Computer Science Department
School of Computer Science, Carnegie Mellon University
The Options Approach to Software Prototyping Decisions
Prasad Chalasani, Somesh Jha, Kevin Sullivan
Keywords: Software engineering, economics, prototyping, real options,
sequential investing, financial options
Prototyping is often used to predict, or reduce the uncertainty over,
the future profitability of a software design choice.
Boehm [Boehm84] pioneered the use of techniques from statistical decision
theory to provide a basis for making prototyping decisions.
However his approach does not apply to situations
where the software engineer has the flexibility of waiting for more
information before making a prototyping decision. Also,
his framework considers only uncertainty over one time period,
and assumes a design-choice must be made immediately after prototyping.
We propose a more general multi-period approach that takes into
account the flexibility of being able to postpone the prototyping
and design decisions. In particular, we argue that this flexibility is
analogous to the flexibility of exercise of certain financial
instruments called options, and that the value of the flexibility
is the value of the corresponding financial option.
The field of real option theory in finance provides a rigorous framework
to analyze the optimal exercise of such options, and this can be applied
to the prototyping decision problem. Our approach integrates the timing
of prototype decisions and design decisions within a single framework.