No.70 - Real Options in ICT Sector
Communications & Strategies - 30/06/2008
2nd Quarter 2008
This dossier on real options is oriented on methodology, giving in the meantime the opportunity to deal with the different aspects of the uncertainties in the Telecommunication sector, particularly concerning investment that should be made.
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Dossier
Real Options in ICT SectorEdited by James ALLEMAN & Gary MADDEN
A Real Options Approach to ICT Investment Decisions
James ALLEMAN & Gary MADDEN
Real Option Applications to Information Security
Pythagoras PETRATOS
Real Options Methodology Applied to the ICT Sector: A Survey
James ALLEMAN, Gary MADDEN & Hak KIM
An Investment Criterion Incorporating Real Options
Hirofumi SUTO, James ALLEMAN & Paul RAPPOPORT
Investment Decision in a Broadband Internet Network:
A Real Options Approach
Charlotte KRYCHOWSKI
Invest Today or… Tomorrow?
A Real Option Approach to Strategic Development in the French DSL Market
Nicolas GRESSER, Cuong Hung VUONG & Laurent BENZONI
From Experimentation to Citywide Rollout:
Real Options for a Municipal WiMax Network in the Netherlands
Bert M. SADOWSKI, Mathijs VERHEIJEN & Alberto NUCCIARELLI
Interviews with
Pierre DANON, Chairman, Eircom
Peter CULHAM, Chief Economist, Ofcom
Other papers
Telecommunications Regulation, Regulatory Behavior and its Impact - A Systems View
John DAVIES, Bronwyn HOWELL & Victoria MABIN
Reinforcing the Commission's Power in the Communications Sector
An Issue for the Regulatory Framework Review
Annie BLANDIN-OBERNESSER
Features
Regulation and Competition
• Analogue Switch-off - Opportunities for Broadcasters?
Sophie GIRIEUD
Firms and Markets
• Satellite Broadband in Europe and North Africa
Maxime BAUDRY
Use Logics
• The Future of the Press: Online Strategies - New Services and Business Models
Gilles FONTAINE & Marc LEIBA
Book Review
• Cristiano ANTONELLI, Localized Technological Change, Towards the Economy of Complexity
by Bruno LANVIN
• Martin FRANSMAN, The new ICT Ecosystem: Implications for Europe
by Jean-Gustave PADIOLEAU
• Terry SHINN, Research-Technology and Cultural Change. Instrumentation, Genericity, Transversality
by Jean-Gustave PADIOLEAU
• Jonathan ZILTRAIN, The Future of the Internet and How to Stop it
by Jean-Gustave PADIOLEAU |
Pythagoras PETRATOS
Real Option Applications to Information Security
Key words: Real options, information security, valuation, information security investment, capital budgeting, portfolio theory, information security risk.
Real options present advantages over the standard discounting methods. In this paper we analyze them briefly and examine their potential applications on information security. The applications of real options on valuation of information assets, information security investment and capital budgeting provide considerable benefits. Finally portfolios of real options and other financial products can reduce information security risk.
James ALLEMAN, Gary MADDEN & Hak KIM
Real Options Methodology Applied to the ICT Sector: A Survey
Key words: Discounted cash flow, economic methodology, information and communications technology (ICT), investment, investment under uncertainty, options, present discounted value, real options, valuations.
This survey focuses on the application of real options methodology to the information and communications technology (ICT) industries. It examines the development of the methodology to areas as diverse as wireless cell site investments to dynamic pricing issues. In addition to aiding the reader in understanding the breadth of the applications, it demonstrates the importance of the topic. It provides a guide to the reader who is interested in exploring the topic in greater depth.
Hirofumi SUTO, James ALLEMAN & Paul RAPPOPORT
An Investment Criterion Incorporating Real Options
Key words: Real Options, Decision, Investment, Economic Methodology; Statistical Decision Theory, Criteria for Decision-Making under Risk and Uncertainty.
