Real Options and System Dynamics for Information Technology Investment Decisions: Application to RFID Adoption in Retail

We propose a unique combination of system dynamics and real options into a robust and innovative model for analyzing return on investments in IT. Real options modeling allows a cost benefit analysis to take into account managerial flexibilities when there is uncertainty in the investment, while system dynamics can build a predictive model, in which one can simulate different real-life and hypothetical scenarios in order to provide measurements that can be used in the real options model. Our return on the investment model combines these long-established quantitative techniques in a novel manner. This study applies this robust hybrid model to a challenging IT investment problem: adoption of RFID in retail. Item-level RFID is the next generation of identification technology in the retail sector. Our method can help managers to overcome the complexity and uncertainties in the investment timing of this technology. We analyze the RFID considerations in retail decision-making using real data compiled from a Delphi study. Our model demonstrates how the cost and benefits of such an investment change over time. The results highlight the variable cost of RFID tags as the key factor in the decision process concerning whether to immediately adopt or postpone the use of RFID in retail. Our exploratory work suggests that it is possible to combine merchandising and pricing issues in addition to the traditional supply chain management issues in studying any multifaceted problem in retail.