Real options for risk management in information technology projects

Given the rapid pace of technological innovation, IT projects (especially software projects) are fraught with technology risk. Anticipating the pace of future innovation is difficult but essential. Furthermore, once a decision is made to invest in a current technology, additional risks are involved in deciding exactly how much to invest at each stage of the implementation process. Financial options are extensively used for risk management in various industries. Real or embedded options are analogs of these financial options and can be used for everlasting investment decisions made under significant uncertainty. Real options can be identified in the form of opportunity to invest in a currently available innovative project with an additional consideration of the strategic value associated with the possibility of future and follow-up investments due to emergence of another related innovation in future. We explain how option valuation techniques can be used for assessment and management of risks in the adoption of technological innovations. We also present a new risk driven process framework that is well suited for risk management of software projects.