Business and Corporate Strategy

Business and Corporate Strategy
MSC IN CORPORATE FINANCE & BANKING
Sept. – Oct. 2022

Welcome to
Business and Corporate Strategy !
Claus HIRZMANN
Strategic Finance
+33 (0)6 84 99 88 28
claus.hirzmann@strategic-finance.eu
Class Schedule
Date Session Activity
Sept. 05 - 09 Session 1 Introduction, Lecturing, Case study: ZARA vs. ASPHALTE.COM
Sept. 06 - 13 Homework Preparation of session 2: Read The Dollar Shave Club
Sept. 13 - 14 Session 2 Case study: The Dollar Shave Club, Lecturing, Instruction for Simulation Game
Sept. 14 - 22 Asynchronous Simulation Game: Back Bay Battery, read case and play round 1
Sept. 22 - 23 Session 3 Simulation Game: Review of round 1, instructions for round 2, Lecturing
Sept. 23 - 27 Asynchronous Simulation Game: Back Bay Battery, read advanced case and play round 2
Sept. 27 Online exam Continuous assessment (15%), 08h30 – 08h45 (15’), MCQ (12 questions)
Sept. 27 - 28 Session 4 Simulation Game: Review of round 2, Lecturing
3
Class Schedule
Date Session Activity
Oct. 06 - 07 Session 5 Lecturing, Strategy implementation – Design-To-Cost: Lecturing and exercises
Oct. 07 – 13 Asynchronous Entirely facultative round: Simulation Game: Back Bay Battery, read case and play
NEW & optional this additional round.
Oct. 13 – 14 Session 6 Strategy implementation – Real Options: Lecturing
Oct. 17 Online exam Simulation Game (30%) (final exam part 1) :
further advanced case (round 3), 09h00 – 11h00 (120’)
Oct. 20 - 21 Session 7 Strategy implementation – Real Options: Lecturing
Oct. 24 Q&A Online Q&A sessions on Collaborate, one for each group A, B, C, D, 1.5h each.
Oct. 27 On-campus exam Final exam part 2 (55%), 13h30 – 15h00 (90’), MCQ (22) + Real Options Case study
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The Key Role of Corporate Finance & Banking in Strategy
01. Introduction
Heavy trends & The Role of Finance in Strategy
02. Review: Key Concepts of Strategic Thinking

What is Strategy, Assessment of Situation, The Rules of the Game, Create & Implement Strategies
03. Current Business Models and Strategic Concepts

Digitalization, Innovator Dilemma, Technology Adoption, Manage R&D, Platforms
04. Key Methods for Strategy Implementation

Real Options, Design-To-Cost
5
The BIG picture: The Role of Finance in Strategy
Key idea: Based on financial analysis, Finance can drive performance optimizations. And there is more !
Dupont Chart
Net Profit
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑅𝑂𝑆 =
𝑆𝑎𝑙𝑒𝑠
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
Sales 𝑅𝑂𝐴 = 𝑅𝑂𝑆 ∗ 𝐴𝑇 =
𝐴𝑠𝑠𝑒𝑡𝑠
𝑆𝑎𝑙𝑒𝑠
𝐴𝑇 =
𝐴𝑠𝑠𝑒𝑡𝑠
𝑹𝑶𝑬 = 𝑅𝑂𝐴 ∗ 𝐷 = 𝑹𝑶𝑺 ∗ 𝑨𝑻 ∗ 𝑫
Assets
𝐴𝑠𝑠𝑒𝑡𝑠 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
Debt 𝐷= =
𝐸𝑞𝑢𝑖𝑡𝑦 𝐸𝑞𝑢𝑖𝑡𝑦
Equity
To improve ROE, simple asset stripping may be dangerous, as vital assets may be concerned. Rather, determine headroom
for improvements by considering distinctly ROS and AT. Benchmark against the best competitor for each indicator.
• For better ROS: Manage margin, i.e. improve price (differentiation) and/or cost (reduce unvalued activities).
• For better AT: Manage assets, i.e. improve productivity, improve asset management (fixed, inventory, receivables).
6
The Role of Finance in Strategy
Change
• Defining Objectives
Finance • Driving Innovation &
Transformation Strategy
• Optimizing Costs
→ Profitable Growth
7
Heavy Trends: The Role of Finance in Strategy
KPMG: “As traditional, historical analysis becomes fully automated, analytics capabilities will shift
from descriptive to prescriptive.”
Descriptive Diagnostic Predictive Prescriptive
What happened ? Why did it happen ? What will happen ? What should we do about it ?
Example: Revenue by dimension, Example: Root cause analysis Example: Future estimations of Example: Strategic scenario
geography, product, service, (explanations of variances) revenues and profitability based analysis of opportunities to
customer Emerging technology: Enterprise on demand drivers improve profitable growth (new
Emerging technology: In memory Performance Management digital Emerging technology: Machine markets, customers, services,
computing, Robotic Process delivery learning, unstructured data channels)
Automation What will change: Speed of processing Emerging technology:
What will change: Speed of analysis What will change: Predictive AI/cognitive, big data analytics
transactions analytics What will change: Hypothesis
generation, advanced customer
and market analysis
8
Heavy Trends: Technological Innovation for the Financial Sector 2021
by Laurent MAROCHINI, Head of Innovation at Société Générale Securities Services in Luxembourg slide 1/7
Digital acceleration
Who led the digital transformation of your company in 2020 ?
(1) CEO
(2) COO • Digital onboarding
(3) CTO • Electronic signatures

(4) Shareholders • Digital interactions
(5) Clients • New ways of working
(6) COVID
9
Data, Big Data and AI
• Cloud infrastructure
• IoT
• 5G
• Data exploitation
(→startups)
10
Tokenization and digital currencies coming out of Lab
• Token economy
• CBDC and stable coins
• Crypto assets and
institutional investors
• Business model focus
• DEFI (decentralized finance)
11
An open ecosystem to benefit innovation
• Rise of fintech and tech

companies
• Business model strategy /
innovation dilemma
• Platform economy
• Open Banking
• APIs vs PSD2
12
Hyper client-centricity
• Societal revolution
• ATAWAD (mobile,
instantaneous, self-service)
• UX “Less is more”
• Co-creation
13
Data: an asset that must be protected
• Cost of cyber attack

• Techniques
• Digital assets … but not
only
14
The future of Environment, Social and Corporate Governance (ESG)
• Client behavior
• Regulation (must keep
pace to secure national
competitiveness)
#Timetochange
#Saveourplanet
Jean-Marc Jancovici: Doing business while disregarding energy and climate ?
GDP = Energy = CO2 15

The BIG picture: The Role of Finance in Strategy
Finance as a function can profit from a broader knowledge about Corporate Strategy …
• New Business Models: Platform economy with their ecosystems

• Digital native, ATAWAD
• Strong network effect drives economies of scale and scope
• Big Data and AI for customer centricity enable network effect and customer lock-in
• Reinvented Business Models:
• Manage the innovation dilemma, transition from “Rising Star” to “Cash Cow”
• Digital native businesses, redesign of value chains, globalization
• Mass customization, XaaS
• Analysis:
• Hypothesis generation, Strategic scenario analysis
• One can read a competitor’s strategy from his/her investments: new products / services, job openings, patents, …
… and can contribute with key methods for strategy implementation:

• Real Options: Investment in innovation, M&A, and strategic agility in operations and deals.
• Design-to-Cost: Optimize Cost/Value ratio, support design of Blue Ocean strategies.
• Value Chain analysis: Focus on added value, redesign for reduction of costs and risks.
16
The BIG picture: Finance has a key role to play …
… for turning Strategy in Reality and thus to …
17
01. Introduction



18
02. Key Concepts of Strategic Thinking
What is Strategy ?
Definition
Assessment of the situation

Strategic Units of Analysis, External Environment, Internal Capabilities
Understand the rules of the game

Quality/Price/Value and according General Strategies, Short-term / Long-term Advantages
Create & implement strategies (change the game)

Market / Corporate level strategies, Strategic Positioning, Competitiveness, Create Strategy,
Portfolio based competition, Scenario-based planning
19
What is Strategy ? Company fundamentals
Mission / Vision
purpose
Values
identity
Objectives
quantified goals
Strategy
plan to be successful
20
What is Strategy ? A plan to be successful
• External factors determine the average performance (ROE) of your industry.

• Internal factors determine how you differ from average.
• ROE = ROS * AT * D is a good measure for financial performance / success.
• Strategy = A plan to be successful thanks to Differentiation and/or Competitiveness:
• How to setup a company such that it produces what customers want / prefer ? (vs. Marketing: How to have
customers perceive the qualities of the product/service ?)
• Put internal decisions in the light of external environment: understand customers, compare to competitors.
• Adapt to and/or modify the environment.
• Produce today’s performance AND create the conditions for future success.
21
What is Strategy ? The Strategic Thinking Process
1. Assessment of the situation:

a. Define homogeneous Strategic Units of Analysis (SUA)
b. Assess the external environment: customers, competitors, trends, requirements
c. Assess the internal capabilities: core competencies, competitive advantages
2. Understand the rules of the game
a. Quality vs. Price vs. Value.
b. Short term profitability vs. Long term market share
3. Create a strategy and implement it
a. Competitive pressure: from where, which tendency, impact on business Create significant
and sustainable competitive advantages
b. Create a strategy / change the rules, i.e. find and exploit holes.
c. Portfolio level management and competition
22
What is Strategy ?
Definition



23
Situation: Thinking in homogeneous Strategic Units of Analysis (SUA)
Key idea: Define and analyse market from a customer focused perspective ! Satisfy customers, not managers !
WHAT ?
Function provided by Product / Service
Value proposition
SUA
by WHAT + HOW
WHO ?
Needs / Key Success Factors
per Customer Segment
HOW ?
The way a Product / Service is made available from a
customer perspective: How to shop, pay, receive, use, dispose.
24
WHO ?
Needs / Key Success Factors per Customer Segment
• Find homogeneous needs / expectations / situations. This defines a Customer Segment. If well defined, key success factors
become obvious.
25
WHO ?
Page content by courtesy of Karin KOLLENZ-QUÉTARD
Beware: Do not conclude from same demographics on homogeneous needs / customer segments !
Example of demographics:
• Male
• Born in 1948
• Raised in the UK
• Married twice
• Practicing Christian
• Lives in a castle
• Wealthy and famous
Prince Charles Ozzy Osbourne

26
WHO ?
become obvious.
• Beware: Do not conclude from same demographics on homogeneous needs / customer segments !
• Important to identify latent needs (market push, see Ford-T, iPhone, Blue Ocean Strategy) vs. expressed needs (market pull).
• The needs of customers relate to their own “job to be done”, see STRATEGIZER canvas. As the provided products / services
help them to achieve their goals and to create value, customers are ready to pay for them.
• Thus, in a B2B setting, remember that the needs of you customers include the needs of their own customers (see
SOMFY example). Account for all needs along the value chain !
27
WHO ?
Careful: Do not only account for the needs of your direct customer but also for the needs of your customer’s customers
all along the value chain !
Engine
Manufacturer OEM Installer Shopping mall Store Consumers
In this example, the engine’s safety unlock feature is important to all. Thus, Somfy should not only account for the
needs of the OEM who integrates its products, but also the needs of all subsequent customers in the value chain !
28
WHO ?
become obvious.
• Dual- or N-sided-markets (platforms*): All sides of the market are your customers, as you have to cater for the needs of all.
A customer is not necessary the party that pays.
* A platform in the sense of an N-sided market is to be distinguished from PLATFORM

in the sense of a basis that allows the efficient creation of multiple (similar) products.
29
Points of Sales
WHO ?
Providers Common
When operating Dual- or N-sided-markets (platforms):

All sides of the market are your customers, as you have to cater for the needs of all. A customer is not necessary the party that pays.
For the Global Distribution System (GDS), both

sides of its dual-sided market have to be taken
care of ; both are customers.
In contrast, the Revenue Model is asymmetric:

When a Point of Sales books an e-ticket
through the GDS, the providers pay a booking
fee to the GDS, and the GDS uses part of it to
pay an incentive to the Point of Sales.
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WHO ?
become obvious.
• Dual- or N-sided-markets (platforms*): All sides of the market are your customers, as you have to cater for the needs of all.
A customer is not necessary the party that pays.
• As per the Technology Adoption Cycle, several discrete customer categories can be distinguished (see Crossing The Chasm).
* A platform in the sense of an N-sided market is to be distinguished from PLATFORM

in the sense of a basis that allows the efficient creation of multiple (similar) products.
31
WHO ?
1 2 3 4 5 Needs / Key Success Factors per Customer Segment
Discrete customer categories / segments as per the Technology Adoption Cycle by Moore:
1. Innovators:
Technology 5. Laggards:
enthusiasts (2.5%) Sceptics (16%)
2. Early Adopters: 3. Early Majority: 4. Late Majority:

Visionaries (13.5%) Pragmatists (34%) Conservatives (34%)
32
WHAT ?
Function provided by Product / Service
• First, think in terms of functions that fulfill needs. Then, think about products / services that
implement these functions.
• This ensures to consider all possible solutions for implementing a function as product / service.
• Moreover, it ensures to consider all relevant competitors. Indeed, a competitor provides same
or similar functions to the same customer segment.
• Example: Fast travelling between Paris and Marseille can be provided by air travel or by high
speed trains. Airlines and the SNCF are competitors in this segment.
• Remember: An industry is not defined by products / services ! Industries are defined by
offers of SIMILAR FUNCTIONS as per customer perception.
• Do not define a function too broadly.

• Example: For travelling in general, airlines and the SNCF may or may not be competitors.
33
HOW ?
The way a Product / Service is made available from a
customer perspective: How to shop, pay, receive, use, dispose.
• The HOW takes a customer perspective: How is a product/service made available to customers, i.e. how
do they shop and pay for it, how do they receive it, how are they supported in its use and disposal ?
• Note: This HOW relates to parts of the operational implementation as per the Business Model: Sales &
Distribution channels, Customer Support, Revenue model. While these are part of the Business Model,
there is more to it. Thus, this HOW is only indirectly and partly about the Business Model.
34
• The Value Proposition strives for satisfying customer needs. It is the combined result of
• WHAT function is provided through products / services, AND
• HOW those products / services are made available to customers.
• The way you choose to operationally implement this Value Proposition is called the
Business Model = How to create, deliver and capture value ?
→ Supply Chain, Technology, Value added, Sales & Distribution channels, Customer Support,
Revenue model.
• Recommendation of internet site about Business Models:

https://businessmodelnavigator.com/network
35
Situation: Assessment of External Environment by player
Competitive Pressure: Where does it come from ? How will it change over time ? How will that impact your business ?
PORTER’s 5 (+1) Forces

Barriers for New entrants
Suppliers bargaining power Intensity of Competition Customers bargaining power

Competitor = similar value
proposition to same
customer segment
Threat from Substitutes Regulatory requirements

Also note competition for
share of wallet (e.g. Apple)
The Competitive Pressure depresses margin. Therefore, measure it by giving a rating for now and the future.
Only the evolution is important. The relevant question is: How much have you changed compared to your
BEST competitor ?” Check for consistency of performance target !
36
Situation: Assessment of External Environment by theme
Competitive Pressure: Where does it come from ? How will it change over time ? How will that impact your business ?
The 10 (+1) Macro Sources of Disruption

Because technology is so intertwined
with everyday life, it is shown as
intersecting with all the other
sources.
Reference to original article:
A. Webb, The 11 Sources of Disruption Every

Company Must Monitor, Disruption 2020, MIT
Sloan Management Review Spring 2020, (see
202003_Disruption2020_MITSloan.pdf, pages 43
to 48).
37
Situation: Assessment of External Environment
Forecasting – Assessment of the future
“Strategy is about forecasting the consequences of what already happened.” M. Montebello
• Projection: Future is presumed to be like the past.
• Prospection: Future is unlike the past:
• Scenario Technique:
1. Look at heavy trends
2. Build pessimistic / optimistic / plausible scenarios
• Delphi Forecasting: expert panels iterate to converge to a consensus.
• Note: For a better forecast, reduce the period of forecasting. E.g.:

• DELL with build-to-order, no need for forecasting
• Benetton, coloring clothes in last stage.
38
Situation: Assessment of Internal Capabilities
• Competitive Advantages arise from Core Competencies / Core resources and allow to deliver
solutions that customers
• value as they address their needs/requirements, and
• perceive as making the difference to competitors.
• Types of competitive advantages:
(1) From Research

• Size (economies of scale, experience effect) → not applicable to starting products.
• A privileged access to resources / pre-emption of scarce resources
• A privileged access to customers !
• A possibility to limit competitors’ moves, e.g. patent, customer LOYALTY, switching
VITAL TO CHECK
costs, network effect
(2) From Theory

• Cost for VOLUME / VALUE situation
• Differentiation for PREMIUM / VALUE situation
• Speed to market
• Sustainable Competitive Advantages are costly to imitate, takes time to imitate.
39
Situation: Assessment of Internal Capabilities
• Validate your Competitive Advantages:
• Check consistency of your specific advantages and the customer expectations.

• How do you compare to competitors ?
Importance of advantage You have a You have a
HIGH
Avoid war and

weakness on a key significant
improve.
variable ! strength !
to customer
Improve it, it’s your Use it, it’s your

MED
weakness. strength.
Don’t
LOW
Don’t care. Don’t count on it.

care.
Worse Same Better

Your position relative to main competitor
40
What is Strategy ?
Definition



41
Rules of the Game: #1 – Types of markets as per customer sensitivity
Customer segment is sensitive to …
QUALITY
Yes No
VALUE (trend) VOLUME
Differentiation, longer term, Commodity, no LOYALTY,
Yes
bigger volumes, Quality is just a constraint,
PRICE e.g. Mercedes Class A e.g. pasta, Windows PCs
PREMIUM not informed
Niche at high-end,
No
e.g. Bugatti Chiron
• PREMIUM / VOLUME: Price = Cost + Margin (“Produce, then sell”).

• VALUE: Price = Target Price = Target Cost + Target Margin (at target quality) → Design-to-Cost method
• Competition from VOLUME position to PREMIUM/VALUE: Takes time, requires to change the image (e.g. Fiat).
• Competition from VOLUME/PREMIUM positions to VALUE : Difficult due to culture (quality/cost management).
• Competition from VALUE position to PREMIUM: Well possible ! Thus, do not wait for competition (disruption), be ready to
do it with your own products. However, cultural barriers may be high.
42
Rules of the Game: General strategies per market type
VOLUME strategy Frontal competition (on price). Use this strategy only if you can
be #1 in your market. “Winner is the one who is able to lose most”.
• Assumptions:
• Customer is PRICE sensitive; demand strongly depends on low price.
• Quality is just a constraint of a commodity – but not to be neglected, quality requirement is constant.
• There is an EXPERIENCE effect: The more a product gets produced, the more efficient production can become.
• Strategy:
Increase Produce
Costs profit more
EXPERIENCE effect
enables
Reduce
Sell more
costs
Σ Production Volume
Note: The maximum possible growth rate depends

on the supported financial leverage L = D / E Decrease
prices
43
PREMIUM strategy Strategy for uniqueness / monopoly situation.