Investment in infrastructure such as the information and communication technology sector requires large, substantial amounts, most of which are sunk or irreversible. Uncertainty of market demand, competition, costs and public policy complicates the investment decision process. This paper provides an investment decision-making criterion under uncertainty using (deferred) real options methodology to evaluate if an investment should be made immediately, cautiously, deferred (wait-and-watch), or foregone. A decision-making index d is developed, which is equal to the expectation of net present value (NPV) normalized by its standard deviation. Under a lognormal assumption of the distribution of NPV discounted by risk-free rate, we find the "break-even point" at which the NPV equals the real option value (ROV): d = D* = 0.276. Using the absolute value of D*, one can make sophisticated decisions considering opportunity losses. This new decision index, d, provides a criterion to make investment decisions to capture underlying uncertainty. When making a decision, a manager only has to observe three parameters: expectation of future cash flow, its uncertainty as measured by its standard deviation, and the magnitude of investment. We discuss examples using this criterion and show its value. The criterion is particularly useful when NPV lies near zero or uncertainty is large.
Charlotte KRYCHOWSKI
Investment Decision in a Broadband Internet Network: A Real Options Approach
Key words: Investment under Uncertainty, real options, telecommunications networks, case study.
This article is a case study analysing the decision of a telecommunications operator to roll out ADSL infrastructures in areas of low population density. This type of investment is characterized by the risk of committing significant sunk costs for a low number of potential subscribers. In addition, the investment decision is complicated by the involvement of local authorities which are interested in offering broadband internet access to the local population, and are prepared to partially fund the project.
Real options are used to calculate the project's value and optimal timing of the investment. Particular attention is paid to provide detail on how to perform real options analysis and valuation. The option is evaluated with the binomial model and we explain how to estimate key parameters such as volatility.
The case study suggests that real options can produce a more sensible recommendation regarding investment timing than the net present value (NPV) rule. It also illustrates the benefits of real options beyond mere valuation aspects. In particular, this approach can help structure discussions with local authorities and enables the operator to establish a roll-out plan of ADSL infrastructures across the entire network.
Laurent BENZONI, Nicolas GRESSER & Cuong Hung VUONG
Invest Today or… Tomorrow? A Real Option Approach to Strategic Development in the French DSL Market
Key words: Broadband, DSL, French communications market, real options, DSL wholesale offers, pricing.
This paper presents a descriptive case study of the new entrants' strategies on the French DSL market, applying the theoretical framework of real options. It is shown that two main strategies have been built around different analyses of the fixed incumbent operator's wholesale offer. The first is based purely on a classical valuation approach (net present value). The second accounts for an "invest tomorrow" real option included in the incumbent's wholesale offer. The trade-off carried out by new entrants with the second strategy is then analysed and illustrated with a real option valuation based on the binomial tree method. Consequently, wholesale offer prices could include a mark-up to reflect the loss of a real option value by the incumbent in favour of new entrants.
Bert M. SADOWSKI, Mathijs VERHEIJEN & Alberto NUCCIARELLI
From Experimentation to Citywide Rollout: Real Options for a Municipal WiMax Network in the Netherlands
Key words: WiMax, European legislation, municipal networks, real options.
The paper undertakes a techno-economic analysis of a WiMax network in the unlicensed band (5 GHz) based on a network design for a medium sized, sub-urban community. WiMax (Worldwide Interoperability for Microwave Access) networks based on IEEE802.16 group of standards have been heralded as "serious competitor" and even as a disruptive technology in the local loop at a time when commercial field trials and initial deployment of these technologies unfold throughout Europe. As traditional net present value (NPV) calculation taking the current European regulatory and legislative framework into account showed that high technical and market uncertainty would delay the implementation of a municipal WiMax network, a real options analysis has been undertaken to examine these uncertainties. An expanded NPV calculation, which included the option to expand, provided positive results. Due to licensing fees and coverage performance of base stations, differences in profitability emerged between WiMax networks operating in the unlicensed (5 GHz) and licensed band (2.5/3.5 GHz). The entry of commercial wireless providers in 2008 in the licensed WiMax band is expected to have repercussions for the viability of municipal WiMax networks.
