Valuating service transformation alternatives using real options

Abstract

Firms that grow through mergers and acquisitions often need to deal with duplicate and disparate business functions. Recently, 'shared services' is emerging as an innovative approach for addressing this challenge. Shared services is a business model in which a centralized workforce, either created in-house or provided by external vendors, performs common functions for multiple business units of a firm. To implement shared services, firms need to transform their IT and business processes through simplification, standardization, consolidation, insourcing, and/or outsourcing. In order to decide whether and how to implement shared services, firms need to estimate the value of different transformation alternatives. Conventional valuation approaches tend to focus on foreseeable cost savings and cannot adequately capture critical aspects such as managerial flexibility that may be embedded in certain types of transformation. In this work, we draw upon existing research in IT service, finance, and strategy, and introduce a novel valuation methodology that can help firms evaluate different transformation alternatives. The methodology is centered on a conceptual map for identifying transformation alternatives and a real-option based model that quantifies the value of managerial flexibility. We illustrate the methodology using a real-life based case study. ©2008 IEEE.