Bypassing competition.
• Assumptions:
• Customer is QUALITY sensitive.
• There is a demand for any price level.
• Strategy:
1. Be perceived unique and remain so. Systematically exceed customer expectations (LOYALTY). Just communicate
on QUALITY, never on PRICE. High price / margin.
2. Maximize (short term) profit, “Skimming / milking the market”
Note: There is no relation between ROE and Size. Size depends on the market.
Demand
Increase
Increase “Skimming the market”
relative
profit
quality
Increase
prices
3rd 2nd 1st Price
44
VALUE strategy This strategy requires to understand what is valued by customers.

Bypassing competition. See Blue Ocean Strategy
• Assumptions:
• There is a (historical) relation between produced QUALITY and PRICE. “You get what you pay for”
• Customers balance PRICE and perceived QUALITY.
• Strategy: Create VALUE by providing a higher QUALITY at same PRICE, or same QUALITY at lower PRICE, or both.
• Higher QUALITY:
• Increase produced quality as per company’s strengths,
• Increase perceived quality e.g. stylish design, add services, longer opening hours, branding / image,
customization, TTM/speed, …
• Lower costs and PRICE: Invest in aspects that are valued by the customers, divest otherwise. Design-to-Cost.
QUALITY
PREMIUM
Systematically exceed
VALUE “You get what you pay for”
“You get what you pay for”
→ Creates LOYALTY
VOLUME
PRICE
45
Rules of the Game: #2 – Long-term vs. Short term Advantages
• How long last your Competitive Advantages ?

• Imitation of competitive advantages by competitors takes time.
• Strategy must be consistent: Advantage should lasts long enough to get at least your money back.
FCF
t
tBE
• As per duration of Competitive Advantage vs. time to Break-Even, target either

• Short-term Profitability or
• Long-term Market Share.
• Reading recommendation:
• Rita Gunther McGrath, The End Of Competitive Advantage, Harvard Business Review Press, (2013)
46
Rules of the Game: First understand in what game you are, then play it
QUALITY (bypassing competition)
Fragmented PREMIUM or VALUE

Sales ROE
“no forecast” “small is beautiful”
ROE No correlation, SIZE
t SIZE depends on the market
• Lower price or good job are no guarantee of future SIZE

success. → No forecasting, each time one short
business → Minimize fixed costs, small is beautiful • Be perceived as unique and remain so.
→ “HIT & RUN” • Action: Systematically exceed customer
Short-term • Action: INNOVATION, SPEED or CHANGE RULES expectations (→ LOYALTY) Long-term
competitive competitive
advantage No correlation with SIZE, COST advantage
ROE ROE #1 Go there only if
can be profitable or not Experience effect
you can be #1 !
SIZE #2
Σ Prod. #3 SIZE
• Customers are in strong position, success depends • Get there if you can be #1, i.e. if you can be fastest
on market only. E.g. Pasta. in achieving best costs / price thanks to experience
• Action: MANAGE COSTS or DIFFERENTIATE (e.g. effect and economies of scale.
Barilla through marketing) or EXIT. • Quality is just a constraint, cannot justify a higher
Fragile price. → Action: COST, COST, COST !!! VOLUME
PRICE (frontal competition) 47

What is Strategy ?
Definition



48
Strategic Positioning: A choice rather than an obligation
“Who are you competing with ? Who do you WANT to compete with ?” M. Montebello
The choice of the targeted customer segment (WHO) and the design of the value proposition (WHAT and HOW)
to address their needs are based on …
• ... the market attractiveness (size, growth, average ROE, risks, ESG, regulations, …),
• … the choice of the general strategic positioning, i.e. to compete as per competitive advantages, or to
bypass competition by creating an uncontested market space as per core competencies.
Market …
grows doesn’t grow (contested)
Compete
Compete for NEW Grab existing customers from competitors.

customers Beware of price war !
Choice
Create NEW, uncontested market space, see Blue Ocean Strategy.

competition
Key is to have a better customer perception, i.e. better perceived quality:

Bypass
• Satisfy customer needs – expressed and/or latent.

• Differentiate, consider the integrated solution Product + Services.
• Optimize price, reduce costs.
49
Strategic Positioning: The Blue Ocean Strategy
Red Ocean strategy Blue Ocean strategy

Compete in existing market space. Create uncontested market space.
Beat the competition. Make the competition irrelevant.
Exploit existing demand. Create and capture new demand.
Trade-off: Price vs. quality Create value: Better price & quality
Make competition irrelevant by creating a New Product Category.

Operate in your uncontested market, expand and dominate.
1. Customer focus: Needs & frustrations
2. Value Innovation:
a. Quality innovation (improve)
i. Raise specific quality features
ii. Create new features
b. Lower cost & price
i. Eliminate costs
ii. Reduce costs
Watch video on: https://www.youtube.com/watch?v=5Xd5lvyWMe8 50

Competitiveness: Satisfying Customer Needs
• General actions for satisfying customer needs are about PRICE, QUALITY and/or TIME:
• For best PRICE / lower costs, consider

• economies of scale, experience effect,
• focus on value added activities (see next page), can be much more effective than experience effect,
• optimize perceived quality instead of producing higher quality,
• use Design-To-Cost.
• Better QUALITY always pays in PREMIUM or VALUE markets, being average does not. Thus, it is preferable to
be BEST on one variable than average on all (→ Unique Selling Points, e.g. Google) ! Distinguish:
• Produced quality: a good product, it does what it is designed for. Drives costs, thus produce quality as
good as necessary (customers, competition), not better !
• Perceived quality: e.g. stylish design, add services, longer opening hours, branding / image, customization,
TTM/speed. “I think, perception leads the world”. M. Montebello
• Latent quality: An imaginative product/service whose function addresses a latent need, e.g. iPhone, “No
service” in British Airways’ 1st class to let people sleep. Creates NEW segments, see Blue Ocean Strategy.
• TIME: The faster the better !
“The average customer does not exist. An average strategy satisfies nobody”. M. Montebello 51
Competitiveness: Reduce costs throughout the internal Value Chain
PORTER’s generic
value chain
(for internal analysis)
Activity creates Activity contributes to Activity is

Advice
value to customer ? core competencies ? compulsory ?
YES YES don’t care Key activity, invest ! No outsourcing.
YES NO don’t care Key activity, invest ! Can be outsourced.
NO YES YES Invest for the future.
NO YES NO Maintain if important contribution.
NO NO YES Maintain and make it NOT compulsory.
NO NO NO Eliminate or otherwise justify !
Example: Get rid of intermediate resellers, sell direct (see DELL Computers). 52
Competitiveness: Creating Competitive Advantages
• Objective of a competitive strategy is to gain significant advantage over competitors at an acceptable cost.
• Competitive advantages come from:

• Superior positioning: use existing capabilities to perform, be able to adapt (flexibility)
• Superior (use of) resources: invest in capacities, create the conditions for future performance.
• (Reminder) Competitive Advantages allow to deliver solutions that customers

• value as they address their needs/requirements, and
• perceive as making the difference to competitors.
• Types of Competitive Advantages

(1) From Research
• Size (economies of scale, experience effect) → not applicable to starting products.
• A privileged access to resources / pre-emption of scarce resources
• A privileged access to customers
• A possibility to limit competitors’ moves, e.g. patent, customer LOYALTY, switching costs, network effect
(2) From Theory
• Cost for VOLUME / VALUE situation
• Differentiation for PREMIUM / VALUE situation
• Speed to market
• Sustainable Competitive Advantages are costly to imitate, takes time to imitate.

53
Create Strategy: Consistency: External Environment vs. Internal Capabilities
SWOT analysis
• Opportunities / Threats: External evolutions that may have a positive / negative future impact on your business.
• Strength / Weakness: Internal characteristics that may have a positive / negative future impact on your business.
• S/W to be assessed in relation to O/T. → First list O/T, then assess S/W.
• S/W to be assessed vs. competition and importance to customer segment.
• Analysis: “Criss-Cross” S/W with O/T to identify an action plan for meeting your objectives – your strategy:
• S+O: Matching strategy, S+T: Neutralisation strategy, W+O: Transformation strategy, W+T: Defence strategy
Positive impact Negative impact

Strengths Weaknesses
Internal
origin
!
Opportunities Threats COMPULSORY
External
in business creation
origin
54
Create Strategy: Consistency: External Environment vs. Internal Capabilities
SWOT analysis – Attention points

• Define quantified objective (S.M.A.R.T.), otherwise the SWOT analysis ends up with wishful thinking.
• Competitive analysis myopia: Analyses …
• Focus on existing resources, existing competitors and past strategies,
• “Take only a snapshot of a moving car”
• Are more focussed on results (financial indicators) than causes (competitors’ strategies).
• “All men can see the tactics whereby I conquer, but what none can see is the strategy out of which
great victory is evolved”. Sun Tzu
• The Assessment Traps:
• The NO ANALYSIS trap: “I know it all, I have seen the business for years”.
• The SELF-JUSTIFICATION trap: “Tell me why I am right, and let me accept anything that validates my (already
reached) conclusions (anyway I won’t listen when it does not)”.
• The ANALYSIS-PARALYSIS trap: “Let’s make another analysis to reach perfect information”.
• The FAKE ANALYSIS trap: “We have decided what our customers want, we have done our analysis”.
55
Create Strategy: Change the Game: How to better satisfy customers
1. Better relative quality: Possible moves:
(a) Be better than competition Relative Quality score of competitors

on most important criteria, for each decision criteria
but difficult as everybody 100
focusses on that.
90
80
(b) Competitive hole, everybody 70
is bad on that. You can easily
create a huge difference
60
here → will become 50
important to customers (e.g. 40
Citicorp Bank). See Blue 30
Ocean Strategy. 20
10
0
KSF 100 KSF 80 KSF 50 KSF 30 KSF 25
Compet 1 Compet 2 Compet 3 Me
“The average customer does not exist. An average strategy satisfies nobody”. M. Montebello
→ It is better to be outstanding on some decision criteria than average on all.
56
Create Strategy: Change the Game: How to better satisfy customers
2. Better VALUE: Possible moves: QUALITY

PREMIUM
Systematically exceed
VALUE “You get what you pay for”
“You get what you pay for”
→ Creates LOYALTY
VOLUME
PRICE
Levers (Reminder)
• For better PRICE / lower costs, consider

• economies of scale, focus on value added activities, optimize perceived quality instead of producing higher
quality, use Design-To-Cost.
• Better QUALITY always pays in PREMIUM or VALUE markets, being average does not. Thus, it is preferable to
be BEST on one variable than average on all (→ Unique Selling Points, e.g. Google) ! Distinguish:
• Produced quality: a good product, it does what it is designed for. Drives costs, thus produce quality as
good as necessary (customers, competition), not better !
• Perceived quality: e.g. stylish design, add services, longer opening hours, branding / image, customization,
TTM/speed.
• Latent quality: An imaginative product/service whose function addresses a latent need, e.g. iPhone, “No
service” in British Airways’ 1st class to let people sleep. Creates NEW segments, see Blue Ocean Strategy.
57
Market Level: General Growth Strategies
Key idea: By growing along one axis, one can reduce risks as the other two axis remain constant.
WHAT ? WHAT ? WHAT ?
SUA
SUA SUA SUA SUA SUA
SUA
SUA SUA
WHO ? WHO ? WHO ?
HOW ? HOW ? HOW ?
Product based strategy: Find new buyers Customer based strategy: Find new Channel based strategy: Find new sales &
(Market Development). Increase VOLUME, products (Product Development). distribution channels (Market
reduce costs. Give lower costs to buyers, SPECIALZATION on one customer group, Penetration). Address one group of
otherwise dissatisfaction / competition. Be build a strong PLATFORM* of products and customers through several channels
your own cannibal on PRICE. Not a profit add further products to have customers (DISTRIBUTION strategy).
margin game. buying more. Create LOYALTY by exceeding
expectations; be your own cannibal on * PLATFORM in the sense of a basis that
QUALITY. Competitors will attack one slice allows the efficient creation of multiple
where they are best. (similar) products. 58
Corporate Level: Growth Strategies through M&A
Key ideas: Synergies, Economies of scale / scope, Control, Risk diversification.
WHAT ? WHAT ?
SUA
SUA SUA
SUA SUA
SUA
WHO ? WHO ?
Business Model:
SUA Supply Chain, Sales &
Distribution channels …
HOW ? HOW ?
Unrelated diversification: M&A to Related diversification: M&A to achieve

diversify business risks. synergies / economies of scale or scope
by acquiring
Forward / Backward integration:
• new buyers, Integrate your neighbors in the value
• new products (or technology) and/or chain, thereby creating synergies and
• new sales & distribution channels. control.
59
Portfolio based competition: The original BCG matrix
Beware: The original BCG matrix is only applicable to VOLUME markets ! “The best way not to lose money
is not to spend it, and then you
are dead”. M. Montebello
→ Manage presence AND future !
Market Growth
Opportunism Question Mark Rising Star

Invest in growth
attractive
“Increase the chances
for success, then 1. Invest 2. Lead
jump into it”. M. Need for cash Even cash in & out
Montebello Entrepreneur Grower / Manager
Manage for earnings
unattractive
3. Harvest Ensure to maintain

Divest Generation of Cash cycle by re-investing !
Care taker Financial Manager
Manage for cash or Dog Cash Cow
use as weapon
0.1x 0.5x 1x 2x 3x … Relative Market Share
Beware: Divest only if
attractiveness of other M.S. of largest or
products is unaffected ! 2nd largest competitor
See fail of Berliet Trucks
60
Portfolio based competition: The general BCG matrix
Note: The general BCG matrix is applicable to VOLUME, PREMIUM and VALUE markets !
Environmental Choose the indicators of ‘Environmental attractiveness’ as suitable,

attractiveness e.g. Sales, Margin, Market potential.

Invest in growth
attractive
1. Invest 2. Lead
Need for cash Even cash in & out
Entrepreneur Grower / Manager
Manage for earnings
unattractive

Care taker Financial Manager
Manage for cash or Dog Cash Cow
use as weapon
Competitive position or
Ability to compete
Portfolio based competition:
If attack of ‘Cash Cow’ with ‘Dog’ to cut-off cash for investment in ‘Question Mark’: Counter attack competitor’s
‘Rising Star’ or ‘Cash Cow’. “Don’t attack the army of your enemy, but their strategy”. Sun Tzu
61
Example 1: XEROX – IBM (Small Computers, 1969)
Market
Growth
XEROX acquired
small computer Question Mark - Invest Rising Star - Lead
company to attack attractive IBM’s rising Small
IBM with price fight. Computer business
XEROX IBM, > 50%
unattractive
Dog - Divest Cash Cow - Harvest

Market Share
IBM reacts with acquisition of small photocopier company (30 times smaller than XEROX) and reduce photocopier
prices by 25%. They react where it hurts XEROX (cash cow business) and do NOT reduce prices where IBM was
leading. → IBM lost 25% of 50 m$ = 12.5 m$, whereas XEROX lost 10% of 1200 m$ = 120 m$.
62
Example 2: Eastman KODAK vs. Sony vs. Fuji Film: The perfect scissors attack
Introduction of Sony’s first digital camera. Sony intends

Market to lead. Kodak also wants to lead, but KODAK intends
Growth to finance the digital business by its cash-cow.
Question Mark - Invest Rising Star - Lead Details:

KODAK expected to harvest,
Fuji was expected to quit. • Fuji holds M.S. of 90% in big JP
attractive
market → much money to attack
But when Sony introduced KODAK Sony
its first digital camera, Fuji digital • Fuji uses cost effective automatic
cut prices by 32% in manufacturing → constant quality
Germany (they let compete, and cost advantage
unattractive
3 central buyers with M.S. of KODAK • KODAK uses manual manufacturing

70%, fast effect) and Fuji, ROS = 32% processes → varying quality and
Northern EU (no reason, M.S. < 10% M.S. > 80% cost handicap.
just to confuse). Dog - Divest Cash Cow - Harvest
Market Share
If KODAK reduced prices in Germany, this would require a price reduction in all EU. Scissors attack,
• Choice 1: Do not fight on price → Loose now. no way out for
• Choice 2: Do fight on price → No money to invest in digital business, loose in the future. KODAK
63
Example 3: Attack at group levels (German Group vs Swedish Group), Amazement at BU level
Swedish BU gets attacked by Competitor A (part of a big German Group) who reduces
Market prices by 32%. Given the dominance of the Swedish BU and the unattractiveness of the
Growth market, Competitor A is likely to incur losses. Amazing ! Why is Competitor A so stupid ?
Question Mark - Invest Rising Star - Lead Solution:

While the competition did not make
attractive
•
US subsidiary sense at BU level, it happened at
of Swedish BU Group level. → Advice: Always
Swedish BU (part of a big
presume that competitors are
Swedish Group) intends to
smart !
invest in its US subsidiary.
unattractive
Swedish BU
M.S. > 90%

Market Share
Attack was in Sweden, target was its US subsidiary, the Swedish Group should attack Group in Germany
(because the attacker makes money there. However, could not react in Germany (too strong), thus bluff with
Czech company to compete in Germany.
64
Scenario-based planning: Taking decisions under uncertainty
“I don’t believe in
Page content by courtesy of René ROHRBECK, Chair FIT
strategic planning. It
collapses with the first
unforeseen event”. M.
Montebello
65
66
Example: Restaurant owner wonders about (a) duration of COVID shutdown, (b) any allowed activities.
https://www.linkedin.com/pulse/three-important-lessons-i-learned-business-covid-19-times-rohrbeck/
67
68
Example: Restaurant owner: Select consistent sets of actions – various strategies for each scenario.
https://www.linkedin.com/pulse/three-important-lessons-i-learned-business-covid-19-times-rohrbeck/
69
See page 204 for Real Options based representation. 70

71
01. Introduction



72
03. Current Business Models & Strategic Concepts
How Digitalization Breaks-Up Value Chains

1O110 Value Chain Analysis & Focus on added value, Changing the game
Case study: ASPHALTE.COM vs. ZARA
Managing Innovation and Disruption #1

Value Proposition, Managing Disruption
Case study: The Dollar Shave Club

The Innovator Dilemma, Technology Adoption & Crossing the Chasm, Creating Project Plans
Simulation game: The Back Bay Battery company
From Industries to Eco-systems

Platforms & Network effects
Case discussion: GDS for airline tickets
73
1O110 How Digitalization Breaks-Up Value Chains
Case study: ZARA vs. ASPHALTE.COM
vs.
74
Analysis of ZARA, a brand of INDITEX:
• Questions of interest:
1. WHO are ZARA’s target customers, i.e. what needs do they have ?
2. WHAT kind of products does ZARA deliver, and HOW does ZARA make them available to its customers ? Distinguish
produced and perceived quality.
3. What is the Value Chain of INDITEX (see Annual Report 2021, pages 176 - 178) ?
4. How does INDITEXT manage forecasting uncertainty of fashion preferences (see Annual Report 2021, page 178- 179) ?
5. What is the price point for a “premium” Jeans, e.g. Jeans Wide Leg ?
6. Does INDITEX (ZARA) create LOYALTY ? How ?
• Resources:
• WEB Sites:
• https://www.zara.com/us/ (EN) or https://www.zara.com/fr/ (FR)
• www.inditex.com
• Annual Report 2021: annual_report_2021.pdf, available on BlackBoard.
75
• Answers:
1. ZARA’s target customers are:
• WOMEN, MEN and KIDs, “… people looking for responsible, sustainable, and quality fashions”.
• Accessible / affordable products
• Enjoyable buying experience
2. The kind of products that ZARA delivers, and how ZARA delivers them.
• Clothes, Shoes & Bags, Accessories, Perfumes & Beauty
• Produced Quality
• Product quality: fairly good
• Responsible and sustainable products: not strongly communicated to / perceived by customers
• Perceived Quality
• Fashion level: Fairly fashionable / trendy
• Stores / Online: Enjoyable buying experience
• Satisfied or money back (Store and Online: Try-on, touch, feel, return/exchange, Online Size guide)
• Image / Brand equity / Made in …
76
• Answers:
3. What is the Value Chain of INDITEX ?
Logistics to Shipment Online

Online
Online to Store:
commerce
Mfg: Raw Finished Warehouse Consumers Reporting
Design of Sales
material, Goods
collection Forecasting
Production Inventory Logistics to Retail Retail
Retail Store: Mktg Store:
Stores & Sales Reporting
2x per week
4. How does INDITEXT manage forecasting uncertainty of fashion preferences ?

