Modeling Real Options to Switch Among Alternatives in Product Development

Abstract

High uncertainty in the performance of product design alternatives has forced developers to consider multiple alternative designs in parallel. Traditional wisdom dictates the selection of the final alternative as quickly as possible. But delaying decisions on alternatives as designs develop has provided sustainable competitive advantage for Toyota, a leader in automobile development. Real options can potentially explain how Toyota’s set-based development approach provides this advantage. The current work builds, initially tests, and uses a system dynamics model of automobile system development at Toyota to: 1) test the hypothesis that Toyota uses real options to switch among alternatives to operationalize set-based development and 2) propose and test a hypothesis of how real options at Toyota add value. Simulation results support these hypotheses and suggest that the effective use of real options requires a deep understanding of both the development process and the structure of real options. Research needs are discussed.

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