ABSTRACT
Abstract: We analyze a class of information technology (IT) investment decisions, interdependent projects in a portfolio, which can be informed by the application of real option analysis from financial economics. We specifically identify the attributes unique to IT investments, both within and across projects. We examine previous literature in real option analysis of IT investments and extend the methodology with a log-transformed binomial model to a portfolio of interdependent IT projects. Using data from a representative portfolio of a large health care company’s Internet initiatives, we model complex interdependencies between the e-health projects in our portfolio as a series of nested options. We frame our analysis in light of current research and address ongoing issues on managerial tractability of real options analysis in IT investments. Keywords: Empirical Model, E-Health, Investment Evaluation, IT Value, Log-Transformed Binary Model, Option-Adjusted Value, Project Portfolios, Real Options
INTRODUCTION
The rate of growth of spending on information technology (IT) has been steadily increasing in every part of the world during the past decade. The rate of increase has ranged from an average of 1.5 percent in Asia to an average of 7 percent in America and Canada (Gartner Group, 2004). In the United States alone, IT spending accounted for a full third of total corporate spending in 1998, comprising 7 percent of the gross national product (Lentz and Henderson, 1998). Yet for the magnitude of this investment, the analysis of the IT investment remains a daunting challenge. The direct benefits and costs are difficult to quantify. IT investments often encompass a myriad of interdependent risk factors, both endogenous and exogenous to the firm. These risk factors include financial risk, project risk, and political risk, as well as competitive risks and environmental uncertainties (Benaroch, 2002). Although IT investment evaluation remains complex, managers nonetheless must make investment decisions with real dollars subject to real budget constraints. This chapter addresses the problem with a real option method for evaluating a portfolio of interdependent IT initiatives that incorporate managerial flexibility (Luehrman, 1998).
