David Houldridge
Technology Valuation Manager
E-mail. David.Houldridge@Smith-Nephew.com
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 Overcoming Barriers to adoption
–
Why they may exist.
– How Smith & Nephew overcame some.
 Upside of using options
–
What it may lead to
 Practical advice on using Real Options
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“The innovation process must be set at the highest level of the corporation by identifying goals and priorities, ... The targets you set must be clear and challenging, for you cannot wait for innovation just to show up at your company one day. But you need not, and should not, possess the entire solution to the challenge you set. You have to be sure…that that you raise is realistic, though it might appear impossible.”
-
Akio Morita - Sony Corporation
The Innovation Lecture London Feb 1992
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C = SN([Ln(S/X)+(r+
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4
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
“Successful investment risk management is dependent on the right company culture being in place , so chief executives and senior management must take a major interest in the development and application of their procedures.”
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From Strategic Investment Decisions. Harnessing opportunities managing risks. L Krantz, A Thomason. FT/Prentice Hall. London.1999.
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“The challenge from the point of view of the finance department is to put parameters around curiosity and determine what is and what is not productive. After all, our success or failure in R&D won’t result from the quality of our scientists alone; it will also come from the quality of our thinking about where to invest
”
Scientific Management at Merck. - an Interview with CFO Judy Lewent. Harvard Business Review, 1994.
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 Rules

“Quality” systems
 Planning
 ‘Bean counters’
 Predictability
 Tasks
 Budgets
 Assets
 Flexibility
 quality “Systems”
 What ifs
 Investors
 Uncertainty
 Objectives
 Resource Flexibility
 Knowledge
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“Typical” decision maker characteristics








Intuitive
Computer averse
Short attention span
Skim readers
Set in ways
Make ‘long lasting’ decisions
Are right most of the time
Have invested a lot of themselves in the old way
 Analytical
 Utilise technology
 Focussed
 Flexible
 Accuracy is not needed
 Conceptual


Knowledge gathering
Utilise “Team”
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 Decisions based on intuition are commonly flawed because of bias and missing or misleading information.
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From Strategic Investment Decisions. Harnessing opportunities managing risks. L Krantz, A Thomason. FT/Prentice Hall. London.1999.
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 Alternatively, proper analysis may be discouraged because it is seen as
– too complex to conduct,
– too time-consuming,
– too costly or ineffective.

Individuals may prefer to rely on intuition, ‘gut feelings’, to determine their course of action.
From Strategic Investment Decisions. Harnessing opportunities managing risks. L Krantz, A Thomason. FT/Prentice Hall. London.1999.
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What decade did your decision makers learn their trade?
Inputs
What was the current state of technology at that time?
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Output??
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 What are they employed for?
 How much have they invested in their advice?
 How much has the company invested in their advice?
 Do they know their job?
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 How do we get them turned on?
GO
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 Assumption: being right will not gain support and buy-in.
 Permeation will occur when and where weaknesses allow it.
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Smith & Nephew for example
 Lead customer
 Early adoption by a big customer
 Raised as questions in other business situations
– Not imposed on middle management
– Just communicated with examples for discussion
 Raised awareness of opinion leaders within S&N
 Used as part of idea selection
– adoption by scientists / project leaders.
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 Broadly accepted need
– Justified gut feel projects that other methods throw out.
 Key enablers in place to allow adoptions
– Forecasting, Portfolio management
 Solution not threatening to top management
– Presented as a decision support tool for top management
 Methodology allowed better representation of key information
–
Presenters and recipients were more comfortable
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GRC Project Portfolio
-2.0
Consider Carefully
HOLD
NEVER
-1.5
-1.0
7
6
Probably
Invest
3
2
5
4
1
NOW
-0.5
0
0.0
0.5
1.0
LN(Value/Cost quotient)
1.5
2.0
BUILD
2.5
3.0
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 Traditionally
–
If Return is >>> Investment

“No Brainer”
–
If Investment >>> Return

“Kill”???
 Look for marginal calls, where the decision maker has a vested interest.
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Value
Option
£0
DTA
DCF
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From Vrettos & Steiner.In Vivo May 1998, p27-32
Project Lifetime
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 Tissue Engineering ten years ago?

