.

An options value changes when new information comes in. If the information is very bad the option would become worthless but if it is good the option would become more valuable.

One of the difficulties with Real Options is actually quantifying their theoretical Value. I suspect that it is far easier to give various options a relative value (bigger, smaller, about the same) than to actually quantify them in any absolute sense. I confess I have not managed to work out a precise theoretical Value of any Real Option.

The theoretical value of the option is how much you would be prepared to pay to have it given what you know right now. So the difficulty is in estimating both the likelihood and impact of good information vs. bad information.

A zero Cost or free option is always worth having. Its theoretical Value cannot be lower than the Cost. If bad information comes in it has cost you nothing whereas if good information comes in you gain Value by having the option.

One of the nice things about Real Options is that they provide a very general argument in support of making decisions ‘at the last responsible moment’. This can be re-interpreted as never exercise a zero Cost option early. They also provide a very general argument that there will always be a price worth paying for an option (even if it is not so obvious how to calculate it). However, if you can show that the Value is “clearly” greater than the Cost of the option then having exact figures does not matter.

So; Real Options are worth having when the Cost of setting one up is clearly less than its theoretical Value.

@John Beyer

First, Toyota had to change their approach in the US to fit with the local culture. Apparently in Japan they have a much tighter relationship with their customers.

More important is their approach to design. When designing a component, they will keep three streams running in parallel: a fallback based on known practice, an improvement that they expect to be able to make in the time, and an impossible target that will change the game. At the last possible moment, they will pick one. This means that they always hit their design dates, but sometimes get to make radical improvements.

The point is that they understand that minimising cost (i.e. only picking one stream) does not bring the most value. They're prepared to spend on options to achieve reliable delivery and, possibly, better quality.

Interesting article. I think there definitely something in our make-up with causes us to strongly prefer certainty, but if we can let go of this there is often a far better outcome available.

It's also true that you can use options theory as a tool to analyse certain situations, but how you apply this as a tool is highly subjective. For example, this article suggests deploying projects resources on a least-experienced first basis, since you're buying a cheap option; However, you could equally apply option theory and decide that by putting the most experienced developer on the project, you're buying a cheap option (the option to reuse component that the more experienced developer has used before). Is 'Option theory' just a posh way of saying 'keep your options open'? The real art of management is look at the infinite range of possible options and determine which are valuable to you.

I think we have to be careful that we don't try and look for something too scientific here, and I think the link to financial options is a bit of a red herring (it tells us that keeping an option open has value, but we should know that already, even if we don't always apply it). A financial option contract is useful for managing a known unknown (e.g. a UK company buying an American product in 3 months doesn't know what the GBP/USD exchange rate will be, but it a clearly defined one dimensional unknown). A project manager's job, however, is largely about unknown-unknowns.

In my role as project manager, I prefer early decisions, instead of having them as late as possible.

Early decisions reduce the complexity and gives direction to the team, and clarity for the customer what we are really doing.

I finally arrived at this article, today!
ditto, ditto.

It is easy to show by math that the sigma of the potential value times its possibility through all the possible branches of the future can be maximized by Real Options.

Is the sigma of "fun" also maximized ??

-Kenji

I found a paper which state that "because the value of flexibility increase with uncertainty, high variable and low fixed costs become more attractive as uncertainty increases. Real-option theory therefore implies that the ratio of variable to fixed costs should increase with high uncertainty."

Actually, I don't understand this statement, anyone can help me to understand? thanks!

I'm rereading this article as I want to explain Real options to a clients managers. Since I first read this, I have also read The paradox of choice. www.amazon.com/The-Paradox-of-Choice-ebook/dp/B...
In the book Schwartz says that having more options does not make us any happier. (on the contrary)
Could this paradox be a reason why people prefer to make choices earlier?

To clear up a common misconception about the XP Customer, XP always wanted a real customer to work in the building with the team at all times. Many times this is not practical or possible, so the commonly advised compromise was a "proxy" who got out of the building early and often to talk to the real customers. At no time, at least as far as I have seen, did XP prefer or advocate the customer "proxy".