The real options approach to standardization

Abstract

In this paper we propose a new model of technology standardization under market uncertainty and show how its value is quantifiable using the theory of real options. Our options-based approach to standardization shows that a rational way to standardize some IT technology in uncertain markets is with correct structure and proper staging of the standard. First, highly modularized standards provide a higher option value because of the ability to pick and choose the best modules to change at a fine granularity. Secondly, a modular structure that promotes easy and non-disruptive parallel experimentation (such as end-2-end applications) enhances the option value by providing a larger field of options from which to select. Lastly, allowing the standard to evolve along with the customers' expectations of the technology is a good strategy to match standards with uncertain user markets.