Architecting/Designing Engineering Systems Using Real Options

Everyone concerned with engineering systems faces a common issue: How do we design systems to perform well in a constantly evolving and thus risky context? As professionals concerned with the system (rather than its individual pieces), this design issues predominantly relates to the overall configuration, the architecture of the system. This paper presents an approach to this fundamental issue. It suggests how we could architect flexible engineering systems that can evolve optimally to meet new challenges and opportunities. It suggests that the methods of “options analysis”-- that have revolutionized thinking about investments -- can provide a conceptual basis for defining optimal configurations. When these procedures are applied to design issues, they are generally known as "real options analysis". The fundamental result of "real options analysis" is the determination of the value of flexibility. It thus permits system designers and managers to decide which flexible design elements, that permit their system to evolve effectively over time, are worth their cost. It thus provides a clear rationale for when to design specific types of flexibility into the system

Book Review: Burghouwt, G. (ed.) Airline Network Development in Europe and its Implications for Airport Planning

This book is a remarkable achievement. Dr. Burghouwt deserves our congratulations and thanks for producing this text, especially so early in his career. The standard he has set promises well for future contributions the profession may expect from him. The text is clearly the current benchmark for analysis and description of air transport networks. Every researcher in the area ought to be familiar with it. Whether you agree with his approach and interpretations or not, it constitutes a ‘must-read’ reference. The text is full of interesting analyses that others may want to emulate. It offers a most interesting discussion of the recent historic evolution (from 1990 to 2003) of airline networks in Europe as they worked their way through the first decade of airline deregulation and intra-European “open skies”

Low-Cost Airports for Low-Cost Airlines: Flexible Design to Manage the Risks

The paradigm of airport planning and design is changing fundamentally. Low-cost airlines have become significant drivers of airport planning, along with aircraft size and other technical factors. They have different requirements than the “legacy” carriers. They focus on cost and on alternative ways to handle passengers. Now being sizeable participants in the air transport industry, they are influencing airport design. They are central to the proliferation of secondary airports and metropolitan multi-airport systems. They are catalyzing the development of cheaper airport terminals configured internally much differently than traditional designs. These factors lead to the creation of “low-cost airports” for low cost carriers around the “legacy main airports” built to serve the “legacy airlines”. Consistent with economic theory, the competition between the legacy and low cost airlines is extending to their major factors of production, that is, the airports. This competitive reality creates great uncertainty and poses substantial strategic issues for airport and airline managers and planners. The paradigm shift introduces great risks into practice. The paper proposes a flexible design strategy to deal with such uncertainties. This is significantly different from traditional airport master planning. The core element is to build “real options” into the design, which allow the airport owners to match the development to the way the traffic demands unfold in the decades ahead. A review of developments in Portugal illustrates the current risks in airport development, and suggests how airport owners and investors could apply flexible design process to develop a strategy that would manage these uncertainties to maximize expected value

Multi-Airport Systems in the Era of No-Frills Airlines

The development of no-frills airlines is promoting a remarkable expansion in the number of secondary airports in major metropolitan areas. These new carriers are creating a significant alternative to the traditional full-service carriers. In effect, they are establishing a parallel market and corresponding network of airports. This conclusion results from the analysis of a worldwide database on major metropolitan airports. This effect supplements the "number of originating passengers", that has been the traditional significant factor that promotes the establishment of viable multi-airport systems. This factor maintains its importance, but no longer is as decisive as it has been. Airlines and airport policies further reinforce the independent network of secondary airports. Nofrills airlines that sell only through the web to customers effectively cause their services at secondary airports to disappear from the airline reservation systems. Airports that choose not to provide low-cost service to no-frills airlines likewise strengthen the role of the secondary airports. Such strategies, most visible in Europe, have led to a remarkable proliferation of secondary airports in unexpected areas. This trend implies a traffic shift away from the expensive, congested airports toward the no-frills, inexpensive and uncongested airports in major metropolitan areas. If the current major airlines do shrink substantially, as could happen, this would greatly change the pattern of airport traffic in major metropolitan areas

Uncertainty, Flexibility, Valuation & Design: How 21st Century Information & Knowledge Can Improve 21st Century Urban Development

The 21st century presents humankind with perhaps its greatest challenge since our species almost went extinct some 70,000 years ago in Africa. A big part of meeting that challenge lies in how the urbanization of three billion additional people (equal to the entire world population in 1960) will be accomplished between now and mid-century, on top of necessary renewal and renovation of the earth‘s existing cities. China alone will urbanize 300 million more people between now and 2030. (That is equal to the entire population of the U.S., the world‘s third most populous country, and just 20 years!) This is development on a scale and pace that is an order of magnitude greater than the past century, in a world resource and climate environment that is near the breaking point, in a context of greater technological, financial, and economic uncertainty than ever before. To meet this challenge will require that we use the best tools in our kit, including ones that have become available to us only in this new knowledge and information-based century. Technology got us here, and technology will be key to getting us through. In this paper we will review and synthesize two important methodological developments in our profession that can help infrastructure and real estate physical development (i.e., urban development) to be accomplished more effectively and efficiently in a world of uncertainty. The first methodological development is the honing of real options theory and methodology for practical application to identify and evaluate sources of flexibility in the design and operation of capital projects. The second development is the marriage of digital data compilation of property transactions records with the honing of econometric analysis methodology to allow the practical quantification of real estate and infrastructure asset price dynamics. We argue that this latter development provides the key input to the former development, enabling a much more complete and rigorous treatment of design and evaluation problems for urban development. We also argue that an engineering systems approach to option modeling is likely to find better traction in actual professional practice than the economic theoretical models that have dominated the academic literature. We provide a concrete example by applying the suggested approach to the Songdo New City development in Korea. The result can be better informed design and valuation, more efficient urban development laced with greater flexibility to avoid the worst down-side outcomes and to take advantage of the best up-side opportunities, saving vital resources of capital, land, raw materials, and energy. Finally, we argue that a global, thought-leadership institution such as the RICS can and should play a leadership role in supporting and promulgating the new information bases and interdisciplinary educational formations (property, land, construction) that must underpin the successful dissemination of such 21st century tools of analysis