• INDITEX adapts very quickly to customer preferences as observable from the actual sales success: at the
Design stage, collections are updated constantly through the seasons. Manufacturing is highly flexible
and adapts to customer demand, thereby minimizing surplus. Logistics are constantly fine-tuned to
adapt to sales decisions. They distribute twice per week to stores and online warehouses, keeping
inventories small. Stores/Online report back on customer preferences in real-time.
77
• Answers:
5. What is the price point for a “premium” Jeans ?
• As per the ZARA online store, the Jeans Wide Leg is priced 39.95 €
• INDITEX achieves this very good price point through:
• Quick adaption to customer preferences and highly effective inventory management (see value chain),
• Economies of scale (multi-brands, volume) & scope (cross-selling)
• Vertical integration of design, logistics and distribution, stores/online
6. Does INDITEX (ZARA) create LOYALTY ? How ?

• Yes, they create LOYALTY through these levers:
• Consumers get consistently very good VALUE for money.
• Consumer preferences are constantly tracked to serve them best.
• Logic of continuity: New articles arrive frequently (~weekly basis), which is an incentive for consumers
to get back for shopping. Moreover, this drives consumers to take immediate purchasing decisions, as
the articles may be available for a few weeks only.
78
Analysis of ASPHALTE.COM:
1. WHO are ASPHALTE’s target customers, i.e. what needs do they have ?
2. WHAT kind of products does ASPHALTE deliver, and HOW does ASPHALTE make them available to its customers ?
Distinguish produced and perceived quality.
3. What is the Value Chain of ASPHALTE ?
4. How does ASPHALTE manage forecasting uncertainty of fashion preferences ?
6. Does ASPHALTE create LOYALTY ? How ?
• Resources:
• WEB Sites:
• www.asphalte.com/en-us/h (EN) or www.asphalte.com (FR)
• www.asphalte.com/en-US/h/pages/about (EN) or https://www.asphalte.com/f/pages/notre-mission-f (FR)
79
• Answers:
1. WHO are ASPHALTE’s target customers, i.e. what needs do they have ?
• Men and women who are looking for durable, classic, quality clothes, produced in a sustainable and cost
effective manner.
2. WHAT kind of products does ASPHALTE deliver, and HOW does ASPHALTE make them available to its customers ?
Distinguish delivered and perceived quality.
• Clothes, Shoes and Accessories
• Produced Quality
• Outstanding product quality: Comfort and long lasting
• Responsible and sustainable products (environmental, social)
• Outstanding value for money: cost effective (pre-order, no intermediary, no shop), long lasting usage
• Perceived Quality
• Classic style, does not easily become unfashionable
• Online Co-creation with customers --> Customers get exactly what they want
• Satisfied or money back (Try-on, touch, feel, return/exchange, Online Size guide)
• Pre-ordering --> No over production, intrinsically eco-friendly and cost effective
• Sense of community
80
• Answers:
3. What is the Value Chain of ASPHALTE ?
Co-creation Pre-order
Mfg: Raw
of Few campaign Shipment to
Design material,
Products (Mktg & Consumers
Production
( & Mktg) Sales)
4. How does ASPHALTE manage forecasting uncertainty of fashion preferences ?

• There is intrinsically no uncertainty about the desired products and the sales volumes, thanks to
co-creation and pre-ordering.
81
• Answers:
• As per the ASPHALTE.COM site, the “Ultimate Jeans” is priced 139 € (99 €) (comparable to Hugo BOSS)
• ASPHALTE.COM achieves outstanding value through:
• co-creation and pre-ordering: 100% avoidance of surplus and unsolds
• no intermediary: no inventories, no mark-ups
• no physical shops
• long lasting usage (produced quality, classic style)
• intrinsically eco-friendly and cost effective (resources, manufacturing)
6. Does ASPHALTE create LOYALTY ? How ?

• Yes, they create LOYALTY through these levers:
• Consumer gets consistently outstanding VALUE for money.
• Consumer identifies with sustainability goals of ASPHALTE.
• Logic of continuity: Get back to ASPHALTE, over time you build your complete wardrobe.
82
Comparison of INDITEX (ZARA) and ASPHALTE.COM:
1. How do both value chains compare ? Which one is more focused on added value to the customer ?
2. What is their relative position in a QUALITY-PRICE space ? How may HUGO BOSS and PIMKIE score ?
3. May ASPHALTE.COM become a competitive threat to any of the incumbents ?
QUALITY
Decision criteria INDITEX (ZARA) ASLPHALTE.COM PREMIUM
VALUE
VOLUME
PRICE
50 € 100 € 150 €
83
Comparison of INDITEX (ZARA) and ASPHALTE.COM: 1. Comparison of value chains
INDITEX (ZARA)
Logistics to Shipment Online
Online
Online to Store:
commerce
Mfg: Raw Finished Warehouse Consumers Reporting
Design of Sales
material, Goods
collection Forecasting
Production Inventory Logistics to Retail Retail
Retail Store: Mktg Store:
Stores & Sales Reporting
2x per week
ASPHALTE.COM
Co-creation Advantages: Co-creation ensures match with customer
Pre-order Mfg: Raw Shipment preferences, Pre-ordering avoids surplus, Direct shipment
of Few
Design campaign material, to
Products avoids intermediaries, inventories and physical shops. →
(Mktg & Sales) Production Consumers
( & Mktg) Intrinsically cost effective and eco-friendly.
Digitalization enables ASPHALTE.COM to focus on value Consistency ! (1) Classic fashion → Co-creation feasible
added activities and to change the rules of the game ! (customers can tell), waiting for delivery ok (pre-ordering),
(2) High quality & lifespan → worth to take the time for co-
creation, co-creation allows to set quality level right.
84
Comparison of INDITEX (ZARA) and ASPHALTE.COM: 2. Relative position in a QUALITY-PRICE space
Relative Quality score of competitors

for each decision criteria QUALITY
PREMIUM
INDITEX (ZARA) ASPHALTE.COM
10
9 Hugo BOSS ASPHALTE.COM
8 VALUE
7
6
5
INDITEX (ZARA)
PIMKIE
4
3
2
1 VOLUME
0
ProdQuality ESG Value Fashion (vs Experience Satisfaction Brand PRICE
lifespan) 50 € 100 € 150 €
Note: The difference in fashion level reminds us that

INDITEX and ASPHALTE address different customer
segments, i.e. they are not competitors so far. 85
Comparison of INDITEX (ZARA) and ASPHALTE.COM:

3. May ASPHALTE.COM become a competitive threat to the incumbents ?
ASPHALTE.COM has changed the rules of the game in terms of

product qualities. Together with an intrinsically cost effective QUALITY
and eco-friendly value chain, it reaches a QUALITY-PRICE PREMIUM
position that becomes perceivably comparable to the classic
product line of HUGO BOSS, thus becomes a competitor. Hugo BOSS ASPHALTE.COM
VALUE
Whether ASPHALTE.COM evolves to a threat to HUGO BOSS
depends on its success in growing sales volumes in its current
position.
INDITEX (ZARA)
INDITEX may not consider ASPHALTE.COM as a potential PIMKIE
threat, as both companies target very distinctive fashion levels;
ASPAHLTE’s positioning and according way of operating is VOLUME
unlikely to evolve towards the fast fashion segment.
PRICE
50 € 100 € 150 €
86




87
Managing Innovation and Disruption #1: Responding to Disruption
Case study: Gillette vs. Dollar Shave Club
vs.
DOLLAR SHAVE CLUB
88
1. Why has Gillette been successful for so long?

2. What is DSC’s value proposition ?
3. What are the main differences between Gillette’s and DSC’s
business model ?
4. What are the strategic options open to Gillette in responding to
DSC ? Which of these options should Gillette pursue ? Why ?
89
Which innovations have significantly changed the razor industry in the last 100 years ?
90
1900: the safety razor

Technical innovation, value chain disruption, pricing model innovation

91
1922:
“Give ‘em the razor; sell ‘em the blades !”
Marketing/pricing innovation
92
1962: Schick’s stainless (=rust-free) blades

Technical innovation, value improvement
93
1971: TRAC II® – First twin-blade shaving system – A Closed System

Technical innovation, strategy innovation
94
1974: BIC launches the first fully disposable razor

Strategy innovation (low cost)
95
Since 1975: Only incremental, sustaining innovation

1. Who ? Typically aims to retain or expand existing

customer segments
2. What ? Typically improves on or adds to the
existing value proposition
3. How ? Tends to build upon existing organizational
structures, culture, processes and marketing (4Ps).
$680 million
development cost
96
Main reasons for Gillette’s success (until 2011) …

• First mover advantage: Disrupting existing value chain and creating a new, uncontested one.
• Highly successful in protecting the industry via

• Building barriers to entry: Technology, patent protection, specific manufacturing
capabilities, brand image.
• Increasing switching costs: Closed razor system
• Preempting scarce resources: Strong relationship with distributors/retailers
• Outstanding strategy execution, economies of scale and scope
• Industry structure
• Stable prices in oligopolistic markets: Continued incremental innovation prevents price
erosion.
97
… and then DSC entered the game in 2012

Watch video on: https://www.youtube.com/watch?v=ZUG9qYTJMsI
98
WHO are DSC’s target customers, i.e. what is their need ? → Use value Proposition Canvas by STRATEGYZER
Step 3: Describe GAINS, i.e. benefits, Step 1: Describe the jobs that customers
expected / desired / surprising: want to fulfill:
• Functional utility (quality, quantity, • Functional (perform, solve, …)
performance, speed, accessibility) • Social (look good, gain power or status, …)
• Social gains • Emotional (esthetics, feel good, security, …)
• Positive emotions • Basic needs (communication, news, …)
• Savings (cost, time, effort, …)
Consider also ancillary jobs in roles of Buyer,
Step 2: Describe customer PAINS while Co-creator, Transferrer (resell, …)
trying to get the job done:
Outline in which specific context a job is done,
• Negative emotions
because that may impose constraints (e.g. while
• Undesired costs and situations driving, outside, …)
• Risks before, during and after
getting the job done (financial, social,
technical, social, …)
Watch video on:
https://www.strategyzer.com/canvas/value-proposition-canvas
99
WHAT and HOW addresses DSC the customer needs ? → Design of the Value Proposition
Step 4: List the products & services the

Value Proposition builds on, check fit
• Describe in which way they are PAIN
relievers and/or GAIN creators address
customer’s PAINS / GAINS (check fit).
Step 5: Reiterate step 4 and optimize

• Focus on most important customer
needs and adjust/optimize. This is a
matter of the desired positioning and
feasible capabilities. Goal is to be able
address the selected set of needs
EXTREMELY well.
Tipps:
• Keep steps 1-3 separate from 4-5, i.e. first observe needs, then design proposition.
• Emotional & social jobs are at least as important as functional ones !
100
GROUP work #1: What are the jobs, pains & gains of DSC’s target customers ?
Please take 15 minutes to answer these questions:

• Step 1: Describe the jobs that customers want to fulfill
• Functional
• Social
• Emotional
• Step 2: Describe customer PAINS while trying to get the job done
• Negative emotions
• Undesired costs and situations
• Risks
• Step 3: Describe GAINS, i.e. benefits, expected / desired / surprising

• Functional utility
• Social gains
• Positive emotions
• Savings
101
Answers:
• Step 1: Describe the jobs that customers want to fulfill
• Functional: To get shaved in a safe (safety blades), fast (every day), comfortable (fresh blade), pleasant (scent)
and appropriate (skin type, …) way
• Social: To look good / neat / groomed
• Emotional: Feel comfortable, feel stylish
• Step 2: Describe customer PAINS while trying to get the job done
• Negative emotions:
• Feeling ripped off by high-priced, over-engineered and over-marketed products
• Unpleasant, tedious purchasing experience (boring, irritation from glass cabinets)
• Feeling stupid by accepting all this.
• Undesired costs and situations:
• Spending more money than necessary
• Too much time spent for choosing the most appropriate solutions (razor + blades + grooming)
• Risks:
• Risk of forgetting to repurchase consumables (blades, grooming products), running out of them.
102
Answers (cont’d)
• Step 3: Describe GAINS, i.e. benefits, expected / desired / surprising
• Functional utility: 'Produced' qualities: Safety blades, pleasant and appropriate products, fast to use.
• Social gains: To look good / neat / groomed
• Positive emotions:
• Feel considered, being not just a consumer, part of a club
• Feel smart, not exploited
• To be comfortable
• Feel stylish
• Savings: Save time (physical purchasing, product selection) and money
103
Step 4: List the products & services the Value Proposition builds on, check fit
• DSC products (by Dorco):

• Functional utility: Good 'produced' quality: No over-engineered features, safety blades, comfortable,
pleasant and appropriate, fast use.
• Social gains: Looking good / neat / groomed
• Positive emotion: Feeling stylish.
• Subscription model --> Automatic renewal:

• Functional utility: Ensure fresh blade quality (comfortable shaving experience)
• Saving Time: No need for tedious physical purchasing.
• Risks: No risk of running out of shaving products / using worn-out products.
• Subscription model with flexibility (change, add or cancel whenever)

• Risks: No risk of inadequate quantities or being locked in a bad deal.
• Easy-to-understand product lines and bundles, Support in grooming decision on website, Monthly
magazine with advice:
• Saving Time for choice of most appropriate solution
• Positive emotion: Feeling taken care of / advised
104
Step 4: List the products & services the Value Proposition builds on, check fit (cont’d)
• Lower price:
• Saving Money
• Positive emotion: Feeling treated in a fair way: getting suitable products at the right price.
• Satisfied or money back, Trial with Twin model (1 US$ and free shipment), no commitment
• Risks: No risk of being locked in a bad deal.
• Positive emotion: Feeling treated in a fair way / considered.
• Pleasant customer experience / entertaining communication (videos, articles, Monthly Magazine, …), Small
gifts (e.g. samples) :
• Positive emotion: Feeling considered (part of a club), stylish and smart.
• Positive emotion: Surprising and humorous.
• E-commerce model, Direct-to-consumer shipment (note: this aspect is about the customer experience, not the
business model)
• Positive emotion: Comfortable, pleasant and fast shopping & purchasing.
105
Gillette’s business model DSC’s business model

• Supply Chain: Own production, supply • Supply Chain: Production fully outsourced
concerns raw materials / components
• Technology and Value added:
• Technology and Value added: • R&D fully outsourced
• R&D (high spending) • Marketing creating brand appeal
• Own production • Customer relationship outstanding (club),
• Marketing creating brand awareness customer insight (data, behavioral target
• Customer relationship little to none, marketing)
Gillette is ‘distant’ to customers • Sales & Distribution channels:
• Sales & Distribution channels: Retail outlets, • Online store for sales.
e.g. department stores, general stores, • Product distribution by mail shipment,
supermarket, drugstores, Amazon. logistics fully outsourced.
• Customer Support: standard • Customer Support: Active support
• Revenue model: Razor & blade model with dual • Revenue model: Subscription model with
pricing flexibility to consumer
106
Comparison of GILLETTE and DSC: Relative position in a QUALITY-PRICE space

Relative Quality score of competitors

for each decision criteria
QUALITY
GILLETTE DOLLAR SHAVE CLUB PREMIUM
3
VALUE
DSC
2 GILLETTE
VOLUME
0
Functionality Convenience CustExp Service Brand Trust PRICE
107
Market
Potential
Question Mark - Invest Rising Star - Lead

attractive DSC grabs significant and
increasing sales volumes from
Dollar Shave Club Gillette’s safety razor business.
attack
Gillette’s safety razor business is one
unattractive
of Procter & Gamble most profitable

Gillette businesses (EBIT margin ~ 30%).
Revenue losses in 2016 mostly
caused by DSC.
Ability to compete
108
“Think through all options instead of jumping to maybe the wrong conclusion”.
K. Kollenz-Quétard
or with direct (old) competitor
and enhance it
Companies may move from one option to another as the disruptive threat evolves.
109
3. Play both games

1. Do Nothing: Take a step back and evaluate the real

If there are synergies between your ‘old’ business model and
impact.
the new one, acquire a disruptor or copy its business
E.g.: White labeled bottled water (30% cheaper) vs Evian,
E.g.: Lufthansa & Eurowings, Société Générale & Boursorama,
Perrier, … → Made products mainstream, just increased
Daimler & Car-sharing platform “car2go”
market size.
Beware: Risk of cannibalization.
2. Enhance existing business to maintain sufficient 4. Build the best of both worlds: Combine selected
competitive advantage. elements of the disruption with strengths of your business
E.g.: Nespresso answered to eco-friendly and cheaper Advantage for the incumbent: Difficult for disruptor to imitate.
coffee in supermarkets by (a) superior customer Maybe need to continue with option 7.
experience, (b) strong branding, (c) recycling of capsules.
E.g.: Hybrid cars, TAG-Heuer’s connected watch that can swap
Beware: This option may be insufficient in the long run. connected module with mechanical one.
110
6. Create a Blue Ocean

5. Partner with disruptor or direct competitor
Reposition towards an uncontested market space throughout value

Feasible if resources and capabilities are complementary innovation: Create new product/service categories and provide
AND partners are interdependent. them at optimized costs / prices.
E.g. #1: Hewlett-Packard and ASUS Tech for making PCs E.g.: Le Cirque du Soleil
and Laptops: HP brings brand equity and customer
insight, ASUS Tech provides cost competitive procurement
and manufacturing. Risk: Nurturing of disruptor.
7. Embrace the innovation:
If disruption comes from big, dominant platforms (GAFA
etc.), if may be best to partner with the direct competitors If the disruption is simply superior to your way of doing business,
to counter-balance disruptor. adopt it and scale it up, using your existing resources and
capabilities. Difficult, as it requires massive transformation !
E.g. #2: Company “Here”, owned by German auto-makers.
It provides GPS precision maps, as alternative to Google Note: In many cases of digital disruption, this will be the final
Maps or Apple Maps. option for incumbents. E.g.: Transformation of GE by Jeff Immelt.
111
“Think through all options instead of jumping to maybe the wrong conclusion”.
K. Kollenz-Quétard
10
Strategic Decision Process:
9
1. Consider all options 8
2. Define evaluation criteria 7

Do
and evaluate all options 6 Discuss
Benefits
3. Develop recommendation 5
and implement 4
3
Don’t do
2
Possible
1
0
0 pt 1 pt 2 pts 3 pts 4 pts 5 pts 6 pts 7 pts 8 pts 9 pts 10
pts
Effort
112
GROUP work #2
Please take 10 minutes to answer these questions:
1. What are the strategic options open to Gillette in responding to DSC ?

