Flexible decision making in uncertain R&D projects

Uncertainty is one of the major inherent difficulties for R&D, especially for innovative R&D projects. The objective of this paper is to develop a flexible decision making methodology based on the real option concept to improve development flexibility for R&D projects. The proposed methodology identifies potential risks that may occur during R&D, recognizes a cascading option structure to resolve the identified risks, and evaluate the value of development flexibility of the project. Instead of using traditional option pricing method, a dynamic programming model that considers multidimensional product performance and market payoff for an R&D project is developed to evaluate R&D project´s value. Using the proposed methodology, managers can easily identify future scenarios as a function of the management actions. The proposed methodology can help managers improve development flexibility of an R&D project and increase the success rate of product launch to the market. A drug development project is used to illustrate the proposed concept.