Dealing with uncertainties in the biotechnology industry: The use of real options reasoning

Abstract

Managers of biotechnology companies face great technological and market risks in making investment decisions. Traditional investment decision tools such as the discounted cash flow (DCF) approaches are often deemed insufficient in the face of the highly uncertain environment surrounding biotechnology projects. More recently, there is an increasing interest in real options approaches, which, in contrast to DCF, explicitly takes into account the managerial flexibility to respond to changing internal and external conditions during the course of the project. It is this flexibility that makes real options reasoning not only perceived to be superior for evaluating projects, but also for developing value-enhancing strategies. However, there is considerable confusion about when the real options approach might be applicable in practice, be it in a formal or an informal way. Based on insights derived from interviews with European biotechnology investors and managers, this study provides an overview of the potential benefits and limitations real options thinking has on evaluating and managing risky projects, particularly with respect to biotechnology companies.