a. What is the level of advancement of the disruption ?
b. What is the relation between the disruption and the ‘old’ model ?
2. Which of these options should Gillette pursue ? Why ?
Answers:
1. What are the strategic options open to Gillette in responding to DSC ?

a. The level of advancement is medium to strong: DSC continuously grabs Gillette’s market share.
b. From the perspective of the ‘old’ model, DSC is substituting, with complementarities on the product level.
2. Which of these options should Gillette pursue ? Why ?
• Play both games: Leverage product synergies and copy the business of DSC (see https://gillette.com)
113




114
Managing Innovation and Disruption #2: Business Rejuvenation
Simulation game: Back Bay Batteries
Overall learning objectives:
• Experience the main challenges of managing innovation within companies
• Learn to assess and understand the impact of external changes in demand,

technology, competitors’ behavior on products in different stages of their lifecycles
• Learn to optimize resource investment, pricing and sales forecasting
Objective of first scenario:
• Familiarize yourself with the simulation: interface; company; products, its features
and markets; customer segments and their preferences;
• Playing at least one to maximum 3 runs of the simulation (one run covers
approximately 8 periods).
115
Instructions for ‘Back Bay Batteries’ Simulation, available as of Sept. 14, 2022:
1. Follow this link: https://hbsp.harvard.edu/import/973840
2. Register or Log-In to Harvard Business Publishing (HBP)
• Please use your EDHEC e-mail address as user name. At first usage, create
a user account and password. At later usage, use the Forgot Password
link on the login screen if necessary.
3. Click ‘Run simulation’
4. Read ‘Foreground Reading’ available on Blackboard and in the Prepare Section

of the simulation
5. View ‘How to Play’ Video available in the Prepare Section of the simulation
116
1.1 Assessment of the situation: (a) WHO: customer needs/expectations, (b) WHAT, (c) HOW
AGM readily
Recharge Cycles well positioned
are of low to address the
importance → automotive
Don’t care market.
Price does not

need to fully meet SC well
customer positioned on
expectations, just Self-Discharge
be competitive. and Recharge
to address any
market. Need
to improve
Energy Density
and Price.
117
1.2 Assessment of the situation: External environment – Customer demand / bargaining power
Automotive market
is of substantial size.
Sales potential of automotive market ends as of

year 5, thus competitive pressure will increase
that year. → Either develop a cash-cow in
another market, or become highly competitive in
this market before year 5.
118
Warehouse market
is ~3 times smaller
than automotive.
Sales potential of warehouse market decreases,

despite of a positive offset in year 6 related to
supercapacitors. Competitive pressure will increase
over time. → Smaller and decreasing potential, thus
not an ideal target market.
119
UPS market is
~3 times bigger
than automotive.
Sales potential of UPS market grows continuously. In

addition, further market potential arises from use of
SC starting as of year 5. → Big and strongly growing
market segment, thus attractive target market.
120
1.3 Assessment of the situation: Internal capabilities
• R&D available to respond to Customer needs / expectations, i.e. ‘produced’ quality levels.
2. Rules of the Competitive Game

• VALUE positioning as price and quality count. Possible to create LONG-TERM competitive
advantages.
3.1 Strategic Positioning for future success

• Choice: Compete for NEW customers in the big and growing market of UPS.
3.2 SWOT analysis

• S+O: Matching strategy: Use existing AGM performances to address expectations of current
target markets. Objective: Maintain revenue growth of 40 m$ annually until year 5.
• S+T: Neutralization strategy
• W+O: Transformation strategy: Perform R&D to improve SC performances to address
expectations of UPS market. Objective: To maintain overall revenue growth, SC revenues shall
annually grow by at least 40 m$ starting as of year 5.
• W+T: Defense strategy: Perform R&D to decrease SC costs. Objective: SC shall provide a positive
contribution margin after 5 years of R&D, i.e. by year 6 or 7.
121
3.2 SWOT analysis → Focusing R&D activities as per available budget ($11m in years 2 and 3)
Features Annual Project Cost Project Length Total Cost

AGM: Energy Density $3m – $9m 4–6 years $12m – $54m
AGM: Recharge Cycles $1m – $6m 5–8 years $5m – $48m
AGM: Self Discharge $2m – $4m 5–8 years $10m – $32m
AGM: Recharge Time $1m – $5m 4–7 years $4m – $35m
AGM: Process Improvement $1m – $6m 4–7 years $4m – $42m
SC: Energy Density $4m –$1m 5–7 years $20m – $70m
SC: Recharge Cycles $2m – $9m 5–8 years $10m – $72m
SC: Self Discharge $2m – $8m 5–8 years $10m – $64m
SC: Recharge Time $1m – $6m 5–7 years $5m – $42m
SC: Process Improvement $3m – $7m 5–7 years $15m – $49m
Strategy:
• Focus on UPS market, perform R&D that addresses the needs / expectations of this market.
• Do so through SC, as technology better positioned than AGM to address UPS needs.
• As attractiveness in automotive market decreases as of year 5, do not spend R&D on AGM
(will be too late to receive benefits, tbc). 122
3.3 Portfolio Management
Market
Potential
Question Mark - Invest Rising Star - Lead Super Capacitors (SC), promising
technology to replace AGM
attractive
batteries, or to complement them
Super Capacitor in hybrid configurations.
move
AGM battery, current mainstream
unattractive
technology, strong foothold in

AGM battery automotive market.

Ability to compete
Task:
• Create cash from AGM (mostly in automotive market) to finance R&D on SC such as to bring
it in cash-cow position for target market (mostly UPS).
123
4. An example of results
Cumulative profits = $1,909m
Company well positioned in
future growth market.
124
Simulation game: Back Bay Batteries, Round 2
Instructions for ‘Back Bay Batteries’ Simulation round 2, open as of Sept. 23, 2022:
1. Log-In to Harvard Business Publishing (HBP) in the same way as for round 1. Use same URL.
2. Read ‘Foreground Reading’ available on Blackboard and in the Prepare Section of the simulation:
Round 2 - BBBV3_ForegroundReading_Solar_Warehouse_Marine.pdf
3. Round 2 uses the “intermediary” difficulty level: Sales forecasts do not affect R&D budget. However,
players will be fired for large losses (but can restart should this happen).
125
1.1 Assessment of the situation: (a) WHO: customer needs/expectations, (b) WHAT, (c) HOW
Solar: AGM well AGM may remain
positioned despite attractive to solar
of low Recharge & warehouse,
Performance. SC competitiveness
insufficient on could be improved
Energy Density and by R&D on Energy
Price. Density and Costs.
Marine would
Warehouse: AGM
require better Self
poorly positioned.
Discharge.
SC better but
insufficient on SC may be
Energy Density and attractive to solar
Price. & warehouse,
Marine: AGM & SC once R&D has
poorly positioned: improved Energy
insufficient on Density and Costs.
Energy Density, Self Marine would
Discharge and require better Self
Price. Discharge.
126
Solar market is of
substantial size.
Initially, solar market seems to stop growing

around year 7 to 8. However, it turns out that its
growth remains substantial. → Market remains
attractive
127
Warehouse market
is ~3 times smaller
than solar.
Initial installed base is ~half of solar, Warehouse market growth slows down, despite of a
i.e. non-negligible. Majority (~60%) positive offset in year 6 related to supercapacitors.
from SC, despite of high price. Market potential ~ 3 times smaller than solar. →
Warehouse has a non-negligible market potential.
128
Marine market is
~4 times smaller
than solar.
Initial installed base insignificant, Marine market grows slightly and continuously.
visibly the expectations of the Market potential ~ half of solar. → Non-negligible
Marine market are not met. market potential, but visibly harder to tap into.
129
1.3 Assessment of the situation: Internal capabilities

• R&D available to respond to Customer needs / expectations, i.e. ‘produced’ quality levels.
2. Rules of the Competitive Game

• VALUE positioning as price and quality count. Possible to create LONG-TERM competitive
advantages.
3.1 Strategic Positioning for future success

• Choice: Compete for NEW customers in the solar and warehouse markets using SC technology.
3.2 SWOT analysis

• S+O: Matching strategy: Use existing performances to address expectations of current target
markets. Objective: Maintain annual revenue growth of 40 m$ (revised to 10 m$).
• S+T: Neutralization strategy: Compensate negative contribution margin of SC by increasing prices.
• W+O: Transformation strategy: Perform R&D to improve SC performances to address
expectations on Energy Density. Objective: Be ready by year 7 to address warehouse (revised to
address solar, as sales stable).
• W+T: Defense strategy: Perform R&D on SC to decrease costs and thus prices. Objective: Same
130
3.2 SWOT analysis → Focusing R&D activities as per available budget ($10m in year 2)
Features Annual Project Cost Project Length Total Cost

AGM: Energy Density $3m – $9m 4–6 years $12m – $54m
AGM: Recharge Cycles $1m – $6m 5–8 years $5m – $48m
AGM: Self Discharge $2m – $4m 5–8 years $10m – $32m
AGM: Recharge Time $1m – $5m 4–7 years $4m – $35m
AGM: Process Improvement $1m – $6m 4–7 years $4m – $42m
SC: Energy Density $4m –$1m 5–7 years $20m – $70m
SC: Recharge Cycles $2m – $9m 5–8 years $10m – $72m
SC: Self Discharge $2m – $8m 5–8 years $10m – $64m
SC: Recharge Time $1m – $6m 5–7 years $5m – $42m
SC: Process Improvement $3m – $7m 5–7 years $15m – $49m
Strategy:
• Focus on SC to provide attractive new capabilities to all markets, thereby changing the game and
capturing the growth potential of solar and the other markets if possible (depends on price level).
• Increase price of SC to avoid cash drain. Decrease prices when SC has suitable performances.
131
3.3 Portfolio Management
Market
Potential
Question Mark - Invest Rising Star - Lead Super Capacitors (SC), promising
technology to reach unpreceded
attractive
performance – game changer to
Super Capacitor capture future growth in all markets.
move
AGM battery, current mainstream
unattractive
technology, strong foothold in solar

AGM battery market. Little headroom for
sustaining innovation (ED, costs).
Ability to compete
Task:
• Create cash from AGM (mostly in solar market) to finance R&D on SC such as to bring it in
cash-cow position for target market (mostly solar).
132
4. An example of results
Cumulative profits = $366.1 m
Company well positioned in
future growth market.
Contribution margin of AGM is

steady, whereas SC captures the
growth potential (mainly solar).
133
Strategy from Florian / Victor: ~$370 m

• SC: R&D to improve energy density and costs,
with priority on costs to address the negative
contribution margin of SC.
• Temporary increase of SC price (→ lower cash
drain).
1,347
$10.69
134
Strategy from Hongxiang: $344.3 m

• Defend AGM: R&D on Energy Density and
Costs, keep AGM price constant, decrease later.
• SC: Increase price to improve contribution

margin.
$4.28
135
Strategy from Victoire: $339.2 m

• Invest in cost leadership for AGM and SC.
• AGM prices slightly adjusted, SC prices constant
$10.79
$4.31
136
Strategy from Siona / Hugo : $330m

• Continue the R&D on AGM Self Discharge to
“swing the orders”. → Provide cash for the
transition, even with negative contribution
margin from SC.
• SC: R&D to improve energy density and costs.
• No change of prices.
137
Strategy from Kevin : $305m

• SC: R&D to improve energy density and costs,
with priority on costs to address the negative
contribution margin of SC.
• No change of prices.
138




139
Managing Innovation and Disruption #2: The Innovator’s Dilemma
Market
Attractiveness

→ Innovation Scouting, Invest in growth →
attractive
invest per Real Options 1. Invest 2. Lead Real Options or NPV
approach ! Need for cash Even cash in & out
Entrepreneur Grower / Manager
Manage for earnings
unattractive

Financial Manager
Dog Cash Cow
Ability to compete
Dilemma: How to maximize present results while preparing future success ?

Need to invest in … Financial managers of a Cash-Cow business
• … sustaining innovation to maintain present Cash Cow. may tend to not invest in Rising Stars and
Question Marks, as they may be incentivized
• … whatever innovation to grow Rising Star to Cash Cow position.
by ROI and happen to be in charge for less
• … disruptive innovation to nurture Question Marks for the future. than a cycle (~ 7 years).
140
A Theory by Clayton Christensen
C. Christensen’s key message: Successful companies can fail in

the face of disruptive innovation.
• Sustaining innovation: Company improves current products’

performance (cash cow position) based on feedback from
customers. It satisfies current needs.
• Disruptive innovation addresses a need that exists in a niche

market and that is neglected by current incumbents. →
Opportunity for a challenger to enter the market at this niche.
• C. Christensen suggests that initially, the disruptive
innovation may feature lower performance than the
established technology.
• However, disruptive innovation may have the potential
to evolve (see “Detectable”, “Clear” and “Inevitable” as
Question Mark and Rising Star) such as to meet future
needs better, thereby disrupting the incumbents and
becoming the “New normal” as Cash Cow.
→ Do both simultaneously, sustain your current business and
look at niche markets to identify potentially disruptive
Clayton Christensen, Michael Raynor, Roy McDonald, What Is Disruptive
innovations.
Innovation?, Harvard Business Review 2015, (see 2015_Christensen_What IS
Disruptive_innovation_HBR.pdf, available on BlackBoard)
141
A Theory by Clayton Christensen
C. Christensen’s key message: Successful companies can fail in

the face of disruptive innovation.
• Sustaining innovation: Company improves current products’

performance (cash cow position) based on feedback from
customers. It satisfies current needs.
• Disruptive innovation addresses a need that exists in a niche

market and that is neglected by current incumbents. →
Opportunity for a challenger to enter the market at this niche.
• C. Christensen suggests that initially, the disruptive
innovation may feature lower performance than the
established technology.
• However, disruptive innovation may have the potential
to evolve (see “Detectable”, “Clear” and “Inevitable” as
Question Mark and Rising Star) such as to meet future
needs better, thereby disrupting the incumbents and
becoming the “New normal” as Cash Cow.
→ Do both simultaneously, sustain your current business and
look at niche markets to identify potentially disruptive
C. Bradley, C. O’Toole, An incumbent’s guide to digital disruption, McKinsey
innovations.
Quarterly May 2016, (see 2016_An-incumbents-guide-to-digital-
disruption_McK.pdf, available on BlackBoard together with further articles)
142
Managing Innovation and Disruption #2: Technology Adoption Cycle
Customer Segments & Crossing The Chasm, by Geoffrey A. Moore
Key idea: During its lifecycle, technology gets adopted step-wise and by distinct customer segments.
• For a successful technology deployment, the distinct needs of each segment needs to be addressed specifically.
• The transition from one customer segment to the next one is not necessarily smooth – it depends on how much those communicate.
• A significant gap (“chasm”) occurs in the communication between the Early Adopters and the Early Majority; thus, success in the
former does not imply success in the latter. → Use the Beachhead strategy to cross this chasm and get access to greater market
volumes.
1. Innovators:
Technology 5. Laggards:
enthusiasts (2.5%) Sceptics (16%)
2. Early Adopters: 3. Early Majority: 4. Late Majority:

Visionaries (13.5%) Pragmatists (34%) Conservatives (34%)
143
Customer Segments & Crossing The Chasm: Customer segments
1. Innovators: Technology enthusiasts (2.5%)

• Technology enthusiasts: Geeks, want to be the first to test innovation, ok if bugs (help to debug), great contributors
to open innovation.
• Challenges: Want unrestricted access to all technical details and top technical people.
• Pricing: Free or at cost (as they are contributors).
• Important, as gate keepers to the Early Adopters
2. Early Adopters: Visionaries (13.5%)

• They see how the innovation will change the world, provide an important competitive advantage from revolutionary
breakthroughs. May accept bugs and glitches.
• They are risk takers (high risk for high return), strategic thinkers, have a great imagination for the potential strategic
applications of an innovation (→ REAL OPTIONS). Want references from other industries (horizontal), ok to buy from
startups.
• Pricing: Not very price sensitive, as they see the enormous potential of an innovation.
• Demand fast TTM and a high degree of customization and support.
• Their key role is to fund the development of the early market.
144
3. Early Majority: Pragmatists (34%)

• Main motivation for adopting innovation: Efficiency gains or productivity improvements. Expect bug-free products.
• They are not looking for breakthrough innovation or radical change. They prefer evolutionary change.
• Astute managers of important areas of business: They understand the real world challenges of implementing new
technologies. They are aware of the trade-offs.
• They want to see a positive Business Case (NPV>0) before buying or implementing an innovation.
• They are keen on seeing innovation already successful implemented elsewhere in the same industry (vertical), ideally by
the market leader. A POC is not enough to convince them.
• So there is a catch 22: Early Majority waits for one another to adopt an innovation, so the innovation may get stuck.
• Use the Beachhead Strategy to resolve the catch 22 and cross the chasm.
• Challenges: They insist on good references from colleagues they trust. And they want to see the solution already in place
on a reference site.
• Extremely important for innovation to attract pragmatists, as 1/3 of the market and open mainstream.
145
4. Late Majority: Conservatives (34%)

• Primary motivation: Avoid a competitive disadvantage; stay even with competition and peers.
• They are very risk-averse.
• Pricing: They are price sensitive.
• Generally: They are better with people than with technology. Ease of use and simplicity are paramount.
• Often, they rely on a single trusted advisor.
• Important due to its size. And it extends the product lifecycle and thus increases profitability.
5. Laggards: Sceptics (16%)

• They adopt innovation when they have to, because there are no more alternatives.
• Their objective is to maintain the status quo.
• They are good at debunking marketing hypes, they generally do not believe in arguments about "productivity
improvement"
• They like to take an contrarian position and seek to block purchases of new technologies.
• They are not a customer but play a critical role in the diffusion of innovation, as they can delay or impede the
adoption of innovation.
146
Customer Segments & Crossing The Chasm: The Beachhead strategy for cross the chasm
How to cross the chasm ? → Apply the Beachhead strategy:

1. Focus on a single beachhead segment, i.e. a niche of the Early Majority segment.
2. Optimize product/services specifically for this niche.
3. Become a market leader in just this niche.
4. Leverage user references to attack nearby segments.
References:
• Geoffrey A. Moore, Crossing The Chasm, Collins Business Essentials (2014)
• Summary Crossing the Chasm.pdf on BlackBoard
147
Managing Innovation and Disruption #2: Managing R&D portfolios
Creating Project Plans to Focus Product Development
Key idea: R&D resources run the risk of being too much
scattered. Focus on a few projects to achieve strong and
perceivable results.
• Distinguish types of R&D projects: (1) Derivative, (2) Platform,

i.e. creation of core products that then can be varied to
efficiently create many variants, ≠ “network platforms”,
(3) Breakthrough, (4) Research and advanced development,
(5) Alliances and partnerships of types 1 to 4.
• To build and aggregate project plan:

1. Classify existing projects according to the 5 types.
2. Estimate the time & resources needed for each project.
3. Identify the existing resource capacity
4. Determine the desired mix (types) of projects. Cover all
5 types, pay special attention to platforms (type 2).
5. Allocate available resources as per desired project mix.
6. Decide which projects to pursue or to cut.
S. C. Wheelwright, K. Clark, Creating Project Plans to Focus Product Development,
Harvard Business Review (2003).
148




149
From Industries to Eco-systems: Platforms and Network effects
The Effects of Digitalization
Reduction of transaction costs: Deconstruction & disintermediation of value chains

