Principles and Practices for Orchestrating Digital Value Chains

The use of financial business cases to guide sourcing decisions is common practice. And with the current pressure on lowering cost, needs even the smallest investment to be accompanied with a business case showing a solid financial return. The effectiveness of the typical financial business case can be further improved in two key area’s. These are: Monitoring whether the expected return and investment envisioned in the business case materialize and,  The limitations of the standard Discounted Cash Flow (DCF) methods as it ignores the required flexibility required to define, execute and manage investments. In this post I explore how Real Options can help to overcome these drawbacks. The typical DCF calculation assumes a static scenario, ignoring the financial value represented by the flexibility to change course during an (outsource) project. In real life people learn during a project, and want to adjust their decisions accordingly, effecting the business case. Think of a manag...

The ideas in this post are based on the work of Chris Verhoeff, a professor at the Dutch Free University in Amsterdam. More of his work you can find here . I made some minor adjustments, but most of this post is based on his work. The reason I wrote this post is that I use his ideas in approaching sourcing decisions from a more strategic risk-return perspective (I’m now working into the direction of combining this approach with option pricing principles to get a more advanced financial approach). Even though only a very few will find this post usable, those one or two out there might help it in your search for knowledge. The cost of capital of a portfolio with outsource contracts. Some outsourcing contracts in the portfolio will be successful and add value and some of them will not. This needs to be accounted for when setting overall thresholds on potential returns. The threshold for each outsource agreement needs to be at least the Weighted Average Cost of Capital (WACC), plus the av...