John DAVIES, Bronwyn HOWELL & Victoria MABIN
Telecommunications Regulation, Regulatory Behavior and its Impact – A Systems View
Key words: Telecommunications, Regulation, Unbundling, Multi-methodology, Systems Thinking, Theory of Constraints, Causal Loop Diagrams, Systems Archetypes.
This paper examines the case of telecommunications sector regulation in New Zealand, and does so by providing a constructive illustration of the mutually informing use of systems methodologies and alternative systems representational tools as a means of building understanding of the dilemmas faced by regulators. In doing so, the paper not only seeks to provide a means of providing an appropriate decision-making platform for regulatory and industry decision makers, but also complements other work that seeks to harness the use of systems methodologies in addressing problematic situations. The paper highlights the importance of regulators distinguishing between the short-term 'local' outcomes that arise from their actions, and the systems behaviour that may be described as the unpredictable or unanticipated 'emergent' properties of the system that evolve over time.
Annie BLANDIN-OBERNESSER
Reinforcing the Commission's Power in the Communications Sector
An Issue for the Regulatory Framework Review
Key words: Competition law, Electronic communications, European Commission, European Regulator, European Regulators Group, Harmonization, Internal Market, National regulators, Regulatory framework, Relevant market analysis procedure, Review.
The reform of the regulatory framework for electronic communications is in progress. One of its major issue could be an institutional one, as the European Commission announced its intention to reinforce its own power, in particular in order to supervise the remedies imposed by national regulators to the dominant operators. Highlighting the importance of the objective of consolidation of the Internal Market, this article examines the case for this reinforcement and analyzes the institutional architecture which endorses it. Even if the proposal to create a European Electronic Communications Authority constitutes an event, the issue of the reinforcement of the Commissions's power should not be considered in the sole light of this project which could be rejected or amended.
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James ALLEMAN is Professor Emeritus in the College of Engineering and Applied Science, University of Colorado, Boulder, where he taught economics and finance in the Interdisciplinary Telecommunications Program. He is currently a Senior Fellow and Director of Research at Columbia Institute of Tele-Information (CITI), Columbia Business School, Columbia University, where he was a visiting professor (2001-2002). In the fall of 2005 Dr. Alleman was a visiting scholar at IDATE in Montpellier, France. Dr. Alleman has also served as the Director of the International Center for Telecommunications Management at the University of Nebraska at Omaha, Director of Policy Research for GTE, and an economist for the International Telecommunication Union. Dr. Alleman was also the founder of Paragon Service International, Inc., a telecommunications call-back firm and has been granted patents (numbers 5,883,964 & 6,035,027) on the call-back process widely used by the industry. He has conducted research in the area of telecommunications policy, with emphasis on pricing, costing, and regulation as well as on interconnection, international telephony settlements, communications in the infrastructure and related areas. More recently, he has been researching the application of real options valuation techniques to network industries and the causes, consequences and remedies of the financial infirmities of the communications and information technologies sectors. He provides litigation support in these areas.
http://www.Colorado.EDU/engineering/alleman/
Maxime BAUDRY is a consultant at IDATE. His main area of endeavour is monitoring the satellite industry, the telecommunications services market and operator strategies. Before coming to IDATE, he worked for two years for Aon Explorer, a strategy consulting firm specialised in the space industry, where his work focused primarily on industrial analysis of satellite telecommunications for space agencies and the sector's equipment providers. Mr. Baudry holds a Masters degree in Technology & Management (Ecole Centrale de Paris), and is a graduate of the Ecole Multinationale des Affaires/Bordeaux Business School (E.S.C Bordeaux & Fachhochschule Münster's ERASMUS programme).
m.baudry@idate.org
Laurent BENZONI is Professor of Economics in the University Paris 2 (Panthéon) where he manages the Master of Industrial Economics option telecommunications, Internet and media. He is an international expert in the field of Industrial Organization, competition and regulation economics. He has published many articles and books in this field. Laurent Benzoni is also managing partner and founder of TERA Consultants (1995), the French based leading firm in economic consulting. He is also Scientific Director of Quantifica (a research firm specialized in data base on telecommunication markets) and member of the scientific board of the Competition Workshops. Scientific awards: Harvard-l'Expansion price 1985 for the book Economics of Energy, Industrial Organization Prize, 1986, medal of IREST (1989).
benzoni@tera.fr
Annie BLANDIN-OBERNESSER is Professor at TELECOM Bretagne/Institut TELECOM and member of the Center for European Research (IODE – UMR CNRS 6262). She specialises in European electronic communications and media law. Her research deals also with legal issues related to privacy, information system security and intellectual property. She is author of numerous articles and books.