• Direct links between producer and consumer
• New entrants to established industries
Polarization of Economies of Scale
• Fragmentation of selected layers of the value chain: User created content, On demand economy, Crowd sourcing /
crowd funding
• Concentration on other layers
• Where economies of scale still valid (e.g. infrastructure, R&D intensive sectors)
• Where strong economies of scope / experience curve (e.g. data collection)
• In businesses with network effects, i.e. the more players of each eco-system participate, the better → Platforms
Customization
• Customized products or commoditized products with customized services

• Based on individuals’ data or do-it-your-self components.
• AI and Big Data will automate customization.
150
Industries will merge into eco-systems, dominated by platforms
Eco-system illustration:
Estimated total sales in 2025, in US$ trillions
Not all industries or sub-categories are shown. Source:

McKinsey 2017, competing in an world of sectors
without boarders.
151
Basic Platform Types
Def. Platforms: Digital platforms bring together

two or more market actors and grow through
network effects.
• Network effect: Digital platforms create self-

sustaining positive feedback loops that potentially
increase the value of the platform with each new
participant.
• Eco-system: Third party firms and individual

contractors that allow platforms to bypass the
traditional supply chains and labor pools.
• Common challenges: (1) Choose who to bring

together, e.g. buyers/sellers, users/innovators,
(2) Ignite the network effect, (3) Design a revenue
model, (4) Rules for use of platform, (5) Cultivate
eco-system.
Reference to original article:
M. A. Cusumano et al, The Future of Platforms,

Disruption 2020, MIT Sloan Management Review
Spring 2020, (see 202003_Disruption2020
_MITSloan.pdf, pages 26 to 34).
Case Discussion: GDS for distribution of airline tickets
Global Distribution System (GDS):

• Transaction Platform: Airlines can make their flights available
through the GDS, and Travel Agents purchase according e-
tickets via the GDS. Network effect: The bigger the better.
• Usage: Travel Agents (a) search for available flights, (b) retrieve
the fare quotes, (c) reserve a flight, (d) pay a flight, (e) receive
the e-ticket.
• Revenue Model: When a Travel Agent sells an e-ticket, the GDS
receives a booking fee. From that amount, the GDS pays an
incentive to the Travel Agent.
• Risk of disruption: Direct sales over the internet sites of the
airlines, meta-search internet sites to find best flights.
• Responses to disruption:
• Enhance existing business: Improved IT solutions for
Travel Agents, well integrated with their ERP systems,
higher incentives.
• Play both games: Provide airlines with internet sites and
business IT systems (for both distribution and general
airline operations).
153
01. Introduction



154
Design-To-Cost
Examples, Key Concepts, Technical / Functional / Systemic Optimization
Real Options
Overview of use cases, Resource allocation in Portfolio Management
155
Design-To-Cost: Introduction
Design-To-Cost is a method to improve the competitiveness of products, services or projects by

improving their quality (value) vs. price (cost) positioning:
• Reduce costs (and thus price) while maintaining or increasing quality (value), or
• Maintain costs (and thus price) while increasing quality (value).
This method is important in VALUE markets, i.e. when customers are sensitive to price and quality.
Note: Design-to-Cost is also referred to as Design-to-Value or Value Engineering.
156
Design-To-Cost: Warm-up Brainstorming
How to improve the competitiveness of this product ?
157
Design-To-Cost: Warm-up Brainstorming
How to improve the competitiveness of this product ?
158
Design-To-Cost: Examples of use cases
Bridge crane Dashboard Wire pipes Tower crane Gearbox

(Aluminum smelter) (Automotive industry) (Chemical industry) (Construction ) (Automotive industry)
Production facility Electric kettle Deep-fryer Waffle maker Conveyors

(Silicon chemistry) (Small household appliance) (Household appliance) (Small household appliance) (Logistics)
Automatic storage Medium-voltage eq. Sheet metal machine HT section switch Powertrain
(Logistics) (Electro-technical) (Electro-technical) (High tension) (Shop grid)
159
(space for drawing)
160
Seat Gas turbines Flight simulator Hydraulic motor X-Ray 3D

(Aeronautical) (Energy) (Aeronautical) (Construction ) (Dental)
Portal Chip card Valve Spot Gas boiler

(Industry) (Electronics) (Energy) (Swimming pool) (Energy)
NGV Heat exchanger Washing machines Security group Fiber optic

(Express ferry) (Automotive industry) (Large household appliances) (Heating) (Telecoms)
161
Design-To-Cost: Approach
• Do the right thing: Set price & quality targets to reach a competitive position in the Price-
Quality space (VALUE market), i.e. exceed the “You get wat you pay for” expectation. →
Products & services shall be as good as necessary (targeted), not better.
• Doing it right: Use Design-to-Cost to actively reach the price & quality targets. Do not
discover costs and price at the end of the development process.
“Common” process “Design to Cost” process

Marketing survey Marketing survey
COST PRICE
+ -
Mktg: Product MARGIN Mktg: Price & Quality targets,
MARGIN
specification Target margin
DTC: Setup cross-functional

R&D: Product design
team, cost & quality framework
PRICE COST TARGET
Procurement & Manuf. Cross-functional team:
Discover costs Product Design, considering Optimization:
procurement & manufacturing • Technical
Acceptable • Functional
Reached Price & No
No cost / price ? • System
Yes
Quality target ?
Yes
Production kick-off Production kick-off

162
Design-To-Cost: Setting targets
• Targets must …
• meet a competitive Price-Quality position
• be ambitious to make a difference that is perceivable by customers
• be credible, i.e. attainable, otherwise demotivating
• Setting the targets is an important part of change management: Motivate to find new
solutions, no business as usual.
Out of reach
Success
Performance
motivation
163
Design-To-Cost: Use DTC right from the outset
• Attaining targets depends on by when Design-to-Cost is started. Ideal to use right from
the beginning of a development project:
Expression of Design Production Exploitation

needs
Design to Cost Design to Cost Project Continuous

20 to 40% 10 to 20% Management improvement
<5% <3% / yr
164
Design-To-Cost: Cross-functional team
• Constitute cross-functional team from the very beginning of the development project.
Cost controlling
Suppliers Marketing & Sales

Project manager
Procurement Engineering
Manufacturing
Execs and management
165
Design-To-Cost: Cross-functional team: Onboard suppliers
Key idea:
• To reduce the supplier’s price, it is better to optimize the supplier’s costs rather than putting
his/her margin under pressure.
- Price • Major lever to optimize supplier costs: Buyer should design products that call for abilities that
Margin the supplier is good at, i.e. easy to do for the supplier.
Establish a partnership relation between buyer and supplier:

• Choice of preferred supplier who becomes part of the cross-functional team
Costs • Clear explanation of quality & cost/price target
• Agreement on game rules:
• Ethics: Confidentiality of shared information, in particular supplier cost structure
• Economics: How investments and savings will be shared
• Intellectual property: Who can register patents, who can use innovations, on what conditions
• Project planning
• Industrial plan: Target quantities, ramp-up, commitment or not
• Both parties must commit right level of resources
166
Design-To-Cost: Cost framework – Total Cost of Ownership (TCO)
Use
Marketing & Sales
Secondary
• G&A
• B&F Logistics Sales Price
• R&D Maintenance
• HR, …
Production
Disposal
Procurement of sub-
assemblies, components Recycling
and raw materials
167
Design-To-Cost: Cost framework – Cost Categories
• Cost categories:
• You need to understand and define the various dimensions of cost before setting cost
target of DTC
Saving are easy to identify and measure
Saving are easy to identify and difficult to measure
Energy, Labor, Saving are difficult to identify and measure

Shared
cost water, … Press,… No Savings possible
Specific Labor,
Material Non-Accessible
cost Molds,…
Accessible
Variable Fixed
cost cost
• Attention with unused installed capacities (machines, labor) when allocating shared
costs to a product or when spreading fixed costs over the production volume !
168
Design-To-Cost: Cost framework – Optimize product and/or process
• Design To Cost applies to any manufacturing type:
Ease of DTC implementation
Projects & Make to order / Batch In-line / Continuous

Investments Customer tailored mode Standard
Optimize Optimize Optimize Optimize

product AND product product AND process
process process
169
Design-To-Cost: Quality framework (functional model)
• Quality encompasses …
• Produced quality is measurable. Examples: Performance level, equipment, reliability, lifetime,
maintainability, adaptability/agility, societal and environmental impact.
• Perceived quality is intangible. Examples: Style / aesthetics, brand image.
• The qualities of a product deliver functions that address the customers’ needs.
Relative Quality score of competitors For each quality aspect,
for each decision criteria quantify the
• importance to customers
100
90 Compet 1
80
Compet 2
Compet 3 (surveys, focus groups,
70
60
Me
market price of optional
50 features, relative assessment)
• achieved satisfaction rating
40
30
20 (ideally with perform. scale).
10
0 → Quality score =
Rating x Importance
KSF 100 KSF 80 KSF 50 KSF 30 KSF 25
Example of Seating Ease of Lifetime Ease of ESG

office chair: comfort / moving mainte-
ergonomics nance
170
Design-To-Cost: Technical Optimization
Search for optimization ideas – useful questions to ask

• Product design
• What is the component used for ? Is it needed ?
• Can we find similar components in other products (internally or externally) ? • Identify Cost
What is their cost ? Why is their cost different ? Drivers, i.e.
• Materials
parameters with
great cost impact.
• Are these materials and their dimensions standard (internally, for the industry) ?
• Can we find more standard materials with similar performance ? • Assess saving
• Is it possible to reduce Raw weight (lower net weight, lower scrap, recycling, …) potential
• Labor together with
• What causes need for rework ? a. impact on
• Is it worth automating? quality score
• Do certain operations require specific skills ? b. Implementation
• Process risk, time and
investment.
• Is this technology or process under control/well known in the industry ?
• Are dimensions compatible with standard tools and processes ?
• Are tolerances consistent with technologies used or available skills ?
171
Design-To-Cost: Technical Optimization – Example of Software Tool
172
Design-To-Cost: Functional Optimization
Search for optimization ideas
1. Functional Model 2. Value contribution of each function
Importance Overall Value Overall Value Contribution

Rating Quality score
(weight) Contribution 45%
Seating comfort 3 8 24 43% 40%
Moving 2 6 12 21% 35%
Lifetime 2 4 8 14% 30%

25%
Maintenance 2 5 10 18%
20%
ESG 1 2 2 4%
15%
56 100%
10%
Rating Scale: 5%
10 = outstanding 0%
0 = poor Seating comfort Moving Lifetime Maintenance ESG
173
Design-To-Cost: Functional Optimization
3. Functional cost breakdown: Contribution of 4. Value analysis: Value creation of a

each component to the implementation of a function vs. its costs of implementation
quality aspect (function)
List of Seating
Moving Lifetime
Mainte-
ESG Overall Value Contribution vs. Costs
Components comfort nance
(BOM) Costs 70%
Seat
60%
Structure 12.00 € 75% 20% 5% 100%
Foam 1.50 € 75% 20% 5% 100% 50%
Fabric 3.00 € 60% 15% 20% 5% 100%
Tilt adjustment 9.00 € 78% 20% 2% 100% 40%
Armrests (x2) 6.00 € 95% 3% 2% 100%
30%
Stand
Adj. column 17.00 € 78% 20% 2% 100% 20%
Legs (x5) 10.00 € 95% 5% 100%
Wheels (x5) 15.00 € 5% 75% 15% 5% 100% 10%
0%
73.50 € 48.16 € 11.25 € 10.78 € 0.60 € 2.72 € Seating Moving Lifetime Maintenance ESG
Total
100% 66% 15% 15% 1% 4% comfort
174
Design-To-Cost
Examples, Key Concepts, Technical / Functional / Systemic Optimization
Real Options
Overview of use cases, Resource allocation in Portfolio Management
175
Reading recommendation
Discovery-Driven Growth: A Breakthrough Process to Reduce Risk and Seize Opportunity
This bestseller from Rita Gunther McGrath and Ian C. MacMillan provides the managerial
framework that is quantitatively described as Real Options.
“You've been charged with growing your business. Incremental growth can no longer
deliver the results you need. You need truly dynamic growth - and you need to achieve it
without risking a hugely expensive gamble. How can you encourage innovative new
ventures and pursue ambitious growth while minimizing risk?
In Discovery-Driven Growth, authors McGrath and MacMillan show how companies can
plan and pursue an aggressive growth agenda with confidence. By carefully framing their
strategic growth opportunities, testing each project assumption against a series of
checkpoints, and creating a culture that acts on evidence and learning instead of blind
stumbling, companies can better control their costs, minimize surprises, and know when to
disengage from questionable projects--before it's too late.
Providing tools that will help you select and better assess the potential of any strategic
venture, from new product lines to entirely new businesses, the authors outline a
comprehensive process that lets you identify, manage, and leverage your company's full
portfolio of opportunities. By reducing up-front costs and eliminating unnecessary risks,
you'll be able to avoid missteps and explore more options to create the breakthrough
growth that your business requires.”
176
In a nutshell: How I* evaluate a start-up pitch from a strategic perspective
• Do they have a clear vision ?

• Do they know where they are going ?
• Do they all aspire to achieve the same ?
• Is the picture of the world they are painting realistic ?
• Do they have the resources and capabilities to get there ?
* Page content by Karin KOLLENZ-QUÉTARD
• What do they need / what do they have ?

• Are they aware of potential gaps ?
• Do they have a realistic plan to fill these gaps ?
• Are any of these resources and capabilities VRIS (Valuable, Rare, Inimitable, Exploited by the Organization) ?
• What is unique about their business model ?
• Who might adopt it ?
• What differentiates the value proposition from existing and future competitors ?
• How will they deliver the value they promise ?
• Is the BM scalable ?
• Is the BM sustainable ?
177
Real Options: Overview of Use Cases
Early Adopters (Visionaries) of new

technology will benefit from Real To grow from a niche market to the Early Majority market,
Options based business creation use the beachhead strategy and expand from the niche
to nearby segments, managed as Real Options steps.
Market
Attractiveness Manage further market penetration
as Real Options steps.
Use Real Options to invest Question Mark Rising Star
in disruptive innovation,
attractive
Manage for earnings

manage portfolios, 1. Invest 2. Lead
structure M&A deals, Need for cash Even cash in & out • Invest in sustaining innovation. Use Real
value patents / licenses / Entrepreneur Grower / Manager Options for transformation projects
IP / intangible assets. (digital, migration of technologies, …)
• Create resiliency to protect the cash
unattractive
3. Harvest cow position, use Real Options to decide

Divest Generation of Cash on creation of resilience. E.g.:
Financial Manager • Flexible sales/purchasing contracts
Dog Cash Cow • Industry 4.0, XaaS, redundancies
Ability to
compete
178
In an ever faster changing world,
innovation and agility are essential
to sustain competitiveness.
Real Options: Scope of application
Innovation Strategic Agility
• Products / Services • Flexible production / Industry 4.0

• Market development projects • Flexible work week
• M&A / patents / licenses • SaaS, IaaS, MaaS, EaaS, …
• R&D / Exploration • Flexible purchasing / sales
contracts
180
Shall we invest in innovation ? Is it worth to invest in the

creation of agility ?
Innovation and Agility = +
181

Innovation and Agility = + How to know to invest ?
182

How to know to invest ?
183
How to know to invest ?
Project design Financial Investment

(planning) representation strategy / decision
184
Knowing how to invest
… in innovation and agility is a key enabler to …
185
Real Options
Competitive Strategies for Investing in Innovation and Agility
01. Introduction
Mindset, Key concepts, Benefits
02. Valuation Techniques

Financial Options, Replication
03. From Financial Options to Real Options

How to transpose financial option valuation techniques to business cases
04. Real Options case studies

Business cases about the creation of strategic agility and innovation projects
186
01. Introduction
Mindset
Project Design, Financial Representation, Investment strategy / decision
Investing in Innovation Projects

Key concepts, Example, Benefits
Investing in Strategic Agility

Key concepts, Examples, Benefits
187
Project design: Waterfall & NPV → For projects with little uncertainty
WBS €1
€2
€3
€4 €ROI
Predefined execution.
Decision to invest in the entire project, if NPV > 0
188
Project design: Waterfall & NPV → NOT applicable to innovation !
Version (n+1) of an established product Innovative product
Product
Car with regular combustion engine Full electric car

Technology Known Disruptive
Market Known Attractive but uncertain
Waterfall Predictable Waterfall NPVoptimistic > 0

NPV Investment Investment
project NPV project NPVpessimistic < 0
NPV criterion is applicable, NPV no longer applicable, hesitation to invest.

invest if NPV > 0. • Loss of precious time (losing speed)
• Risk of missing attractive innovation opportunities
• Risk of leaving attractive opportunities to competitors
Project design: Waterfall & NPV → NOT applicable to innovation !
Version (n+1) of an established product Innovative product
Investment strategies
Product
Access to
opportunity
Voiture avec moteur à combustion
①Car with regular
③ combustion engine Full electric car
Full
Risk-taking Flexible
Technology Known Disruptive
Market Known
Projet VAN
Attractive but uncertain
Limited
Investissement ②
n/a prédictible
Waterfall
prédictible
Predictable Waterfall NPVoptimistic > 0
NPV Investment Cautious Investment
project NPV project NPVpessimistic < 0
Critère
Riskyde la VAN est applicable,Investment
Careful
investissez si VAN > 0.
attitude
NPV criterion is applicable, NPV no longer applicable, hesitation to invest.
invest if NPV > 0. • Loss of precious time (losing speed)
• Risk of missing attractive innovation opportunities
• Risk of leaving attractive opportunities to competitors
Project design: AGILE & Real Options → Suitable for Innovation !
Structure the project in steps, each step resolving one uncertainty.
1. Investigate one uncertainty
3. Adjust the next project steps

2. Discover the result at
according to result and as per
the end of each step
available choices, i.e. options
(agile steering).
191
Real Case Example: Medical Drug Development and Commercialization
Clinical phase 1 Clinical phase 3 US: Tariffs ? US: TAM ? US: FDA ? US: Mkt launch
€6H €ROI.H
€5H
€4H Mkt HIGH
€6M €ROI.M
Tariffs HIGH €5M
€1 €2 €3
Mkt MID
€6L €ROI.L
€5L
€4L
Mkt LOW
Tariffs LOW
192
Real Case Example: Medical Drug Development and Commercialization Deferring big investment commitment
until uncertainty has been resolved.
• The Real Option value is 0.9 2.1 2.3 2.3 2.6 …

intelligible and depends on Clinical phase 1 Clinical phase 3 US: Tariffs ? US: TAM ? US: FDA ? US: Mkt launch
• the future Free Cash Flows 800€ 2500€
and Investments (concepts 50€
The Real Options value 75% 1700€
well known from NPV),
evolves with each project step. 1033€
• their risk-levels (value and Investing in a project step buys the
probability distribution), and opportunity (Option) to maybe 1.5 € 66% Mkt HIGH
• their timing. continue with the next step,
881€
accessing eventually some ROI 444€ 1589€
• Real Option Trees can have Tariffs HIGH 25€ 75% 1144€
any complexity: Number of 80% 704€
nodes, branches, probability 0.3 € 0.6 € 0.2 €
66% 95% Mkt MID
distribution, timing. 318€ 604€ 699€
• Beware: A Real Option value is 267€ 1133€

