Title: Real options in service investments: scenarios from defence

Authors: Tarik Driouchi, Paris Pennesi, Dharm Kapletia, Rachel Cuthbert

Addresses: Department of Engineering, University of Cambridge, Mill Lane, Cambridge, CB21 RX, UK. ' Department of Engineering, University of Cambridge, Mill Lane, Cambridge, CB21 RX, UK. ' Department of Engineering, University of Cambridge, Mill Lane, Cambridge, CB21 RX, UK. ' Department of Engineering, University of Cambridge, Mill Lane, Cambridge, CB21 RX, UK

Abstract: This paper addresses the theme of investment under uncertainty in services. We specifically apply principles of contingent-claims analysis to underline the value of flexibility, i.e., the real options, embedded in service level agreements (SLAs) and maintenance & repair investments in the context of aerospace and defence. We focus on path-dependent and complex contingent-claims, to show how the design of |exotic| type options in service investments can provide valuable insurance policies against operational and financial risks for the customer, in addition to enhancing providers| incentives from superior service performance. For illustration, we highlight examples of barrier, lookback, compound, chooser and extendible options as flexibility clauses/alternatives for service provision in defence contracts.

Keywords: service level agreements; SLAs; maintenance investment; repair investment; real options; uncertainty; services; aerospace; defence contracts; flexibility; service investments; operational risk; financial risk; risk management; service planning; service provision; decision making.

DOI: 10.1504/IJSSCI.2009.021959

International Journal of Services Sciences, 2009 Vol.2 No.1, pp.1 - 28

Published online: 11 Dec 2008 *

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