AIR ACCESSIBILITY IN NORTHERN CANADA: PROSPECTS AND LESSONS FOR REMOTER COMMUNITIES

This paper assesses the impact of Canada’s air transportation policy on air accessibility of remote and arctic communities in a context of liberalization of the aviation industry. The central objective is to examine policy’s impact on essential air service – travel and shipment. An observational study of the federal government’s National Airports Policy (NAP) of divesting smaller airports to local entities is conducted using airport cases both inside and outside the National Airports System (NAS) covering 12 communities in Ontario (Ont.), Manitoba (Man.), British Columbia (B.C.), Quebec (Que.), the Northwestern Territories (NWT), and Yukon Territory (YT). The paper also evaluates the impact of Airports Operations and Maintenance Subsidy Program (O&MSP) and investigates the impact of several federal government departments in assuring air accessibility to remote areas. It is argued that: (a) local management allows for greater entrepreneurship and leads to some efficiency gains, (b) remote and arctic airports seem to be unable to sustain and operate their infrastructures without receiving local or federal contributions, and (c) Health Canada, Indian and Northern Affairs Canada (INAC), and Inuit organizations, such as the Makivik Corporation through its subsidiaries carriers First Air and Air Inuit, play a significant role in making air travel accessible. It concludes that, although the decentralization strategy and the subsidy mechanisms are benefiting remote communities, Canada’s policy success is constrained by its failure to incorporate changing conditions, loss of focus, and flaws in performance evaluation. Keywords: National Airports Policy (NAP), Remote airports, Arctic airports, Inuit organizations, Health Canada, Indian and Northern Affairs Canada (INAC), Canada.

Building Real Options into Physical Systems with Stochastic Mixed-Integer Programming

The problem of building real options into physical systems has three features: real options are not as easily defined as financial options; path-dependency and interdependencies among projects mean that the standard tools of options analysis tools are insufficient; and the focus is on identifying the best way to build flexibility into the design – not to value individual options. This paper suggests a framework for exploring real options in physical systems that especially addresses these two difficulties. This framework has two stages: options identification and options analysis. The options identification stage consists of screening and simulation models that focus attention on a small subset of the possible combination of projects. The options analysis stage uses stochastic mixed-integer programming to manage the path-dependency and interdependency features. This stochastic formulation enables the analyst to include more technical details and develop explicit plans for the execution of projects according to the contingencies that arise. The paper illustrates the approach with a case study of a water resources planning problem, but the framework is generally applicable to a variety of large-scale physical systems

Making Infrastructure Procurement Processes more Flexible under Uncertainty

A third to a half of development projects undergo restructuring due to changes in project objectives, scope or other unanticipated changes, therefore requiring schedule extensions, budget additions and rework. Current procurement processes discourage managers from responding strategically by anticipating and preparing for such changes in advance through better information search and design concept evaluation. This paper suggests three principles for making the front-end phases of procurement more flexible - understanding uncertainty, studying system-wide impacts, and phasing designs. A case study analysis of urban water system design in Kabul demonstrates the conceptual and analytical application of these principles

Nuclear Power: a Hedge against Uncertain Gas and Carbon Prices?

High fossil fuel prices have rekindled interest in nuclear power. This paper identifies specific nuclear characteristics making it unattractive to merchant generators in liberalised electricity markets, and argues that non-fossil fuel technologies have an overlooked à ¢à  à  option valueà ¢à  à  given fuel and carbon price uncertainty. Stochastic optimisation estimates the company option value of keeping open the choice between nuclear and gas technologies. This option value decreases sharply as the correlation between electricity, gas, and carbon prices rises, casting doubt on whether private investorsà ¢à  à  fuel-mix diversification incentives in electricity markets are aligned with the social value of a diverse fuel-mix

Value of Options in Airport Expansion - Example of AICM

http://www-sre.wu.ac.at/ersa/ersaconfs/ersa11/e110830aFinal00149.pdfInvestments decisions for airport capacity expansion are usually taken, either when demand exceeds the current capacity and the airport is working under congestion, or when current demand is expected to overcome current capacity sometime in the near future. In any case, decisions are taken taking into account forecasts of future demand. In many situations, deterministic analysis lead to a discouraging net present value (NPV) which in turn causes delays in the deciding process and eventually leads to further losses. This paper takes the Mexico City International Airport (AICM) as example, and performs an analysis of expansion investment, both in runways and terminals capacity, taking a perspective that is twofold: we take uncertainty of demand into account based on historical data of relevant parameters; we use flexibility in design by incorporating options in project, for both new runways and new terminal. Using a binomial lattice model, we calculate the value of options, perform sensitivity analysis and determine the expected statistical distribution of NPV. We obtain significant differences when compared with the deterministic perspective, and illustrate by example how real options and flexible design may dramatically improve the attractiveness of an investment decision