Real Organizations for Real Options: The Administrative Implications of Creating and Exercising Real Options through Corporate Diversification

Diversified corporations competing in industries characterized by uncertain and rapidly changing structures can enhance their competitiveness by increasing their level of strategic flexibility, i.e., their ability to reconfigure divisional relationships to exploit shifting industry-level complementarities. The value of this kind of strategic flexibility can be understood using a real options framework. Specifically, part of the value of a diversified portfolio of operating assets is a function of the present value of future synergies between currently unrelated businesses that are subject to market convergence. By diversifying and acquiring assets in industries subject to increasing complementarity, firms acquire the right, but not the obligation, to pursue interdivisional synergies when and as appropriate. In other words, under particular circumstances, diversification creates real options on the integration of currently separate operating units. This paper investigates the administrative implications of attempting to create and exercise real options on future synergies through diversification. For whereas an investor can acquire and exercise a financial option simply by issuing the appropriate " buy " orders, creating and exercising a real option on future synergies has potentially significant organizational ramifications. Using a case study methodology, this paper examines the implications of a real options approach to diversification on the nature and quality of corporate-divisional and interdivisional relationships and proposes an administrative theory of real options diversification. 1 The basic frameworks used to understand the diversified firm have not changed in their essentials since the seminal works of the 1960s (Ansoff 1965). In particular, existing theories of diversification are essentially static, and leave corporate executives without meaningful ways to think carefully about their most important strategic challenges, such as determining the range of services that a firm should offer in order to compete most effectively. For example, in telecommunications, some important strategic questions are: Does a services provider need a wireless capability if it is to compete in the long distance market? How critical is the local loop network to the wholesale data market? Is broadband access a separate market, or will it become an essential complement to existing services? In other words, the scope of the firm has become a critical strategic variable. Many firms competing in industries subject to this kind of uncertainty have responed by diversifying. Financial services firm Donaldson, Lufkin, and Jenrette has launched an online distribution channel and runs it as a separate business. Entertainment giant Disney has branched out into broadcasting (the ABC acquisition), …