Valuing technology investments: use real options thinking but forget real options valuation

When facing risky technology investments or ventures 'real option thinking' – the managerial flexibility to capitalise on opportunities when they arise and/or to minimise the impact of threats – is precisely what is needed. Notwithstanding this, we argue Real Options Valuation (ROV) is inferior to traditional decision tree analysis for this context. Our reasoning is twofold. Firstly, ROV techniques provide a sophisticated treatment of market risks, but do not deal with firm-specific risks. However, the elevated risk facing technology ventures is predominantly firm-specific risk. Secondly, ROV has a severe practical limitation for new technology ventures. The starting point for ROV is to value the "underlying asset" – the venture/project in the absence of the 'real options' – using discounted cash flow techniques. But the risk profile/discount rate can not be established for this nonsensical hypothetical entity – because the 'real options' are an integral part of technology venture.