A Real Options Approach to Evaluating Alliance Benefits for IT-Capable Firms

• In Event: AIS and Firm Value

Abstract

Companies develop IT capabilities over time. These capabilities, like products and services, have a life cycle. As the IT capability approaches the end of its life cycle; its strategic contribution, though not necessarily its operational contribution, diminishes. The evolution of the IT capability from a source of competitive advantage to an operational necessity forces managers to make a decision regarding the future of the IT capability. This work explores the options available, focusing on strategic alliances built around the IT capability. Strategic alliances are voluntary arrangements between two or more firms to complement each other’s competency in order to compete in a market. Strategic alliance members exchange, share, or co-develop products, technologies, or services and achieve goals that each one of them could not achieve independently. Prior literature argues that an alliance presents its partners with three potential benefits: lower governance cost, exploitation of economies of scale and scope as well reciprocal learning, and positive knowledge spillovers.
The number of firms forming alliances has risen over the years, yet approximately half of them fail. Alliances are difficult to execute successfully because alliance participants have to deal with environmental uncertainty from a lack of information about the market and task environment, and from partners’ fear that the alliance may not be profitable. There is also social uncertainty in alliances due to a lack of information and trust about the intentions of alliance partners. Social uncertainty causes partners to underinvest in the alliance. IT-capable firms that want to explore alliance prospects are faced with the dilemma of making relational investments to ensure the success of the alliance while knowing that most IT strategic alliances fail. This study leverages recent research to propose that collective real options provide an approach to dealing with this dilemma. Firms can adopt a real options approach in order to ensure that they appropriate all rents that an alliance has to offer, while limiting the risk associated with an alliance failure. The advantage of this approach is the following: While the best case scenario means that the IT-capable firm can exploit three types of rents (transaction, collaboration and firm-specific), the worst case scenario is that the IT-capable firm will be no worse off than the firm would have been if it had chosen the market option from the beginning.

Authors

• Theophanis C Stratopoulos, University of Waterloo

• Bruce Dehning, Chapman University