NOT equal to the probabilistic 10€ 75% 866€
NPV. Differences can be 0.3 € 66% 542€
significant ! Each step allows to learn about an 293€
hypothesis (uncertainty) and to steer to the Mkt LOW
next step according to the learning and Tariffs LOW ROI: Value of return Free
available choices. Cash Flows
Project design: AGILE & Real Options → For Innovation & Strategic Agility
This Real Options based investment strategy has been suggested by the MIT.
It applies to
• Innovation projects
Net Real Option Value = NPV + Value of Agility
• Creation of Strategic Agility
Value of Agility = Net Real Option Value – NPV
194
01. Introduction
Mindset


195
Agile Innovation Projects: Financial Key Concepts
• Financial representation: Each step is a Real Option on the next step (“Options on Options”), and
ultimately on the ROI.
• Investment decision:
• Scope: decision just about the investment in the very next step. Subsequent investments will be decided later.
• Criterion: invest in the next step, if its Real Option Value > Investment in this step.
• Additional criterion at project start: enter this project only, if the maximum possible loss could be
acceptable.
196
Agile Innovation Projects: Financial Key Concepts
• Investment strategy: Defer the big investments, first find out whether they are worthwhile →
At each project step, get full access to the business opportunity AND invest carefully:
• Flexibility of investments: invest in next steps as long as justified but stop as soon as necessary.
• Investment profile: small investments at the beginning and bigger at the end, in line with the risk profile.
• Flexibility of steering: pivot the project, enhance or mitigate financial results according to project event
• Cultural aspects:
• Stopping a project before finishing is not sign of failure but of learning !
• We cannot predict the future, but we can and do describe its possible scenarios and react most suitably
according to the learning from each step and to our available options (like startups or entrepreneurs).
197
Agile Innovation Projects: Determine optimum project strategy
Real Case Example: Aggressive investment for faster TTM vs. cautious investment and later TTM.
Strategy ① : Fully sequential but later TTM, i.e. lower risk but lower return 1. Create AGILE project structures
a. Assess the optimistic scenario financially.
b. List all assumptions made for reaching this
optimistic scenario. Here: Technical feasibility,
market acceptance, full fledged v02 vs MVP
c. For each assumption, plan a project step that
verifies this assumption. Identify cost, duration,
possible results and probabilities.
Strategy ② : Parallelization for faster TTM, i.e. higher risk with higher return d. Assemble the project steps, either fully
sequentially or with parallelization → Project
Trees ① and ②.
2. Determine OPTIMAL project strategy

a. Use Real Options to determine the value
creation by each project strategy ① and ②.
b. The optimal strategy is the one with the
highest value creation, here: strategy ②.
198
Agile Innovation Projects: Access optimistic estimations
Any uncertainty about the estimation of a project step (duration, cost) can be fully taken into account in the
tree structure.
10 €
Uncertainty
about estimation
6€
25%
optimistic 4€
60%
medium 3€
pessimistic
199
Agile Innovation Projects: Investing in a technology platform
• Business Case of a Technology Platform:

• The investment is justified by the Real Options on the
use-cases that it enables.
• The Technology Platform enables the highly efficient
creation of client solutions (use-cases). Several ones
have been identified right from the outset.
• However, the use cases are uncertain and require each
time a POC. If successful, industrialization and a 1st
deployment to clients takes place. This provides for the
option of subsequent deployments to clients
(deployment phases 2 and 3).
• AGILE management of the Use-Case portfolio :

• At each checkpoint, new ideas for use-cases and
existing use-cases (deployment) compete for budget
and resources.
• Real Options valuation allows to manage the portfolio
based on maximum financial value creation.
200
Agile Innovation Projects: Dynamic Portfolio Management
• Allocate budget in an agile way while respecting Checkpoint at t=3

the annual budgetary envelope: Portfolio
• Know how to launch, stop and pivot projects. time t = 1 2 3 4 5 6 7…
• Be prepared to react faster, be able to seize Initiative 1

(agile)
opportunities.
• Be ready for adjustments, with large consensus.
• Manage budget allocation as per maximum value
created, not as per remaining budget to be spent.
Initiative 2
• Know how to create and manage a hybrid budget (waterfall)
for a mix of standard (predictive) and agile
(adaptive) business projects.
Initiative …
• Know how to invest in innovation despite of the
relating uncertainties.
• Achieve commitment of project teams to costs,
delay and deliverables.
• Implement these new capabilities easily & quickly.
201
Real Options: Resource allocation in Portfolio Management
Allocate scarce resources by calculating a Profitability Index, thereby identifying the highest value
of opportunity:
Net Option Investment Engineering Net Option Investment Net Option Value /
Project Project
Value in next step Headcount Value in next step Next investment
Project 1 19.6 33.8 50 Project 2 20.6 21.9 0.941
Project 2 20.6 21.9 58 Project 7 22.7 34.4 0.660
Project 3 9.6 27.8 63 Project 9 21.3 34.6 0.616
Project 4 11.5 24.8 61 Project 1 19.6 33.8 0.580
Project 5 10.1 24.5 50 Scarce resource Project 4 11.5 24.8 0.464
Project 6 12.9 30.7 32 = Capital Project 8 14.0 31.2 0.449
Project 7 22.7 34.4 47 Project 6 12.9 30.7 0.420
Project 8 14.0 31.2 40 Project 5 10.1 24.5 0.412
Project 9 21.3 34.6 57 Project 3 9.6 27.8 0.345
Total 142.3 263.7 458
Budget: 180.0
Allocated: 180.7
Note:
• This consideration suggests a project choice from a sole financial perspective. Additional considerations like strategic fit
and level of risk diversification shall also intervene.
202
Real Options: Resource allocation in Portfolio Management
Allocate scarce resources by calculating a Profitability Index, thereby identifying the highest value
of opportunity:
Net Option Investment Engineering Net Option Engineering Net Option Value /
Project Project
Value in next step Headcount Value Headcount Engineering HC
Project 1 19.6 33.8 50 Project 7 22.7 47 0.483
Project 2 20.6 21.9 58 Project 6 12.9 32 0.403
Project 3 9.6 27.8 63 Project 1 19.6 50 0.392
Project 4 11.5 24.8 61 Project 9 21.3 57 0.374
Project 5 10.1 24.5 50 Scarce resource Project 2 20.6 58 0.355
Project 6 12.9 30.7 32 = Engineering Project 8 14.0 40 0.350
Project 7 22.7 34.4 47 Project 5 10.1 50 0.202
Project 8 14.0 31.2 40 Project 4 11.5 61 0.189
Project 9 21.3 34.6 57 Project 3 9.6 63 0.152
Total 142.3 263.7 458
Max Engineer Headcount: 250
Allocated: 244
Note:
• This consideration suggests a project choice from a sole financial perspective. Additional considerations like strategic fit
and level of risk diversification shall also intervene.
203
Scenario-based strategic planning
The returns of each scenario correspond to the value of the respective project portfolios.
See page 70 for details on Scenario-based planning. 204

AGILE & Real Options: Benefit #1: Outstanding Access to Innovation
→ Intensify innovation by minimizing financial risks and by evaluating value creation right
from the beginning. Create culture of innovation be minimizing personal risks.
→ Create speed thanks to an adaptive proceeding and minimized risks: quickly launch
innovative projects and learn but be able to stop or pivot as soon as learning implies this
necessity. Seize opportunities, shorten Time-to-Market.
→ Manage portfolios in an agile way, optimize value creation recurrently while respecting
the overall budget. Also applicable to hybrid portfolios, comprising classic and agile
projects.
→ Maximize the value of innovation projects: Optimize the project structure, get access to
optimistic work estimations.
→ Deploy easily & quickly: Little organizational impact, methodology easily intelligible to
decision makers, sponsors and all employees. Strengthen the culture of innovation and
agility (adaptability).
→ Fully compatible with LEAN-AGILE methods like SAFe® and Disciplined Agile (but not
prerequisites).
205
AGILE & Real Options: Benefit #1: Avoid Innovation Pitfalls
→ Taking average assumptions (NPV approach) by fear of

over-commitment
→ Too narrow project scope, neglecting follow-up
opportunities
206
01. Introduction
Mindset


207
Strategic Agility: Key concepts - Mindset
Strategic agility (resiliency) is the capacity to react effectively to unpredictable events.

• Example: When the engine of your car does not start, you may be pleased to be able to resort to
alternative solutions, such as car-pooling, taking the bus, etc.
• Key ideas about managing uncertainty through agility (flexibility) :

• You can only manage uncertainty if you acknowledge it. Indeed, if you deny the existence of uncertainty,
you will not develop proper flexibility.
• Flexibility must be readily available when needed. It must be prepared for.
• Flexibility makes uncertainty acceptable.
• In case of uncertainty, flexibility is valuable.
• Flexibility must be used as needed, i.e. in accordance with the occurrence of an uncertain event. This
requires the capacity to observe whether an event has occurred.
208
Strategic Agility: Key concepts – The Value of Agility (flexibility)
The value of agility (flexibility) is based on 3 elements:

• Expression of uncertainty to understand opportunities and risks.
• Availability of agility (flexibility) that allow for an appropriate reaction when uncertainty
resolves.
• Observation of how the uncertainty resolves (new proprietary information). Only with this
information, it becomes possible to make a suitable and thereby valuable use of the available
flexibility !
→ The greater the uncertainty, the more valuable the agility (flexibility).
! • Check: Ensure that the extra cost for creating agility < the value of agility (flexibility)
209
Strategic Agility: Examples
Flexible Deployment of Geostationary Satellites:

• Uncertainty: The demand for capacity can evolve in
terms of coverage, power and frequency bands
during the satellite lifetime. → A satellite with a static
configuration could become useless
• Flexibility: Ability to reconfigure and relocate a
satellite to the most profitable use of its payload.
• Observation: The market demand for capacity and
the related market prices.
• Extra costs: Equip the satellite with reconfiguration
capabilities (beam shaping, uplink / downlink
frequency flexibility, power flexibility, …)
210
The Flexible Work-Week at Volkswagen:

• Uncertainty: Order backlog and required
production capacity.
• Flexibility: Adjustment of the work-week of
industry workers, thus matching HR
capacities with the order backlog.
• Observation: The order backlog.
• Extra costs: Volkswagen offers a salary
premium in return for this flexibility.
211
Flexible M&A Deal:

• Uncertainty: What is the right acquisition price ?
• Flexibility: Adjust the amount of future acquisition
payments to the target company’s success as
defined in the earnout clauses.
• Observation: Delivery on earnout clauses, i.e.
proof-points for the target company’s success.
• Extra costs: Price premium to incentivize the seller
to agree to such a flexible deal.
Flexible bidding with earnout clauses is more

competitive than the one based on NPV calculation,
while simultaneously minimizing financial risks.
212
Strategic Agility: Benefits: Quick & Rational Decision Making
→ Develop resilience based on a financial rational of

value created by resilience vs. its costs.
→ Create speed in decision making.
→ Creation of culture of resilience.
213
Real Options
01. Introduction



214
Financial Options
Definition, Elementary Option, 2-step American Call Option, B&S Formula
Incomplete Replication method

Key Concepts, Valuation
215
Financial Options: Definition
• The deal: A Call Option on Stock is the right but not the obligation to buy that Stock at an
Exercise Price. This right is valid at maturity date (European Option) or also before
(American Option).
• The value of a Call Option is the fair present value of its future payoffs.
Stock Price V Call Payoff C

Call Option is a flexible deal: buy
underling Stock only if it is worth it
(observable through stock ticker).
C = MAX(V–EX; 0)
Uncertainty about
future Stock Price V
Time Stock Price V
Maturity date Exercise Price EX

216
Financial Options: Valuation of an Elementary Option
1. Uncertainty
Stock Price
t=0 t=1
73 €
2. Observe result at
55 € the end of each step
41 €
* Example:
Call Option with EX=50. Option Value *
Payoff = 73€ - 50€ = 23€ in t=0 t=1
up-case, and 0€ in down-case.
23 € 3. React according to the
?€ observed result and as per
0€ available flexibilities*.
217
Financial Options: Valuation of an Elementary Option
Stock Price Option Value

t=0 t=1 t=0 t=1
73 € 23 €
55 € ?€
41 € 0€
Solutions to Option Valuation :
• Replicating portfolio approach discounts expected payoffs at an implicit risk-adjusted rate.
• Risk-neutral probability approach discounts certainty-equivalent payoffs at the risk-free rate.
218
Financial Options: Replicating Portfolio approach
• Law of one price: Any two assets that yield the same future payoffs at the same risk, must
necessarily have the same present value.
• Replicating Portfolio approach:

• Asset 1 is the Option. The future payoffs of the option can be calculated. But what is the option
value, i.e. the fair present value of the future payoffs ?
• Asset 2 is the Replicating Portfolio. It is made of two constituents:
• m shares of the same underlying asset as the option is written on → same risk as for option
• and a bank loan of a present value B. → no additional risk, as bank loan is risk-free.
• For the Replicating Portfolio (Asset 2), choose the amount of m shares and the bank loan B such that it
yields the same future payoffs as the Option (Asset 1).
• Determine the present value of the constituents of the Replicating Portfolio (Asset 2).
• According to the law of one price, the fair present value of the option (Asset 1) has to be equal to the
present value of Asset 2. Indeed, they yield the same future payoffs at the same risks.
219
Financial Options: Replicating Portfolio approach
Asset 1 = Option Asset 2 = Replicating Portfolio

Stock Price Option Value * • Made out of m shares of the
t=0 t=1 t=0 t=1 same stock the option is
Vu Cu = written on → same risk
73 € 23 €
V0 55 € C0 ?€ • And a bank loan of a present
value B
Vd 41 € Cd 0€
1. For any event, the constituents m and B of asset 2 shall be Cu = m * Vu – B * (1+rf)

chosen such that they replicate the payoffs of asset 1: Cd = m * Vd – B * (1+rf)
2. These two equations can be resolved for determining m m = ( Cu–Cd ) / ( Vu–Vd )
and B: B = ( m * Vu – Cu ) / (1+rf)
= ( m * Vd – Cd ) / (1+rf)
3. Determine the present value of the constituents of asset 2
and make use of the law of one price to set the fair present C0 = m * V0 – B
value of asset 1:
4. Exercise #1: Using the values of the example, rf = 5%: m = 0.7188, B = 28.07€, C0 = 11.47€
220
Financial Options: Risk-neutral Probability approach
Hedge portfolio of one share of the underlying asset V and a short position on n Call options.
Choose n such that the portfolio is risk free (= always same return) over the next short interval
of time. The present value of this portfolio is equal to the Present Option Value.
u * V0 – n * Cu = d * V0 – n * Cd = (V0 – n * C0) * (1+rf)

with
Vu = u * V0 and Vd = d * V0

C0 = [ p * Cu + (1-p) * Cd ] / (1+rf) The Risk-neutral probability p can be seen as a

correction factor that is chosen such that once
with applied to the future payoffs Cu and Cd , it is
Risk-neutral probability p = [ (1+rf) – d ] / (u – d) fair to discount them with rf to calculate C0.
221
Financial Options: Risk-neutral Probability approach
Stock Price Option Value

t=0 t=1 t=0 t=1
Vu 73 € Cu 23 €
V0 55 € C0 ?€
Vd 41 € Cd 0€
Example:
1. Calculate u and d: u = Vu / V0 = 73 / 55 = 1.33
d = Vd / V0 = 41 / 55 = 0.75
2. Calculate p: p = [ (1+rf) – d ] / (u – d) = [ (1+5%) – 0.75 ] / (1.33 – 0.75) = 52.3%
3. Calculate C0 : C0 = [ p * Cu + (1-p) * Cd ] / (1+rf)

= [52.3% * 23 + (1-52.3%) * 0] / (1+5%) = 11.47€
222
Financial Options: American Call Option, 2-steps
Exercise #2:
• Task: Calculate the Present Value C0 of time t = 0 1 2

an American Call Option with two
time-steps until expiration and 2
144.00 € Vu
possible outcomes after each step.
V0
Vu 120.00 €
100.00 € Vd
• Given:
• Value event tree of underlying V0 100.00 €
stock. Note: Tree is built as per a
geometric stochastic process. V0 100.00 € Vu
Vd 83.33 €
• Parameters of Call Option: rf = 5%, 69.44 € Vd
EX = 80€, t = 2 years,
type = American (i.e. the option
can be exercised anytime). Loan interest rate (rf) 5%
Exercise Price (X) = 80.00
V0 100.00 Parameters of geometric stochastic
u 1.200 process for the construction of the
d 0.833 Value event tree
223
Financial Options: American Call Option, 2-steps
Valuation of Call Option: time t = 0 1 2
1. Process: Proceed from right to left. At each

time step and for each event, ask: “Shall I C0 64.00 € Cu
make use of my flexibility right now (i.e. Cu 43.81 €
exercise the option) or maybe later on (i.e. 40.00 € 20.00 € Cd
keep the open option) ? Note: At expiration
date, there is no “maybe later on”, i.e. if it is C0 29.04 €
not worth to exercise the option by then, the
payoff is Zero. C0 20.00 € Cu
Cd 11.26 €
2. Flexibility: The right but not the obligation to 3.33 € 0.00 € Cd
buy the underlying asset by spending the
Exercise Price. → Results are “payoffs”.
3. Discount the payoffs using the Replicating m= 1.000
Portfolio approach. B= 76.19 €
m= 0.888 C0 = 43.81 €
4. Repeat the process until discounting to t = 0. B= 59.74 € m= 0.655
C0 = 29.04 € B= 43.29 €
C0 = 11.26 € 224
Financial Options: Black & Scholes Formula ∞
∞
Calculating the Present Value of an Option with lim n → ∞ time-steps while ∆t → dt : Black & Scholes
Formula:
Value of Call Option = N(d1) * P – N(d2) * PV(EX)

Note: Future investments (EX) are discounted at risk-free rate !
PV(EX) = EX * e -r t
d1 = [ log(P/PV(EX)) ] / [σ * √t] + ½ * σ * √t
d2 = d1 - σ * √t
N(d) = NORMSDIST(d) (EXCEL function, returns the standard normal cumulative distribution, using a mean of
zero and a standard deviation of one)
EX = Exercise Price
r = continuously compounded risk-free interest rate p.a. (e.g. = 4,88% = ln(1,05))
t = number of years to exercise date
P = Present Stock Price
σ = Implied continuously compounded volatility of the underlying stock p.a.
225
Financial Options: Black & Scholes Formula ∞
∞
Comments on the Black & Scholes Formula:
Properties Comment Useful for Real Options

valuation ?
Allows to value Call and Put Options, Flexibility limited to “investing or

European and American type (are not not”. NO
exercised before expiration date).
Uses geometric stochastic process to predict Future value evolution highly
future values. unrelated with value of any business
case.
NO
Topology limited to one decision in
the future.
Future investments (Exercise Price) are Valid for NPV calculation to YES, for valuation of flexibility =
discounted at risk-free rate. compare with Net Option Value ANPV ANPV – NPV
→ The Black & Scholes Formula is NOT useful for a Real Options representation of business cases.
226
Financial Options
Definition, Elementary Option, 2-step American Call Option, B&S Formula
Incomplete Replication method

Key Concepts, Valuation
227
Risk-Value Model: Incomplete Replication
Valuation method proposed by Gleißner and Dorfleitner (2018)1: Decision maker compares risky cashflows
with available reference investment possibilities.
• Reference investment: Portfolio of (1) Risk-free investment, and (2) Risky market portfolio.
• Risk Measure is chosen by the Decision maker: Standard Deviation, VaR, …
• Replication: At time t, the

• Risky Cashflow X has an Expected value μ(X) and a Risk ρ(X), e.g. Standard Deviation σ(X)
• Reference Investment portfolio is constructed by investing (a) y in the risk-free asset and (2) z in the
risky market portfolio. The investments y and z are calibrated such that the Expected Value of the
reference investment and its Risk replicate the ones of the Risky Cashflow X. Thus:
μ(X) = μ( y*(1+rf) + z*(1+RM) ) = y*(1+rf) + z*(1+ μM)

ρ(X) = ρ( y*(1+rf) + z*(1+RM) )
1 Gleißner,
W., and Dorfleitner, G. (2018). Valuing streams of risky cashflows with risk-
value models, Journal of Risk 20(3), 1-27 (https://doi.org/10.21314/JOR.2018.379). 228
When using the Standard Deviation σ(X) as risk measure, it can be shown that
μ(X) – λ ∗ σ(X)
• Present Value of Risky Cashflow X : PV(X) =
1+rf
μ(rm) – rf
with λ= λ being a risk premium that the investment must yield for every unit of risk taken.
σ(rm)
Note: For typical market indices, λ = 0.225 … 0.250.
μ(X)
• Effective Risk-adjusted discount rate [%p.a.]: k= −1
PV(X)
229
Example: Risky Cashflow

t=0 t=1
Xu 10 €
50%
X0 4.85€
50% X
d 2€
• Unitary Risk Premium λ = 0.25 for chosen market index (~typical value)
• Expected value μ(X) = Xu * 50% + Xd * 50% = 6 €
• Risk measure σ(X) = (Xu – μ)² ∗ 50% + (Xd – μ)² ∗ 50% = 4 €
• Present Value PV(X) = ( μ(X) – λ * σ(X) ) / (1+rf)

= ( 6 € – 0.25 * 4 € ) / (1+3%) = 4.85 €
→ Risk-adjusted rate k = ( μ(X) / PV(X) ) -1 = (6 € / 4.85 €) -1 = 23.6% p.a.