Peter CULHAM is Ofcom's Chief Economist. He joined Ofcom as Director of Competition Economics in 2003 and was made Chief Economist in 2005. Before joining Ofcom he was Chief Economist at Oftel. He joined the Government Economic Service (GES) in 1979 and before joining Oftel he previously worked as an economist in a number of Government Departments (Environment, Transport, Defence).
John DAVIES is Head of School for VMS. He graduated from the University of Wales and the University of Lancaster with a background in operational research, and has developed his research interests primarily within the fields of the decision sciences and systems methodologies. He has published widely in leading academic journals spanning the decision sciences, technology management, systems and sports management.
Pierre DANON is Chairman of Eircom, which delivers mobile and fixed communications services for residential and corporate customers in the Republic of Ireland. Additionally since November 2005, Pierre is Senior Advisor to JPMorgan's EMEA Chairman, Walter Gubert. He provides advice and expertise to JPM's team and clients across Europe, mainly focusing on the Telecom, Media and High Technology (TMT) sector. He is a member of the JPMorgan Advisory Council. From April 2004 until March 2008, he was a non-executive director of EMap Plc, a multi media UK-based company. In March 2005, he was named Chief Operating Officer of the Capgemini Group, one of the world's foremost providers of Consulting, Technology and Outsourcing services. Prior to joining Capgemini, Pierre Danon was appointed CEO of BT Retail in September 2000. He was a director of the BT plc Board. Before joining BT, Pierre Danon was President of Xerox Europe.
He holds a degree in civil engineering from the French Ecole Nationale des Ponts et Chaussées, a law degree from the Faculté de Droit Paris II Assas and an MBA from HEC.
Gilles FONTAINE is Deputy Managing Director in charge of production at IDATE, having previously headed up the Media Economics department. Prior to joining IDATE, and after a stint with the Ministry of Culture and the French radio broadcasting company SOFIRAD, Gilles worked for the French national deposit and consignment office, La Caisse des dépôts et consignations, monitoring investments in a large number of media and multimedia companies. Gilles has also been involved in developing thematic TV channel operations. He holds a degree from the highly reputed French business school, HEC (Ecole des Hautes Etudes Commerciales, 1983) and from the Institut MultiMédias (1984).
g.fontaine@idate.org
For more than fifteen years, Yves GASSOT has been at the head of IDATE (www.idate.org), an institute that has established itself as one of the leading research centres in Europe concerned with the telecommunications, Internet and media industries. In this position, he has taken part in numerous studies of the various markets and the strategies being pursued in the telecommunications sector. He is on the panel of several expert committees, including the Conseil Général des Technologies de l'Information , ITS and the advisory Committees of the PTC and Iris Capital. He was special adviser of the European Commissioner of the Information Society during the last regulatory framewoprk review. He serves as director of the journal COMMUNICATIONS & STRATEGIES and is scientific head of the annual DigiWorld Yearbook and DigiWorld Summit. With a background as DPLG architect, he is a graduate of the Institute of Political Studies, Paris (3rd Cycle).
y.gassot@idate.org
Sophie GIRIEUD is a consultant at IDATE, with media markets as her prime area of focus. Prior to this, Sophie worked as an economic consultant for France's National Centre for Cinematography's (CNC) Media Division, where she produced a report on funded media production and the CNC's involvement in animated productions in 2005, in addition to contributing to the Audiovisual Production Observatory. She is a graduate of the EDHEC Business School.
