Valuation of R&D projects and project portfolio - Case: Neste Oil

Abstract

Research and Development projects play a significant role in implementing corporate strategy. Successful R&D work aids companies to stay ahead of its competitors or to change the game in the business. However, existing literature on valuation of R&D activity is limited, probably due to sensitive nature of the topic. This study aims to shed light on what kind of factors are considered in the valuation process of R&D projects and to analyze the suitability of different valuation methods for R&D projects.

The study was conducted as a qualitative case study, case company being Neste Oil, which has come up lately with a totally new business - renewable fuels. New business was enabled by extensive R&D work, thus making the company fascinating for the researched topic. Empirical data was collected by interviewing the key R&D personnel of the case company and using the internal database for R&D projects.

Due to limited existing literature of R&D project and project portfolio valuation, theory part combines literature of R&D project portfolio management, real options and project valuation. There are many similarities between R&D projects and real options, hence treating R&D projects like real options instead of traditional projects could be a feasible approach to find more dimensions for the valuation process.

Empirical findings indicate that traditional project valuation tools - Internal Rate of Return and Net Present Value - are mainly used for the evaluation of R&D projects profitability in the case company. Some of the projects in R&D project portfolio were found to be too abstract to be valuated financially and are valuated using only subjective evaluation. Value drivers of R&D projects vary from finding cheaper and more environment-friendly feedstock to enhanced production performance, new products, increased knowledge and more sophisticated production and research technologies. According to empirical data, there are two major challenges in the valuation of R&D projects: complexity and uncertainty of the projects.

As a solution to handle complexity and uncertainty more comprehensively, the study suggests using binomial tree model for the valuation of projects facing significant complexity and/or uncertainty. Like value of real options, value of R&D projects can go up or down along the time when some events occur that have impact on value of the asset/project. By estimating probabilities and financial impacts of these events, the total range of project's future profit potentiality can be estimated in a binomial tree form as well as the current value of the project. Also, when probabilities and impacts of these possible events need to be determined, project managers and decision makers are forced to put effort in recognizing risks and uncertainties, and to estimate how these events affect the value of the projects.