230
Benefits of this method for Real Options valuation:
• It can be used to value both the PV events and Option events.
PV events Option events

t=0 t=1 t=0 t=1
PVu 150 € ROu 50 €
40% 40%
PV0 89 € RO0 13 €
60%PV 60%RO
d 70 € d 0€
• It applies to any number of future values, not just two.
PV events Option events

t=0 t=1 t=0 t=1
150 € PVu @ 20% 50 € ROu @ 20%
PV0 101€ 120 € PVm @ 50% RO0 15 € 20 € ROm @ 50%
70 € PVd @ 30% 0 € ROd @ 30%
231
Exercise #3: PV events Option events

t=0 t=1 t=0 t=1
PVu 150 € ROu 50 €
40% 40%
PV0 89 € RO0 13 €
60%PV 60%RO
d 70 € d 0€
1. Value PV0 by using the Incomplete Replication approach (λ = 0.25, rf = 3%)
2. Consider PV as the underlying asset of a Call option RO, with EX = 100 €. Use both the Replicating Portfolio
approach and the Incomplete Replication approach to determine RO0. Compare both valuation results.
3. Redo task 2 for the case of NO FLEXIBILITY, i.e. when spending the exercise price EX = 100 € in any event, even
if it is not worth it. As task 2 considers flexibility, and task 3 does not, the difference in valuation is equal to the
Value of flexibility. Please calculate it.
4. Calculate the Value of flexibility and the Risk-adjusted discount rate k of the PV events for probabilities
between 0% and 100% (in 10% steps). Display both graphs and comment on the results.
232
Exercise #3:
• The valuation of the case of “no flexibility” can also be done by calculating the NPV, if discounting investments at r f.
• For unsure cases, i.e. 0% < probabilities < 100%, the effective discount rate is risk-adjusted, thus greater than rf.
• For sure cases, i.e. probabilities = 100% or 0%, the results from the Incomplete Replication are as one would expect:
• The effective discount rate is the risk-free rate rf (applicable to any future value, i.e. PV events and payoffs).
• For a probability of 100% for the higher future value, the Value of flexibility = 0.
• For a probability of 0% for the higher future value (i.e. 100% for the lower future value), the Value of flexibility is
equal to the value of the avoided loss, discounted at r f.
233
Real Options
01. Introduction



234
Real Options
Definition of Real Options, Correspondence with Financial Options, Case Study #1
Flexibilities
Examples for flexibilities, Multiple simultaneous flexibilities
Recipe for Business Cases using Real Options

PV event trees, Option event trees
235
Real Options: Definition
• A Real Option is the freedom to take managerial action on the financial outcome of an uncertain business.
The managerial action is taken in the future, once the resolution of the uncertainty can be observed.
• Checklist: You hold a Real Option, when

• There is at least one other decision to be taken beside the initial investment decision. E.g. decision to
invest or to abandon.
• These additional decisions can be taken later and according to available flexibilities.
• At present, the course of action is uncertain. However, a virtually exhaustive description of all courses of
action can be made.
• In the future, it can be observed which course of action (or value evolution) has materialized. According
to this observation, the decisions will be taken in an informed way.
• Paradigm of Real Options method:

• In case of uncertainty, put in place managerial flexibilities that allow for appropriate reactions when the
actual outcomes of formerly uncertain evolutions can be observed. Sufficient flexibility makes
uncertainty acceptable.
236
Real Options: Correspondence with Financial Options
Financial Options Real Options
As per the Market Asset Disclaimer, the value of the underlying asset is the PV of a
Stock Price (V)
business project, for any point in time and event where decisions are due.
Decision of using available managerial flexibilities as per the observation of the

Decision on Exercising
outcome of former uncertainties.
The degree of uncertainty as expressed by the possible PV events, for most

Volatility of Stock Price (σ)
optimistic to most pessimistic scenarios. Note: PV events do not represent flexibility.
Whatever kind of managerial flexibility as per the business case. Flexibility applies to
Exercise Price (EX)
PV events and result in payoffs.
Time horizon at which decisions are due as the outcome of former uncertainties can
Time to Expiration (t)
be observed.
Highest interest rate that a decision maker would obtain for an investment that
Risk free Interest rate (r f)
he/she considers as risk-free, e.g. bank loan, T-bond.
Option value Value of a business project with flexibility.
237
Real Options: Correspondence with Financial Options
Market Asset Disclaimer (MAD): (T. Copeland, Real Options, 2003, page 94):
“Instead of searching in financial markets, we recommend that you use the present value
of the project itself, without flexibility, as the underlying risky asset – the twin security.
What is better correlated with the project than the project itself ? We are willing to make
the assumption that the present value of the project without flexibility (i.e. the traditional
NPV) is the best unbiased estimate of the market value of the project were it a traded asset.
We call this assumption the Market Asset Disclaimer (MAD).”
238
Real Options: PV event tree construction
PV event trees: Key concepts of their construction
1. Calculate PV events from free cashflows FCFs.
2. Calculate PV events for all those time horizons where decisions are due because observations of the
outcome of former uncertainties can be made.
3. For FCFs at or after the latest time horizon,

a. use the WACC for discounting. Reason: No more uncertainty, thus return to standard business casing techniques.
b. express uncertainty by distinguishing various scenarios, including reasonably optimistic and pessimistic ones.
4. For time horizons before the latest one, describe the project steps that lead to the possible scenarios:
a. Attach objective probabilities to the outcome of each project step.
b. Calculate the PV at the beginning of each project step by considering the PV events at the end of each project
step. Use the Incomplete Replication for discounting. Proceed recursively from later to earlier time horizons,
until reaching t=0.
c. If intermediary FCFs occur at these time horizons, add their value to the respective PV events.
239
Decisions are due at t=0, t=1 and t=2
Exercise #4:
WACC 9.00% p.a. t= 0 1 2 3
Risk-free rate 3.00% p.a. Project step 1 Project step 2 Go-to-market
Market price per risk unit λ 0.250 WACC
FCF events 80% 75.0 € 81.750 €
FCFu - € WACC
40% 20% 50.0 € 54.500 €
FCF0 - € WACC
60% 70% 40.0 € 43.600 €
FCFd - € WACC
30% 25.0 € 27.250 €
PV events 80% 150.0 € PVuu

PVu PVuu
PVu 131.1 €
PVud
40% 20% 100.0 € PVud
PV0
PV0 81.3 € PV0
60% 70% 80.0 € PVdu
PVdu
PVd 65.6 €
PVd PVdd
30% 50.0 € PVdd
μ= 140.0 €
σ= 20.0 €
μ= 91.8 € PV0 = 131.1 €
σ= 32.1 €
PV0 = 81.3 € μ= 71.0 €
σ= 13.7 €
PV0 = 65.6 € 240
Real Options: Case study #1: Designing a flexible purchasing project
Case : Purchasing of a new telecom equipment. However, uncertainty about right

dimensioning.
• Assumptions:
WACC 9.00% p.a.
Risk-free rate rf 3.00% p.a.
Market price per risk unit λ 0.250
Equipment of BIG capacity

InvestmentBIG 100.0 €
Return: PVBIG(t=2) 150.0 €
Probability of market match 40%
Equipment of SMALL capacity

InvestmentSMALL 70.0 €
Return: PVSMALL(t=2) 90.0 €
Probability of market match 60%
241
• Strategy ①: Take the risk and order the big equipment.
WBS
+150 €
40% NPV.BIG = 25.0 €
-100 €
+90 €
60% NPV.SMALL = -25.0 €
NPV.EXPECTED = -5.0 €
242
• Strategy ②: Avoid any risk and order the small equipment.
WBS
-70 € +90 €
NPV.SMALL = 5.8 €
243
• Strategy ③: First resolve uncertainty, then do the right investment.
Observation Flexibility/Agility
WBS
-103 € +150 €
NPV.BIG = 24.5 €
-0.5 €
-72 € +90 €
Option.net = 16.2 € NPV.SMALL = 5.3 €
244
• Strategy ①: Take the risk and order the big equipment.
time t [yrs] = 0 1 2
Contracting date Market uncertainty resolved Telecom equipment in service
InvestmentBIG = 100.0 € WACC PVBIG(t=0) 125.0 €

PVBIG(t=1) = 137.6 € 150.0 € Initial investment 100.0 €
40% NPV 25.0 €
PVexpected(t=0) = 95.0 €
60% WACC PVSMALL(t=0) 75.0 €
PVSMALL(t=1) = 82.6 € 90.0 € Initial investment 100.0 €
NPV -25.0 €
PVexpected(t=0) 95.0 € μ= 104.6 €
Initial investment 100.0 € σ= 27.0 €
NPVexpected -5.0 € PV0 = 95.0 € kadj = 10.1%
245
• Strategy ②: Avoid any risk and order the small equipment.
InvestmentSMALL = 70.0 €
WACC WACC
PVSMALL(t=0) = 75.8 € 82.6 € 90.0 €
PVSMALL(t=0) 75.8 €
Initial investment 70.0 €
NPV 5.8 €
246
• Strategy ③: First resolve uncertainty, then do the right investment.
103.0 € ← Investment adjusted as per observed market size

PayoffBIG(t=1) = 34.6 €
40%
RO(t=0) = 16.7 €
60% 72.1 € ← Investment adjusted as per observed market size
PayoffSMALL(t=1) = 10.5 €
RO(t=0) 16.7 € μ= 20.1 €

Market study = 0.5 € σ= 11.8 €
RO.NET 16.2 € C0 = 16.7 € kadj = 20.7%
m= 0.439
B= 25.0 €
Value of flexibility = 10.4 € C0 = 16.7 €
Conclusion: The telecom operator should not pay more than 10.4 € for creating flexibility.
247
• Strategy ③: Deferral option with flexibility disabled:
Conclusion: When disabling flexibility, the Option valuation results in the expected NPV
(provided that future investments are discounted at the risk-free rate rf). 248
PV event trees: Their entire construction is useful when …

1. the managerial flexibility relies on PV events, e.g. Abandon Option,
2. the Value of flexibility (agility) shall be determined, and therefore the NPV shall be calculated as
representation of the business project without flexibility.
• Remember: NPV = PV(0) – all inflexible investments discounted at rf.
• Alternatively, the NPV can also be determined through Option valuation with disabled flexibility.
249
Real Options
Flexibilities

250
Flexibilities: Examples
Options are future flexibilities. A business project can formulate any kind of flexibility. Examples:
• Deferral Option : Invest maybe later, i.e. defer a decision about investing to a later point in time, when
uncertainty will have been resolved.
• Deferral Option with adjusted investments : Adjust investments according to the observed outcome of
former uncertainty.
• Abandon Option: Bail-out of business and recuperate a residual asset value.
• Expansion Option: Invest to scale-up the business.
• Contraction Option: Scale-down and generate savings.
• Switch Option: Change between modes of operation, each change requiring spending of switching costs.
251
Flexibilities: Multiple Simultaneous Flexibilities
t= 0 1 Risk-free rate rf 3.00%
Market price per risk unit λ 0.250
PV events
Exercise #5: Mean Value μ 111.0 € 150.0 € PVu @ 20%
Volatilty σ 29.1 €
PV0 = 100.7 € PV0 100.7 € 120.0 € PVm @ 50%
70.0 € PVd @ 30%

Option events
Payoffs for … Value of FLEXIBILITY 12.5 €

Abandon Option PVu PVm PVd
Residual Asset Value 93.0 € 150.0 € 120.0 € 93.0 € Value of ALL flexibilities 12.5 €
Scale-down (Contraction) Option Value of Abandon flex. 9.0 €

Scale-down factor (<1.0) 0.9 152.0 € 125.0 € 80.0 € Value of Scale-down flex. 6.4 €
Savings if scaling-down 17.0 € Value of Scale-up flex. 3.1 €
Sum 18.5 €
Scale-up (Expansion) Option
Scale-up factor (>1.0) 1.2 160.0 € 124.0 € 70.0 € Conclusion:
Investment for scaling-up 20.0 €
The value of simultaneously available
flexibilities is not necessarily equal to
the sum of the values of the
t= 0 1
Mean Value μ 122.4 € 160.0 € ROu @ 20% individual flexibilities.

Volatilty σ 23.4 €
Therefore, value them simultaneously
RO0 = 113.2 € RO0 113.17 € 125.0 € ROm @ 50%
as shown.
93.0 € ROd @ 30% 252
Real Options
Flexibilities

253
1. Expression of uncertainty through Present Value events PV(t). Key concepts:

• PV events shall be calculated for various future scenarios, including a reasonably optimistic and pessimistic one.
• PV events shall be available for t=0 and for those future points in time, where results of previously uncertain
aspects can be observed, i.e. decisions can be taken accordingly and as per the available managerial flexibility.
2. Expression of flexibility through Option value events RO(t). Key concepts:

• While it is uncertain which PV event will happen in the future, it shall be ensured that in the future, it can be
observed which PV has happened; the result of previously uncertain aspects can be observed in the future.
• Based on the future observation of what event has happened, an informed decision can be taken of whether to
make use of the managerial flexibility at the considered time horizon. This informed decision acts on the financial
outcome of any event. Result is a payoff RO(t) = f ( flexibility, PV(t) )
• An Option value is equal to the fair present value of its possible future payoffs.
254
1. Expression of uncertainty through Present Value events PV(t). Rules for calculation:
WACC
a. For FCFs that occur at or after the
resolution of all uncertainties, a t
PV event for time t is equal to any 0 1 2 3 4
FCF at time t plus all subsequent
FCF events
FCFs discounted at the WACC. Time
t is considered as the present time
horizon, i.e. a FCF at time t does not PV events PV(3) = FCF(3)
require any discounting. Later FCFs
are duly discounted to time t. PV PV(3)
events can be discounted at the PV(2) = FCF(2) +
WACC. 1+WACC
255
Example: Decisions are due on t=0, 1 and 2
b. For PV events that occur prior to
the resolution of uncertainty, t
calculate them for the next earlier 0 1 2 3 4
time horizon at which a decision
FCF events p “up” event
is due, i.e. either because this is
t=0 or because the next earlier “down” event
(1-p)
project step delivers its results.
Calculate the PV event by using the
p
Incomplete Replication method. PV events PVup(2) = FCFup(2)
PV(1)
(1-p) PVdown(2) = FCFdown(2)
PV(1) calculated per Incomplete Replication method
256
Example: Decisions are due on t=0, 1 and 2
c. If FCFs occur prior to the
resolution of uncertainty, add t
their value to the respective PV 0 1 2 3 4
events.
FCF events p “up” event
(1-p) “down” event
p PVup(2) = FCFup(2)
PV events
PV(1)
(1-p) PVdown(2) = FCFdown(2)
PV(1) calculated per Incomplete Replication method

+ FCF(1)
= PV(1)total
257
2. Expression of flexibility through Option events RO(t). Rules for calculation:

Example: Decisions are due on t=0 and 2
a. For a time t at which the result of
a formerly uncertain aspect can t
be observed, calculate for each 0 1 2 3 4
possible PV event the payoff that PV events p
results from the use of any PVup(2)
PV(0)
available managerial flexibility: PVdown(2)
RO(t) = f ( flexibility, PV(t) ) (1-p)
Option events
ROup(2) = f(FLEX, PVup(2))
ROdown(2) = f(FLEX, PVdown(2))
258

b. Discount the Option events to the
next earlier time horizon at which t
a decision is due, i.e. either 0 1 2 3 4
because this is t=0 or because the PV events p
next earlier project step delivers its PVup(2)
PV(0)
results. Use the Incomplete PVdown(2)
Replication method or the (1-p)
Replicating Portfolio approach to
discount the Option events to this Option events
ROup(2)
earlier time horizon. RO(0)
ROdown(2)
Note: If the discounting covers
another time-step than 1 year, then
adjust accordingly.
259

c. If FCFs occur prior to the
resolution of uncertainty, add t
their value to the respective Option 0 1 2 3 4
FCF events
event AFTER having performed the p “up” event
discounting of future Option events
by using the Incomplete Replication (1-p) “down” event
method or the Replicating Portfolio
approach. PV events
p PVup(2)
Note: Thus, for the Replicating
PV(0)
Portfolio approach, the underlying PVdown(2)
+ FCF(0) (1-p)
asset is the PV event prior to having Underlying asset for
added the respective FCF. = PV(0)total calculating C(0)
Option events ROup(2)

RO(0)
+ FCF(0) ROdown(2)
=RO(0)total 260
Real Options
01. Introduction



261

Sequentially Compound Deferral Options, M&A example

Switch Option
262
Innovation Projects: Sequentially Compounded Deferral Options
Investments at t = 0, 1 and 2
Key to innovation projects is their planning in project

steps where each step investigates one uncertainty.
Thus, the result can be observed at its completion, and
the project can be directed according to this result and PVu PVuu
PVud
available options (flexibilities) for next steps. PV0
From a financial perspective, each project steps can be PVd

PVdu
PVdd
described as Real Option. Due to their arrangement in a
sequence that constitutes the overall project, these
Options are sequentially compounded; they are Options ROu ROuu
on Options. RO0 ROud
Key to the valuation of Options on Options is the ROd

ROdu
identification of the underlying asset, i.e. what asset ROdd
one receives when exercising the (Deferral) Option. The

underlying asset changes for each project step.
263
Example:
When launching a business by making the investment

at t=2, the business operates and generates FCFs as Value of the business
PVu PVuu
return. Those are represented in as PV events.

