TUTORIAL NO. : 02
Name: Sarah Bhalla
Roll No. : J204
ABSTRACT:
In particular, we study the optimal decision problem of building new network capacity in the
presence of stochastic demand for services.
The existing telecommunications infrastructure in most of the world is adequate to deliver voice and
text applications, but demand for broadband services such as streaming video and large file transfer
(e.g. movies) is accelerating.
We notice that sometimes it is optimal to wait until the maximum capacity of a line is nearly reached
before upgrading directly to the line with the highest known transmission rate (skipping the
intermediate lines).
We study the underlying risk factor in the bandwidth market, and then apply real options theory to
the upgrade decision problem.
INTRODUCTION:
To the best of our knowledge, this real options approach has not been used previously in the area of
network capacity planning.
As an alternative, the real options approach, can be used to effectively model investment flexibility.
A number of publications discuss the use of real options theory for optimal investment timing, but
researchers in network planning and management do not appear to have used these concepts .
The outline of this paper is as follows: Section II describes the modelling framework; Section III
presents the mathematical model and introduces an upgrade decision algorithm; Section IV presents
the estimated model parameters; and Section V contains different simulated results.
The volatility present in the demand market for capacity requires the development of risk
management and investment decision systems.
However, a disk manufacturing plant can be profitable as long as demand increases rapidly enough
to offset falling prices due to technological improvements.
Consequently, the revenue to the owner of the network is determined by the prevailing price and
the amount used (demand for capacity).
In some cases, the fundamental factor driving profitability is the amount which can be sold, as
opposed to the price received per unit.
Relentless technological development decrease costs while demand increases exponentially.
In contrast, the price per bit per second is falling exponentially
The price per megabyte of disk drives has decreased exponentially.
We expect that as bandwidth market inefficiencies disappear, price and demand may both be
determining risky factors.