s.girieud@idate.org
Nicolas GRESSER is Senior Consultant at TERA Consultants. His prime area of expertise relates to telecom regulations, with a strong focus on modelling of wholesale costs. During his career, Nicolas has gained a strong experience of fixed and mobile operator finances, acquired through many due diligence projects, for telcos or private equity firms in Europe and Africa. Before joining TERA Consultants, Nicolas worked as a business analyst in the telecom and media practice of Arthur D. Little. He holds a Telecommunications Engineer degree from ENST (Ecole Nationale Supérieure des Télécommunications, 2003) and a Master's Degree in Economics (University of Paris Dauphine, 2003).
gresser@tera.fr
Bronwyn HOWELL lectures in Corporate Management within VMS. She has a strong research background in the health and telecommunications sectors, and before joining VMS, she was a Senior Research Fellow within Victoria University's Institute for the Study of Competition and Regulation.
Hak-Ju KIM is an Assistant Professor for the School of Business in the University of Houston at Clear Lake. He received his Ph.D. (telecommunications) from the University of Pittsburgh. Prior to beginning his academic career, he worked for six years as a research engineer at SK Telecom which is a world-class wireless network operator that launched the world's first commercial CDMA cellular phone service. His main research areas are technology management & assessment (real options), strategic use of IT & enterprise information systems (ERP, CRM & RFID), network economics & regulatory policy, internet accounting & charging, and information security & auditing.
Charlotte KRYCHOWSKI received her Ph.D. in Business Administration from HEC Paris – School of Management in October 2007 where she teaches Strategy Course at Master level. The subject of her thesis is the application of real options to strategic investment decisions. She has conducted several research projects on related topics. Prior to joining the HEC doctoral programme, Charlotte worked for four years as a consultant with A.T. Kearney in their Paris and London offices. She is a graduate of ESCP (Ecole Supérieure de Commerce de Paris). She also holds a Diplom Kaufman from the Technische Universität Berlin, and a Post graduate diploma (DEA) in Business Administration from Paris X University.
Since September 2007, Bruno LANVIN has been the Executive Director of INSEAD's eLab, managing INSEAD's teams in Paris, Singapore and Abu Dhabi. From 2000 to 2007, he worked for the World Bank, where he was inter alia Senior Advisor for E-strategies, and Regional Coordinator (Europe and Central Asia) for ICT and e-government issues. He was also heading the Capacity Building Practice of the World Bank's Global ICT Department, and Chairman of the Bank's e-Thematic Group. From June 2001 to December 2003, he was the Manager of the Information for Development Program (infoDev). In 2000, Mr. Lanvin was appointed Executive Secretary of the G-8 DOT Force. Until then, he was Head of Electronic Commerce in the United Nations Conference on Trade and Development (UNCTAD) in Geneva, and occupied various senior positions. He was the main drafter, team leader and editor of Building Confidence: electronic commerce and development, published in January 2000. Since 2002, he has been co-authoring the Global Information Technology Report, (INSEAD - World Economic Forum). He holds a BA in Mathematics and Physics from the University of Valenciennes (France), an MBA from Ecole des Hautes Etudes Commerciales (HEC) in Paris, and a Ph.D. in Economics from the University of Paris I (La Sorbonne) in France. A frequent speaker in high-level meetings, he advises a number of global companies and governments, and is a member of numerous boards, including that of the Tallinn E-government Academy.
Gary MADDEN is a consultant to Australian government and a Member of the Board of Directors of the International Telecommunications Society. Professor Madden's primary research area is the economic modelling of electronic networks. Within this gambit his particular research fields encompass theoretically motivated short time-series forecasting, the economics of disruptive technologies, digital divide issues, network externalities and Internet evolution, and the welfare impact of economic growth. He is the author of 78 peer-reviewed publications in these fields since 1993.
Vicky MABIN is an Associate Professor in Decision Science within VMS. Prior to joining VUW, Dr Mabin worked for a major NZ research organisation as a consultant to business, government and industry. She graduated Ph.D. in OR from the University of Lancaster, is a Fellow of the OR Society, and is a former President of ORSNZ. Dr Mabin holds TOC-ICO Certification in Operations and Distribution Management, Thinking Processes, has co-authored The World of the Theory of Constraints and published widely in leading international journals.
