Application of real options theory into design projects – Real options as a tool for management in decision-making processes in commercial fashion design

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School of Business | Master's thesis
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This study focuses on discovering the potential utility of the real options (RO) approach for design investments in the fashion industry. The RO approach offers tools to break down capital investment into multiple stages, at each commitment re-evaluating project validity and adjusting according to new market information. It paints the opportunities available at each step as different types of options a firm holds and can choose to activate. This serves as a way to mitigate risk while not capping upside potential. With design projects, evaluation is often based heavily on subjective creative vision and ignore costing and margins until very late in the process, resulting to suboptimal investment decisions. As for traditional capital budgeting practises, they often fail to capture the full strategic potential of projects with multiple option paths opening from their initiation as the systems become more complex. Design projects are also by nature different to the investments DCF methods were created to value; as design classics do not become obsolete, the project becomes essentially eternal in length, creating value year after year. The thesis of the paper is that by adding flexibility and shielding against risks via the RO approach, design businesses could better identify, capitalise and understand their design projects and their derived options. The research is conducted via qualitative analysis utilising the constructive research method. To examine the validity of the proposed RO approach in the design context, the paper first gathers an outlook of current practises based on expert interviews as well as industry analysis. Then, to evaluate the real-world applicability of the RO framework, a process map for design projects is created based on both suggestions of literature and the empirical research. The process map is then utilised to create an illustrating case study. Finally, the end product and implications are presented in the second round of interviews to further assess utility. With these steps, we demonstrate that there is potential both in the utilisation of a process map evaluation for design projects as well as the notion of adopting an RO approach in identifying and exploring real options. As the contributions of this study we arrive at a classification for real options specific to design projects, extending from traditional RO theory. The paper also serves as the first steps towards creating an agile evaluation toolset for the fashion industry to mitigate creative and business thinking by demonstrating the potential benefits.
Thesis advisor
Malmi, Teemu
real options, design business, capital budgeting, fashion design, real options reasoning
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