The Power of Optionality: Tech and Talent

03/11/20207 min read
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Erik Stettler
Chief Economist
Data scientist and venture capitalist who has invested in 50 global tech companies. He is the Chief Economist at Toptal.
The Power of Optionality: Tech and Talent

I hope this article convinces you of two truths. First, that the greatest risks to our companies and careers can be systematically converted into valuable opportunities. Second, new products, markets, and even new companies, can be rapidly explored and validated in low-risk, powerful ways.

We are facing historic and interconnected changes in technology and talent. Depending on our response, these changes will manifest as either existential threats or transformative opportunities. Here, I offer a framework to help organizations and individuals evaluate risk and reward in extreme contexts while utilizing on-demand talent—top-quality individuals hired globally on a per-project basis and vetted through third-party platforms—for more rapid and diverse responses to these opportunities. The uncertainties we fear most can become allies if approached proactively and converted to possibilities using the framework of optionality—creating strategic bets with limited downside but unlimited upside.

A recent survey of more than 1,000 executives around the world found that seven of their top 10 expected business risks in 2020 involved talent and technological change. The talent risks cited included recruiting, retaining, and (re)training for competitive skill sets. The technological threats included cybersecurity, born-digital competitors, and enabling ongoing innovation.

Talent and technology are, of course, inseparable. Talent creates technology, and technology then requires additional skill sets. This creates various risks due to an organization's inability or unwillingness to tackle critical concerns or act upon new opportunities. Talent and technology risks prove especially daunting because of how they differ from most other risks encountered while managing companies and our careers:

While few would deny that talent and technology risks proffer significant challenges to businesses currently, we need not accept them as risks. Instead, remember that change also represents opportunity. The global talent pool available to us amplifies this framework, broadens the frontier of what our businesses can achieve, and systematically converts technological change into potential benefits rather than risks.

The Power of Optionality

Optionality is the ability (but not the obligation) to take a particular key action like launching a new product or entering a new market. It is the most valuable asset in a world governed by extreme change. Optionality in finance has existed for decades: the right (but not the obligation) to buy or sell specific securities such as shares of stock under pre-set conditions.

Suppose I offer to sell you a share of Microsoft stock for $175 at any point over the next five years, subject to your decision to buy, in return for you paying me $5 right now. No matter how high the stock price climbs I’m still obligated to sell it to you for only $175, so your potential upside is unlimited. If the stock goes to zero, you’ll simply elect not to buy it from me and you’ve only lost $5, rather than a loss of the stock’s outright cost.

This asymmetric payoff structure—limited downside but unlimited upside—has made optionality popular with many of the most sophisticated financial firms around the world, allowing them to build portfolios that improve, rather than suffer from market volatility. With protected downside and unlimited upside, these firms embrace change—they want as much of it as possible.

Optionality via On-demand Talent

Opportunities in business can mimic this payoff structure when companies position themselves to take specific, exclusive/proprietary market actions such as new product launches. These situations are termed "real options" and allow business strategies to benefit from extreme and unpredictable volatility in market and technological conditions.

Exclusive/proprietary means focusing on opportunities that offer an unfair advantage. Your product and strategy must be distinct and irreplicable enough to allow for unlimited upside without diminished profits due to competitive pile-on. Means to this end include proprietary technology, patents, brand, or controlling some critical resource, but above all, you must think of exclusivity as an ongoing action. The only way to maintain long-term exclusivity with a product or market share is to be a moving target by investing in continuous learning and improvement both on the business and product level.

While this sounds wonderful, the big question has always been how to cost-effectively obtain these options. Their many benefits come with a price (remember that I still charged you $5 for the financial option in the above example).

Traditionally, when companies considered launching new products or entering new markets, much of the cost and effort was committed to prematurely, before obtaining real clarity on potential results. Decisions were made based on forecasts, despite the understanding that reality could significantly deviate from prediction. This strategy was, in large part, born of necessity due to slower information exchange and limited, less flexible tools and talent.

Circumstances have changed. Through cloud technology and on-demand talent, actions and information are orders of magnitude faster, more flexible, and economical. These advantages are the key transformative benefit that global on-demand talent creates. Through on-demand talent, it is far more economically and technologically possible to approach new initiatives as options, rather than committing to actions with significant potential upsides and downsides.

Suppose you discover an opportunity for a new and more tech-driven product than your industry currently offers and decide to bring it to market. There’s lucrative potential but also a high risk of failure since your product differs from the rest of the industry’s offerings. If you fail to act upon this, but your competitors successfully do so, you may be out of business. Traditionally, with a project like this, you would create a dedicated new division, design an elaborate waterfall product roadmap, and prepare a massive marketing campaign. By the time you launch and receive market feedback, however, you would have already staked immense resources and even your reputation on successful adoption of the new product. Tremendous upside, but also huge risk.

Today, through global on-demand talent, you can instead rapidly create a virtual team to prototype the new idea, identify the best test customers, analyze feedback, and continue iterating. If all goes well, you can scale; if it turns out that you misjudged the market need, then your downside has been minimized. Through this approach, you only need to be correct once to reap vastly disproportionate and even transformative benefits, and you can afford multiple failures (better understood as valuable learnings) along the way.

Traditional finance and business theory states that a company is worth the value of its cash flows plus any options it owns. The magnitude of technological change pushes us instead toward valuing a company as the sum of the options available to it, with cash flows from current operations merely the means to foster and execute upon them.

Taking this approach is not (for lack of a better term) optional anymore, given the extreme changes we are facing in technology and the talent economy. While managing companies and our careers, we have a duty—both to ourselves and those working with us—to understand how to systematically convert these historic changes into opportunities rather than strategic threats.

To better understand our optionality framework, let's look at how options-driven strategies differ from more "traditional" projects:

The difference between optionality-driven and "traditional" projects can also be shown graphically in terms of profit/loss realized versus the distribution of potential outcomes:

The two critical takeaways from this graphic are:

  • The options approach kills the majority of a project's potential downside, as you are strategically spending limited resources to validate the opportunity before going all-in.
  • The "fat tails" in the distribution of potential project outcomes reflect the higher rate of extreme outcomes, whether a total loss or a home run. This makes options-driven strategies even more valuable, as they both guard against the higher potential incidences of total loss and allow for more attempts at the home runs.

Options-driven strategies also force us to adopt an action-driven mindset. Standard cash flow models might appear dynamic by showing income/expense change over time amidst differing scenarios. Beneath the surface, however, they often remain static, insufficiently accounting for the feedback loops that emerge as stakeholders react to unfolding results. The "high" scenario in standard financial models may fail to consider what competitors will do when they see incredible returns, and the "low" scenario may underestimate any course-corrective actions. An options-driven strategy forces us to always think in terms of the next steps available to us as we validate and execute new opportunities.

Closing Thoughts

That talent and technology bring many of the most consequential changes facing our businesses and careers is indisputable. However, change represents either risk or reward depending on how you elect to engage with it and position yourself. Managers have a fiduciary duty to keep their organizations on the right side of this equation, and an options-driven strategy allows for this in a systematic way that limits the downside of failures but offers unlimited upside when you get it right.

Read the other installments in this series:

Erik Stettler
Chief Economist
Data scientist and venture capitalist who has invested in 50 global tech companies. He is the Chief Economist at Toptal.