Critical Access Hospital Informatics
JHIM Web Exclusive
Real Option Analysis: Improving Project Selection in Healthcare Settings
An interview with David K Wyant, PhD
“The effective selection of information technology projects is crucial for achieving gains from healthcare IT,” the author writes. Through example, Mr. Wyant discusses the applications of real options analysis, with emphasis on healthcare settings, and addresses the importance of organizational characteristics on real options analysis. “The real options approach is an improvement over net present value analysis, which uses single estimates of future revenue and costs,” he writes. “Additionally, thinking of projects in terms of options helps design and manage investment strategies by identifying and valuing alternatives inherent in a project.”
He also writes: “An understanding of real options analysis will help HIT professionals perform several vital roles as members of a project selection team. These roles are related to the financial planners’ need for input from HIT professionals. Because the HIT professional is an expert in the business processes of HIT, they can ensure that the financial plan incorporates all of the project’s costs and benefits, and that the time frame for developing the project is reasonable. HIT professionals also need to review the financial plan’s technical feasibility. In addition, HIT professionals serve as representatives for both internal and external customers by ensuring that the financial plan will result in a system that meets users’ needs. Finally, HIT professionals need to be concerned that the financial plan is consistent with the effective and efficient day-to-day operation of the eventual project.”
In this Web-exclusive interview, Mr. Wyant discusses the ideas behind real options analysis, implementing this tool within an organization and how healthcare professionals can realistically manage options and expectations.
JHIM Online: For those unfamiliar with the term, what is real options analysis? What is the history behind it? Why is it considered a best practice?
Mr. Wyant: Real options analysis has emerged as an improvement to the traditional approach to project planning, net present value analysis (NPV). NPV uses a single estimate of revenue and costs for each future period to develop a scenario that estimates the profitability of the project. Frequently, financial analysts develop several different scenarios for a particular project, perhaps labeled “best case” and “worst case” by the financial planners. Real options analysis (ROA) increases strategic flexibility by keeping managers from being locked into projects. It takes into consideration how a plan may adjust overtime. In contrast to NPV, real options analysis does not assume that once a project is started it will necessarily proceed along a single path to full conclusion. Real options allow the analysis to branch at points where critical events will have major impacts on the success of the project. But the decision trees that are created are much more than maps that managers follow passively. Managers can make decisions at each critical point, such as whether to terminate a project.
JHIM Online: What is the template for creating an ROA?
Mr. Wyant: Real options analysis is a gradual process, but the basic template will include finance people and IT people. Typically the financial analyst will depend heavily on the HIT professional’s knowledge of business processes, the customer base and technical constraints. If the HIT professional also has an active knowledge of real options analysis they may be able to point out options that a financial analyst would not recognize. Together, they would put together estimates revenue and cost for the project. It would become a real options analysis when they begin to think about, during the life of the project, building in certain options. With a traditional approach, you would have a plan that went from, say, Year One to Year 10. Real options considers that at some point before Year 10—perhaps several times—they might want to have the options to explore different directions. Clearly, if managers are uncertain about the long term outcomes of a project it can be valuable to plan in advance to have an option to “exit” at some point. An option to exit at a particular point can be created prior to the beginning of the project during the planning stage. This is done by making sure that at the designated exit point all contracts with customers and suppliers could be cancelled.
JHIM Online: What are some tips and advice you have for healthcare professionals in order to manage options and expectations?
Mr. Wyant: When managing options you have to realize is that triggering an option may be politically difficult or too costly. For example, you can create a contract that says, three years from now, if this diagnostic imaging software is not generating sufficient revenue, we are going to cancel the contract. But maybe the physicians who rely on that software resist a cancellation. Real options analysis provides both information concerning where exit points should exist, and information concerning the value of having the option to exit at a particular point.
Incorporating real option analysis into the project selection process may also positively impact other roles of the HIT professional. For example the HIT professional may believe that a particular project is essential to fulfill the HIT professional’s day-to-day management tasks. In this case, identifying the real options inherent in a project and incorporating their value into the analysis could lead to the approval of a project that otherwise is not approved. The HIT professional also might expect to be the individual responsible for the success of the proposed project. In this case the effort to plan an exit strategy in advance of beginning the project may be far less than the effort involved if the HIT professional is locked into a struggling project.