Alberto NUCCIARELLI is currently a postdoctoral researcher at the Department of Technology Management of the University of Technology in Eindhoven, The Netherlands. He received his Masters in Economics from the LUISS University of Rome (Italy) and studied at the University of Vienna (Austria). He received a grant for research activities at the University of L'Aquila (Italy), in February 2007 and his Ph.D. from the Department of Electrical and Information Engineering of the University of L'Aquila. He was also a visiting student at the School of Management of Boston University (Massachusetts, USA). His research focus has been on telecommunications economics and policy, particularly the broadband sector. His research also includes strategic management, decision analysis and real options-based strategies in dynamic industries.
Jean-Gustave PADIOLEAU is associate professor at University Paris-Dauphine and senior researcher at GEMAS-Fondation Maison des Sciences de l'Homme (Paris). He has written several academic books and articles and regularly contributes to newspapers and reviews such as Les Echos, Libération and Le Débat. He is also a member of COMMUNICATIONS & STRATEGIES International Board.
Pythagoras PETRATOS is a Visiting Fellow at the University of Buckingham, England. He has taught postgraduate courses at Queen Mary College, University of London. Among his degrees are a Master of Science in Finance from Cass Business School, City University, London and a Master of Research in European Politics from the University of London. He is currently completing postgraduate work at Oxford University, with a specialty in information security and its economic and policy aspects.
Paul N. RAPPOPORT is the Executive Director of Centris, a firm that specializes in estimating market share and demand for communications and entertainment products and services. He is also an Associate Professor of Economics at Temple University. He has over 30 years of experience in business intelligence, forecasting and data analysis, modeling and statistical assessment, with a specialization in applied telecommunications demand analysis. Dr. Rappoport has written extensively on choice models where he has analyzed network effects and route specific demand. His current research focuses on modeling a household's demand for wireless services; analyzing the competitive impact associated with a telephone company's deployment of fiber for video; estimating price elasticities from estimates of a consumer's willingness to pay using survey data; and measuring and modeling the demand for best practice Voice-over-IP.
Bert SADOWSKI is an Associate Professor of Economics of Innovation and Technological Change at the University of Technology in Eindhoven, The Netherlands. Previously he held appointments at the University of Technology in Delft and at the Maastricht Economic Research Institute on Innovation and Technology (MERIT). He received his Ph.D. from the Science Policy Research Unit (SPRU) at the University of Sussex, UK. In the past fifteen years, he has developed a specialization in the area of telecommunication economics and economics of innovation and technological change. He has carried out a number of projects for government and non-government organizations (European Commission, UNESCO, the Dutch Ministry of Economic Affairs, the Danish Regulatory Agency, the Austrian Chamber of Commerce, OPTA and CBS) as well as for private companies.
Hirofumi SUTO received his Bachelors Degree from Waseda University, Tokyo, Japan. After graduation, he joined Nippon Telegraph and Telephone Co. Later, he had an opportunity to studied Financial Engineering at Columbia University, New York, NY. After receiving his Masters Degree from Columbia, Mr. Suto returned to Nippon Telegraph and Telephone East Co. as Manager, Plant Planning Department at NTT East in Hokkaido. He is currently involved in preparing for the G8 Hokkaido Toyako Summit.
Mathijs VERHEIJEN works as a consultant on innovation projects for H B Berenschot in the Netherlands. He received his Masters in Technology and Policy from the University of Technology in Eindhoven ("cum laude") and studied at the Carnegie Mellon University, Pittsburgh, United States. He has built up extensive professional experience in the area of information and communication technologies in countries such as South Africa and the Netherlands.
Cuong Hung VUONG is a Ph.D. student in economics at ERMES, Université Pathéon-Assas, France. His research interests lie in the field of regulation and competition in telecommunications, especially in mobile industry. Prior to carrying out Ph.D. research, he studied economics at University of Toulouse 1, France and University of Essex, England. At the time of writing, he works at TERA Consultants, Paris.
vuong@tera.fr
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