Understanding and Leveraging Real Options in 3 Clear Steps

Investors, professionals, and amateurs will surely agree that real options are quite popular in finance. Real options relate to small investments that you currently make to guarantee your ability to capitalize on them in the future, if desired. Real options don’t belong only to investors. Researchers in strategy and entrepreneurship commonly adopt this term with the same idea in mind. They claim that ventures should build a portfolio of real options through current small investments in business opportunities that may potentially become worthwhile in the future. This enables them to manage high levels of uncertainty inherent to today’s innovative environment, and to maintain their adaptability.

While this all sounds reasonable, here’s a surprising fact: entrepreneurs are often not familiar with real options. In fact, throughout our own research, we confronted hundreds of founders, and almost none of them heard about real options, let alone attempted to apply them. Why is that?  Well, there is only one likely explanation: real options are sound in theory, but difficult in practice. The entrepreneurial community has not caught on to the phrase because they simply don’t know how to apply it. How can a startup – which is so limited in resources build a portfolio of real options and enjoy its value? Is it at all viable/feasible? While this is surely not a trivial question, there is in fact a clear answer. Studying the market opportunity strategy of hundreds of startups, we found that not only is it possible to implement real options into your strategy, but also that it has clear performance benefits over time. Here is how you can embrace real options into your strategy, in 3 clear steps:

  1. Identify additional market opportunities that could be suitable as your backup or growth options. In case your current opportunity proves to be unsuccessful, you will want to pursue a backup option. A growth option is a market opportunity that you will want to pursue once you are successful with your current opportunity.
  2. Evaluate the relatedness of these possible options to your current market opportunities. Relatedness means that developing and delivering the product, for both markets, require relatively similar resources and capabilities. The more related an option is, the more you can leverage your existing competencies to succeed in it, and this is exactly what we want.
  3. Pick at least one backup and one growth option to keep open. Keeping an option open means that you invest very little resources and management attention in it, just to make sure not to lock yourself out of it. So, when you develop your technology, write your patents, or even set your branding strategy, you keep these options in mind. This is exactly what real options mean! You invest a little bit of effort now, to make your options possible in the future.

By acknowledging and keeping in mind these future options, you get the benefits of real options, and better prepare your venture for dealing with uncertainty, without losing the necessary focus that is so critical for startups. In conclusion, real options should be widely embraced by real startups, its completely viable and truly valuable!