Architecting flexible projects and systems using portfolios of real options: a decision support framework and two case studies

Abstract

The proper decision support to design flexible projects considering downstream decisions under uncertainties is critical yet challenging. While flexibility provides important leverage against uncertainty, decision making that involves the planning and exercising of multiple elements of flexibility under uncertainty is complex, and due to the complexity, organizations often fail in practice to follow a well-structured, accountable and reproducible decision-making process for assessing and selecting flexible projects.

This study inherits the prevailing real options practices in framing downstream decisions as real options and establishing the cause-and-effect relationships between flexibility and project value under uncertainty. The study extends that with an optimization step to develop a framework that can handle portfolios of interacting real options in a combinational design space more effectively than humans alone can with bounded rationality. The framework borrows and integrates simulation-based options valuation methods, decision analysis techniques and evolutionary algorithms to search for flexible solutions more effectively.

The resulting flexible solutions consist of an initial design and a portfolio of real options with their exercising conditions to adapt according to the manners the future unfolds - in contrast to the common real options practices which primarily aim to derive the option value. Evaluated and exemplified through two real-life cases, the evolutionary framework compares favorably with the traditional fixed design approach and delivers considerable improvements over the prevailing real options practices. In the MDP case study, it is found that designing multiple real options into the MDP system using the proposed framework can increase the system value by 13% beyond that from the prevailing real options practices. In the other case study, it is found that the developments and incorporations of innovative water technologies for the water supply system of Singapore are the dominant solutions from multiple perspectives.

The proposed decision support framework facilitates the exploration, analysis, optimization, and selection of solutions effectively in a combinatorial solution space ? the essence of a design process- and allows the decision process regarding multiple threads of interacting flexibility to be within the bounds of reasonable effort on the part of the decision maker. Therefore, the framework can be used to search flexible designs with portfolios of real options, free up design space, and permit human experts to focus on the more creative process of generating design alternatives to harness more from flexibility.

It changes fundamentally the design process by improving the otherwise obscure understanding of flexibility, systemizing the design process regarding flexibility in project design, and facilitating the leverages from flexibility and the ex ante planning of downstream decisions. This framework is especially helpful for large-scale innovation projects, which are usually accompanied by huge technological and market uncertainty and complex downstream decisions.