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Choosing innovation Projects (Quantitative methods of choosing projects…
Choosing innovation Projects
The Development Budget
firms face constraints in capital and other resources
thus use capital rationing -> fixed R&D budget and rank projects
Quantitative methods of choosing projects
Discounted Cash Flow (DCF)
Net Present Value (NPV)
Internal rate of return (IRR): The discount rate the Takes net present value of investment zero
calculators and computers perform by trial and error (excel function: IRR)
potential for multiple IRR if cash flows vary
Strengths and weaknesses of DCF methods
Strengths
provide concrete financial estimates
explicitly consider timing of investment and time value of money
Weaknesses
may be deceptive; only as accurate as original estimates of cash flows
may fail to capture strategic importance of project
Real options
applies stock option model to non financial resource investments e.g. with respect to R&D
cost of R&D program can be considered the price of call option
cost of future investment required to capitalize on R&D program (such as the cost of commercializing a new technology that is developed) can be seen as exercise price
the returns to R&D investment are analogous to the value of a stock purchased with a call option
Random
options are valuable when there is uncertainty
however, real options models have some limitations
many innovation projects do not conform to the same capital market assumptions underlying option models
may not be able to acquire option at small price: may require full investment before it is known whether tech will be successful
value of stock option is independent of call holder's behavior, but value of R&D investment is shaped by the firms capabilities , complementary assets and strategies
Many factors in choice of development projects difficult to quantify
firms thus use some qualitative methods
Screening questions, may be used to assess different dimensions of the project decision including...
Role of costumer
role of capabilities
Project timing and cost
Aggregate Project Planning Framework
Managers map their R&D projects according to levels of risk, resource commitment and timing of cash flows
Advanced R&D Projects
develop cutting-edge technologies, often no immediate commercial application
Breakthrough Projects
incorporate revolutionary new techs into a commercial application
Plattform Projects
not revolutionary, but offer fundamental improvements over preceding generations of products
Derivative Projects
incremental improvements and variety in design features
Derivative projects pay off the quickest, and help service the firm's short-term cash-flow needs. Advanced R&D projects take a long time to pay off (more not at all) but can position the firm to be a tech leader
managers then compare actual balance of projects with desired balance of projects
Q-Sort
simple method for ranking ideas on different dimensions
Ideas are put on cards
for each dimension being considered, the cards are stacked in order of their performance in that dimension
several rounds of sorting and debate are used to achieve consensus about the projects
Conjoint analysis
estimates the relative value individuals place on attributes of a choice
Individuals given a card with products (or projects) with different features and prices
individuals rate each in teams of desirability or rank them
multiple regression then used to assess the degree to which an attribute influences rating. These weights quantify the trade-offs involved in providing different features
Data Envelopment Analysis (DEA)
uses linear programming to combine measures of projects based on different units (e.g. rank vs. dollars) into an efficiency frontier
projects can be ranked by assessing their distance from efficiency frontier
as with other quantitative methods, DEA results only as good as the data utilized; managers must be careful in their choice of measures and their accuracy