PVud
PVu PVuu
PV0
PVud
As the investment at t=2 is only made if it is worth it

PV0
PVdu
(flexible), the value of the possibly launched business PVd PVdd

PVdu
can be valued as a Deferral Option on the business. PVd PVdd
From the perspective of this Deferral Option, the Value of the Option on the business
underlying asset is the Value of the business itself, as
represented by the PV events. ROu ROuu
RO0 ROud
ROdu
ROd
ROdd
264
Example (continued) :
However, one holds the beforementioned Deferral
Option only when having invested at t=1 in the Value of the Option
ROu on the business
ROuu
respective (second and last) project step. ROu ROuu

RO0 ROud
As the investment at t=1 is only made if it is worth it RO0 ROud

ROdu
(flexible), the value of the possibly to move on with ROd
RO
the second project step can be valued as a Deferral ROd
ROdu
dd
Option on the second project step. From the ROdd
perspective of this Deferral Option, the underlying asset Value of the Option on the second step
is the Value of the Deferral Option on the business.
Once this Option on the Option on the business value is RO0
determined, it can be decided whether the investment at
t=0 shall be made. (Note: Also consider at t=0 the
maximum possible loss, and whether this is acceptable).
265
Real Options based Standard Business
valuation techniques apply Case techniques apply
t= 0 1 2 3
Exercise #4: Project step 1 Project step 2 Go-to-market
WACC
FCF events 80% 75.0 € 81.750 €
WACC 9.00% p.a. FCFu - € WACC
Risk-free rate 3.00% p.a. 40% 20% 50.0 € 54.500 €
Market price per risk unit λ 0.250 FCF0 - € WACC
60% 70% 40.0 € 43.600 €
FCFd - € WACC
30% 25.0 € 27.250 €
Value of the business itself

The PV events represent the value of the PV events 80% 150.0 € PVuu
Business Project itself. The various events PVu 131.1 €

40% 20% 100.0 € PVud
express uncertainty but not flexibility. PV0 81.3 € PV0
60% 70% 80.0 € PVdu
For FCFs at or after the last time horizon PVd 65.6 €
of decision making, standard Business 30% 50.0 € PVdd
case techniques apply. Prior to that time
horizon, uncertainty is explicitly μ=
σ=
140.0 €
20.0 €
described, and Real Options valuation μ= 91.8 € PV0 = 131.1 €
techniques apply. σ= 32.1 €
PV0 = 81.3 € μ= 71.0 €
σ= 13.7 €
PV0 = 65.6 € 266
t= 0 1 2 3
Project step 1 Project step 2 Go-to-market
Project step 2 can be financially Value of the business itself
represented as a Deferral Option “on
PV events 80% 150.0 € PVuu
PVu 131.1 €
the Value of the Business Project 40% 20% 100.0 € PVud
itself”. Indeed, at the end of step 2, one PV0 81.3 € PV0
disposes of the freedom to maybe invest 60% 70% 80.0 € PVdu
in launching the actual business and to PVd 65.6 €
generate FCFs as return. Those are 30% 50.0 € PVdd
summarized in PV events that represent

Option events
the value of the business itself. Replicating Portfolio 70.0 €
Value of step 2, i.e. the Option
on the business value 80.0 € ROuu
The value of step 2 is equal to the value ROu 63.1 €
of the Deferral Option “on the Value of 30.0 € ROud
the Business Project itself”; the underlying RO0 21.0 € RO0
asset of this option is the “Value of the

10.0 € ROdu
ROd 5.7 €
Business itself”. This is represented by the - € ROdd
PV event tree.
Knowing the underlying asset, one can m= 1.000
B= 68.0 €
calculate the according option payoffs m= 0.877 RO0 = 63.1 €
and option value (= value of step 2). B= 50.3 €
RO0 = 21.0 € m= 0.333
B= 16.2 €
RO0 = 5.7 € 267
t= 0 1 2 3
Option events
Replicating Portfolio 70.0 €
Value of step 2, i.e. the Option
on the business value 80.0 € ROuu
Project step 1 can be financially ROu 63.1 €
represented as a Deferral Option “on 30.0 € ROud
Project Step 2”. Indeed, at the end of RO0 21.0 € RO0
step 1, one disposes of the freedom to 10.0 € ROdu
maybe invest in launching step 2. When

ROd 5.7 €
- € ROdd
investing in step 2, one receives the value m= 1.000
of step 2. This has already been B= 68.0 €
calculated. m= 0.877 RO0 = 63.1 €
B= 50.3 €
RO0 = 21.0 € m= 0.333
B= 16.2 €
RO0 = 5.7 €
The value of Step 1 is equal to the value
of the Deferral Option “on the value of Value of step 1, i.e. the Option 20.0 €
step 2”; from the perspective of step 1, on value of step 2
ROu 43.1 €
the underlying asset is the value of step 2.
Knowing the underlying asset, one can RO0 11.6 €
calculate the according option payoffs ROd - €

and option value (= value of step 1). m= 0.751
B= 4.1 €
RO0 = 11.6 € 268
t= 0 1 2 3
Option events
Replicating Portfolio 70.0 €
Value of step 1, i.e. the Option 20.0 €
on value of step 2
ROu 43.1 €
RO0 11.6 €
ROd - €
m= 0.751
B= 4.1 €
Having determined the value of step 1, RO0 = 11.6 €
one can decide whether it is worthwhile

to do the investment in project step 1. Net Value 5.0 €
of step 1 RO0 6.6 €
Note: All subsequent investment
decisions are open at that time; they will
be taken later. Moreover, do invest only if
you could accept the maximum possible
loss.
Observation: The Replicating Portfolio approach requires the calculation of the

entire PV event tree as underlying asset.
269
Exercise #4 t= 0 1 2 3
(continued)
Incomplete Replication 5.0 € 20.0 € 70.0 €

shortcut
Value events of step 1 at t=1 80% 80.0 € ROuu
ROu 43.1 €
40% 20% 30.0 € ROud
Net Value
RO0 6.6 € Value events of step 2 at t=2
of step 1
60% 70% 10.0 € ROdu
ROd - €
30% - € ROdd
μ= 70.0 €
σ= 20.0 €
μ= 17.2 € PV0 = 63.1 €
σ= 21.1 € Value events of step 2 at t=1
PV0 = 11.6 € μ= 7.0 €
Value of step 1 at t=0 σ= 4.6 €

PV0 = 5.7 €
Observation: The Incomplete Replicating method does NOT require the calculation of the entire PV event
tree as underlying asset. The PV events at t=2 are sufficient. It yields the same valuation results as the
Replicating Portfolio method → Simplification of valorization of Sequentially Compound Deferral Options !
270
Valuation with flexibility DISABLED, i.e. always investing, even if it is nt worth it:
Exercise #4 t= 0 1 2 3
(continued)
WACC
Incomplete Replication 5.0 € 20.0 € 70.0 €
shortcut
80% 80.0 € ROuu
ROu 43.1 €
40% 20% 30.0 € ROud
RO0 - 9.1 €
60% 70% 10.0 € ROdu
ROd - 22.4 €
30% - 20.0 € ROdd
NPV
PV0 81.3 €
- Invest(0) 5.0 €
- Invest(1) 19.4 €
- Invest(2) 66.0 €
= NPV - 9.1 €
Observations:
• When disabling flexibility in Option Valuation, the result is equal to the NPV.
• A rigid investment strategy (NPV paradigm) would have led to not investing in this example,
whereas a flexible investment strategy (Real Options paradigm) allows to progress and learn
while paying the right price, and to maybe access an attractive opportunity.
271
Innovation Projects: Case study #2: M&A project with earnout clauses
Case : Acquisition of a Startup company.

• The Startup business depends on governmental regulations in the country it operates in, and on public
project awards. The Startup indicates these Cash Flow projections:
FY19 FY20 FY21 FY22 FY23 FY24 FY25 FY26 FY27 FY28 FY29
FCF = -290 -30 200 230 280 330 340 420 500 590 670
PV(t) = 909 1,414 1,704 1,775 1,823 1,821 1,760 1,675 1,481 1,158 670
• With an acquisition cost of 150, the NPV = 909 – 150 = 759. This acquisition looks to be a good deal.
• However, two major uncertainties about the startup’s business exist:

• The governmental regulations may change after the elections in 2019. If the government changes,
regulations will change and all so far awarded public projects will be cancelled by beginning of
2020. The chances for a change of the government are 40%.
• The public project awards will be finalized by end of 2020. By that point in time, it may turn out
that the value of the really awarded projects is only 30% of the projected value. The chances for
this event are estimated to be 60%.
272
According M&A project design with 2 earnout clauses:
Change of government / regulations ? Projections validated ?
2019 2020 2021
100 € +1704 €
10 € 60% 40 € 40%
40% 60% 30 € +511 € = 1704 € * 30%
273
Project phase Timeframe Uncertainty

Valuation: Observe election 2019 (1) Cancellation of projects awarded to Startup for 2019-2020 in 2019 (40% chance).
Validate projections 2019-20 (2) Accuracy of the Startup's award projections beyond 2020.
Operation of business 2021-29 (3) Operation of Startup business
Project Phase = Observe election Validate projections Operation of business

time = 2019 2020 2021 …
time = 2019 2020 2021

Investment in Startup = 150
PV(t=2019) = 60 60% 788 40%

350 818 1,704
FCF(2019) added Awards 60% Projections
40% confirmed confirmed
WACC 18.00% p.a.
Risk-free rate rf 3.00% p.a. -30
Market price per risk unit λ 0.250 FCF(2020) added 0 511
Awards Reality is
cancelled worth
only 30%
μ= 460.8 € μ= 988.6 €
σ= 400.7 € σ= 584.5 €
PV0 = 350.1 € PV0 = 817.9 €
Expected NPV of Startup business = -90 → Do NOT invest !

Optimistic NPV of Startup business = 759 → Ok to invest !
274
Project phase Timeframe Uncertainty

Valuation Observe election 2019 (1) Cancellation of projects awarded to Startup for 2019-2020 in 2019 (40% chance).
(cont’d) Validate projections
Operation of business
2019-20
2021-29
(2) Accuracy of the Startup's award projections beyond 2020.
(3) Operation of Startup business
Project Phase = Observe election Validate projections Operation of business

time = 2019 2020 2021 …
time = 2019 2020 2021
10 40 100
ROnet = 25 60% 700 40%
325 770 1,604
Awards 60% Projections
FCF(2019) added and 40% confirmed confirmed
Invest(2019) subtracted
← Adjusted investment #3
from RO0 = 324.5 € 0 30
0 481
FCF(2020) added and Awards Reality is
Invest(2020) subtracted cancelled worth
from RO0 = 769.9 € less
μ= 420.0 € μ= 930.6 €
σ= 342.9 € σ= 550.2 €
RO0 = 324.5 € RO0 = 769.9 €
→ OK to invest at t=2019, subsequent investment decisions are OPEN !

275
Conclusions:
• Investment decision:
• As the Net Option value is positive, invest in the first step of the M&A project. The subsequent investment
decisions are open and subject to the outcome of the earnout clauses. Also, start investing in this project only if
the maximum loss of 10 € could be acceptable.
• Investment strategy:
• By neglecting the expression of uncertainty, the value of the Startup company is overestimated, with an
optimistic NPV = 759. Investing upfront 150 would be risky.
• By expressing uncertainty but NO flexibility, the expected NPV = -90, i.e. one would not invest upfront an
amount of 150.
• The flexible investment strategy, allows to pay the right price and is satisfactory for both sides. Thus, the
acquiring company gets full access to the opportunity while limiting investment risks.
• Business strategy:
• The flexible investment strategy enables for a competitive bidding versus those who use the rigid (NPV based)
investment strategy. Indeed, the rigid investment will tend to manage risks by making an average bid, whereas
the flexible investment allows to fully satisfy the startup’s expectations, if they prove that they are worth it.
276

Sequentially Compound Deferral Options, M&A example

Switch Option
277
Strategic Agility: Case study #3: Switch Option
Case : A paper manufacturer investigates the value of the flexibility to switch production
between paper making and bio-ethanol production.
• Bio-ethanol can be used as fuel for cars with petrol engines. The ethanol content in
petrol can vary between 5% (E5) and 85% (E85).
• The profitability of paper making is negatively correlated with energy prices. This is due
to the fact that paper making requires lots of energy; energy costs are significant in the
cost structure of paper.
• The profitability of bio-ethanol production is positively correlated with energy prices.
Indeed, the higher the energy prices, the higher the bio-ethanol prices.
• Business strategy: By being able to switch between paper making and bio-ethanol
production, the paper manufacturer could always pick the most profitable production,
regardless of energy price fluctuations.
• Note: Switching costs apply
278
Valuation : FCF projections for both kinds of production, together with the indication of
their correlation (blue arrows)
time t = 0 1 2
FCF Event trees X
D 196.00
X
B 140.00
X X
FCF Technology X A 100.00 E 100.00
(Paper making) X
C 71.43
X
F 51.02
Y
D 82.64
Y
B 90.91
Y Y
FCF Technology Y A 100.00 E 100.00
(Bio-ethanol) Y
C 110.00
Y
F 121.00
279
Valuation : Key: As switching costs apply (15 € for X→Y, 10 € for Y→X), two cases need to be
distinguished: (a) the previous state was use of Technology X, or (b) it was Technology Y.
time t = 0 1 2
Payoffs and Switch Option valuation stay X

D 196.00
stay X
B 272.04
stay X stay X
Assuming previous state was Technology X A 320.24 E 100.00
switch to Y
C 199.73
switch to Y
F 106.00
switch to X
D 186.00
switch to X
B 262.04
stay Y stay Y
Assuming previous state was Technology Y A 325.70 E 100.00
stay Y
C 214.73
stay Y
F 121.00
280
Valuation : Use of switching flexibility: Stay for one period in the previous state of operation,
if this yields a higher value than paying the switching cost and operating in the other state.
time t = 0 1 2
μ= 148.0 €
B σ= 48.0 €
μ= 235.9 € PV0 = 132.0 €
Assuming previous state was Technology X A σ= 36.2 € C0+FCFXB= 272.04 =value if one operates X and can switch in the future
PV0 = 220.2 € μ= 103.0 €
C0+FCFXA= 320.24 σ= 3.0 €
C PV0 = 99.3 €
C0+FCFXC= 170.70 =value if one operates X and can switch in the future
μ= 143.0 €
B σ= 43.0 €
μ= 238.4 € PV0 = 128.4 €
Assuming previous state was Technology Y A σ= 23.7 € C0+FCFYB= 219.31 =value if one operates Y and can switch in the future
PV0 = 225.7 € μ= 110.5 €
C0+FCFYA= 325.70 σ= 10.5 €
C PV0 = 104.7 €
C0+FCFYC= 214.73 =value if one operates Y and can switch in the future
(Gross) Value of flexibility = 37.0 € 281
THANK YOU for your interest and participation !
In case of questions or comments, please feel free to address to
Claus HIRZMANN
Strategic Finance
+33 (0)6 84 99 88 28
claus.hirzmann@strategic-finance.eu
282
Appendix: Bibliographic References (1 of 2)
Industry sector Use of Real Options Quick description of uncertainty and Example of companies Bibliographic reference
flexibility
Oil & gas • Exploration projects • Step-by-step go/no-go Exxon, Mobil Copeland & Antikarov, 2001
• Operational flexibility in • Adapt production mode to
production commodity pricing / demand
uncertainty Shell Kemna, 1993
BP Amaco Miller & Park, 2002
Pharma / Bio- • R&D projects for drug • Step-by-step go/no-go progress Merck Nichols, 1994; Bowman & Moskowitz,
Tech development according to FDA* protocol. 2001
• Valuation of startup companies • Expression of possible pathways
and patents towards value creation / value Genentech Triantis & Boris, 2001; Boer, 2002; Miller
protection & Park, 2002
Eli Lilly, Baxter International, Genzyme, Boer, 2002

Smith & Nephew
* Food and Drug Administration in the USA
283
Appendix: Bibliographic References (2 of 2)
Industry sector Use of Real Options Quick description of uncertainty and Example of companies Bibliographic reference
flexibility
Industry Production & Distribution • Step-by-step investment in Hewlett-Packard Miller & Park, 2002; Billington & Triantis,
innovation and relating product R&D 2003
• Procurement flexibility (multi-
sourcing) Intel Triantis & Borison, 2001; Teach, 2003
Valuation of flexible production • Adapt production mode / size ABB Motors Bengtsson & Olhager, 2002
assets
New product market introduction • Step-by-step investment in market Philips Pennings & Lint, 2000
deployment
Contract negotiation (licenses, order • Expression of possible pathways to • Airbus Industries Copeland & Antikarov, 2001; Miller &
cancellation or modification) value creation • Cadence Design System Park, 2002
• Expression of events and associated
contract flexibility.
Energy Valuation of companies / production • Expression of possible pathways Enron Coy, 1999; Copeland & Antikarov, 2001;
assets / electricity distribution towards value creation.
networks • Adapt production to demand
fluctuation
284

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MSC IN CORPORATE FINANCE & BANKING

Sept. – Oct. 2022

02. Review: Key Concepts of Strategic Thinking

03. Current Business Models and Strategic Concepts

04. Key Methods for Strategy Implementation

Descriptive Diagnostic Predictive Prescriptive

(3) CTO • Electronic signatures

Data, Big Data and AI

Tokenization and digital currencies coming out of Lab

An open ecosystem to benefit innovation

• Rise of fintech and tech

Data: an asset that must be protected

• Cost of cyber attack

The future of Environment, Social and Corporate Governance (ESG)

Jean-Marc Jancovici: Doing business while disregarding energy and climate ?

GDP = Energy = CO2 15

• New Business Models: Platform economy with their ecosystems

… and can contribute with key methods for strategy implementation:

02. Review: Key Concepts of Strategic Thinking

03. Current Business Models and Strategic Concepts

04. Key Methods for Strategy Implementation

Assessment of the situation

Understand the rules of the game

Create & implement strategies (change the game)

• External factors determine the average performance (ROE) of your industry.

1. Assessment of the situation:

Assessment of the situation

Understand the rules of the game

Create & implement strategies (change the game)

Prince Charles Ozzy Osbourne

* A platform in the sense of an N-sided market is to be distinguished from PLATFORM

When operating Dual- or N-sided-markets (platforms):

For the Global Distribution System (GDS), both

In contrast, the Revenue Model is asymmetric:

* A platform in the sense of an N-sided market is to be distinguished from PLATFORM

2. Early Adopters: 3. Early Majority: 4. Late Majority:

• Do not define a function too broadly.

• Recommendation of internet site about Business Models:

PORTER’s 5 (+1) Forces

Suppliers bargaining power Intensity of Competition Customers bargaining power

Threat from Substitutes Regulatory requirements

The 10 (+1) Macro Sources of Disruption

Reference to original article:

A. Webb, The 11 Sources of Disruption Every

“Strategy is about forecasting the consequences of what already happened.” M. Montebello

• Projection: Future is presumed to be like the past.

• Prospection: Future is unlike the past:

• Delphi Forecasting: expert panels iterate to converge to a consensus.

• Note: For a better forecast, reduce the period of forecasting. E.g.:

• Types of competitive advantages:

(1) From Research

(2) From Theory

• Sustainable Competitive Advantages are costly to imitate, takes time to imitate.

• Validate your Competitive Advantages:

• Check consistency of your specific advantages and the customer expectations.

Importance of advantage You have a You have a

Avoid war and

Improve it, it’s your Use it, it’s your