Traditional approaches with negative £ value led to
– “gut feel”
– Soft items
 Science
 Ambition
 Legacies
Real Options can incorporate gut feel especially where it relates to upside £
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NPV
Reducing Uncertainty and Expectations
Max
Actual
Outcome
Possible outcomes at review dates
Min
Time
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after Newton and Pearson
Regulatory
Project Timeline
Development
End of Research
Project start
Return
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 The risk management process requires the integration of qualitative and quantitative analytical support in an iterative cycle of management activities through the whole life of an investment.
 The quantitative analysis tests the insights and conclusions developed during the qualitative analysis by producing real dimensions required for most decisions.
From Strategic Investment Decisions. Harnessing opportunities managing risks. L Krantz, A Thomason. FT/Prentice Hall. London.1999.
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 Volatility
–
Our volatility is limited by the thoughts of the organisation?
–
What if?
 Should lead to how?
?
££££
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Setting targets and Contingency levels
0%
Cumulative Probability
20% 40% 60% 80% 100%
Maximum Cost
Expected Cost
Target Cost
Minimum Cost
20% probability of attaining cost target
Time (years)
20% probability of attaining schedule target
Expected
Target
100%
80%
60%
40%
20%
0%
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
How often do you get…
– “I can guarantee to deliver that”
 Does this lead to rapid growth or maintenance of the status quo?
 Commitment or committed?
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 Intelligent use of Real Options can lead to a
“valuation” of intangibles such as Knowledge, patents…
 Relies on definition of the work and imposing decisions after the acquisition of the intangible.
££
££
££ NOW
FUTURE
STOP
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 Given that some of our investments will fail, how do we know our more risk acceptance culture will pay back?
–
If we are risk averse, why should we change our nature?
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Our Current Portfolio is low risk.
Risk comfort line
New Products
Current Products
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Current Markets New Markets
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Total accumulated revenues, 1976 –1994, of all companies employing each entry strategy
From: Clayton M Christensen, The opportunity and threat of disruptive technologies, 1997
Total Revenues Accumulated by all firms, 1976 -1994
$237
Average per Company $16
New Products
Total Revenues Accumulated by all firms, 1976 -1994
$14420
Average per Company $1800
Current Products
Total Revenues Accumulated by all firms, 1976 -1994
$3056
Average per Company $83
Total Revenues Accumulated by all firms, 1976 -1994
$36050
Average per Company $1500
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Current Markets New Markets
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 If the future is uncertain why do we need to be certain about now?
 What are we trying to do?
–
Justify this piece of work?
–
So how positive does it need to be?
 If the precision improves our thinking on the model of the future it is worthwhile, otherwise…
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C = SN(d
1
) - Xe -rt N(d
2
) t
C
YES
NO
X
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C,X,S all in £
 max
min
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Simple software allows easier examination of inputs
Sensitivity Analysis
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-0.60
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-0.50
-0.40
-0.30
-0.20
-0.10
0.00
0.10
0.20


“Whenever we are tempted to further refine our scoring of uncertainties, we should ask ourselves if we are attempting to use qualitative analysis to produce quantitative measures.”
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From Strategic Investment Decisions. Harnessing opportunities managing risks. L Krantz, A Thomason. FT/Prentice Hall. London.1999.
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 Five data points
 Have an NPV (S)
 Have Cost (X)
 Know T-t
 R is often given
 Sigma – guess or use Pert methods
 Quick Black - Scholes, change variables and understand what happens when the calculation goes belly up off we go.
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 EV = (a + 4m + b)/6
 s.d = (b-a)/6

 a = pessimistic
 b = optimistic
 m = most likely
 Needs experts!
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Can use Delphi approach
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 Successful investments are not delivered by analysis alone and management of both objectives and risks must continue throughout the whole life of an investment.
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From Strategic Investment Decisions. Harnessing opportunities managing risks. L Krantz, A Thomason. FT/Prentice Hall. London.1999.
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
“
Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money becoming little.”
–
Fred Schwed – FT 22/11/99
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