dbmaltby

Daily thoughts, observations, and speculations

Flexibility: Real Options Analysis Under Risk and Uncertainty

So far in this book, most of the strategic analysis has ignored the effect of uncertainty on strategic choice. Chapter 8 tells about how risk can be introduced into strategic thinking through net present value analysis. However, even NPV analysis can be misleading under uncertainty. Instead of adjusting the traditional thoughts concerning strategy, we have decided to adopt financial option theory. This offsets the risk and can even influence the strategy adopted by a company.

Under Armour acknowledges risk and uncertainty in their disclaimer to investors on their investor’s relations page.  Specifically they state “Under Armour does not undertake an obligation, and disclaims any duty, to update any of the information in those documents. Under Armour’s future financial performance is subject to various risks and uncertainties that could cause actual results to differ materially from expectations. “

UA needs to implement flexibility in their strategy by purchasing real options. A real option includes assets like manufacturing plants, products, etc. Since UA is in the consumer goods sector, their beta is very closely correlated with the DJI. In other words, performance in the consumer goods sector depends heavily on consumer behavior. When the economy grows the sector will see an increased demand for higher-end products. When the economy shrinks there is an increased demand for value products. While some product types, such as food, are necessary, others, such as automobiles, are considered luxury items.

So this is the uncertainty UA must hedge, that of a cyclical economy. UA buys options on material when the market is performing poorly, so that way when the economy rebounds they have the option to exercise a low price. This achieves that desired flexibility in their strategy to hedge against uncertainty. I leave you with the picture below, which is a summary of UA’s option chain from www.nasdaq.com.

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This entry was posted on March 9, 2013 by .
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