Mgt Of Tech 8 Essay

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Management of Technology 8
Chaisung Lim, Miller School of MOT 1

‹Methods of choosing innovation projects range from informal to highly structured, and from entirely qualitative to strictly quantitative. ‹Often firms use a combination of method to more completely evaluate the potential (and risk) of an innovation project.


The Development Budget
‹Most firms face serious constraints in capital and other resources they can invest in projects.
‹Firms thus often use capital rationing: they set a fixed R&D budget and rank order projects to support.
™R&D budget is often a percentage of previous year’s sales. ™Percentage is typically determined through industry benchmarking, or historical benchmarking of firm’s performance. 3

The Development Budget
‹R&D Intensity varies considerably across and within industries. 4

Theory in Action
Financing New Technology Ventures
™Large firms can fund innovation internally; new start-ups must often obtain external financing.
™In first stages of start-up and growth, entrepreneurs may have to rely on family, friends, and credit cards.
™Start-ups might be able to obtain some funding from government grants and loans.
™If idea and management are especially promising, entrepreneur may secure funds from “angel investors”
(typically seed stage and <$1 million) or venture capitalists (multiple early stages, >$1 million).


Quantitative Methods for Choosing Projects

‹Most commonly used quantitative methods include discounted cash flow methods and real options.
™Discounted Cash Flow (DCF)
- Net Present Value (NPV): Expected cash inflows are discounted and compared to outlays.


Quantitative Methods for Choosing Projects

- Internal Rate of Return (IRR): The discount rate that makes the net present value of investment zero.
- Calculators and computers perform by trial and error.
- 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


Quantitative Methods for Choosing Projects

™Real Options: Applies stock option model to nonfinancial resource investments. E.g.,with respect to R&D:
- The cost of the R&D program can be considered the price of a call option.
- The cost of future investment required to capitalize on the
R&D program (such as the cost of commercializing a new technology that is developed) can be considered the exercise price. - The returns to the R&D investment are analogous to the value of a stock purchased with a call option.


Quantitative Methods for Choosing Projects
Examples of real call options:


Quantitative Methods for Choosing Projects

‹Options are valuable when there is uncertainty (as in innovation)
‹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 its known whether technology will be successful. - Value of stock option is independent of call holder’s behavior, but value of R&D investment is shaped by the firm’s capabilities, complementary assets, and strategies.


Qualitative Methods of Choosing Projects

‹Many factors in the choice of development projects are extremely difficult (or misleading) to quantify.
‹Almost all firms thus use some qualitative methods. ™Screening Questions may be used to assess different dimensions of the project decision including:
- Role of customer (market, use, compatibility and ease of use, distribution and pricing)
- Role of capabilities (existing capabilities, competitors’ capabilities, future capabilities)
- Project timing and cost


Qualitative Methods of Choosing Projects
™Mapping the Company’s R&D