Quantifying the Strategic Option Value of Technology Investments

We develop an integrated real options and industrial organization framework to quantify the strategic option value of technology investments. Strategic investments (e.g., R&D, capacity expansion or strategic acquisitions) are difficult to analyze based on standard approaches. Yet, it is these decisions that determine a firm’s competitive success in a changing technological and competitive landscape. How much is a strategic option (e.g., Microsoft’s growth opportunities) worth? How does one analyze strategic options in a dynamic, competitive environment? We describe basic principles for analyzing competitive strategies under uncertainty based on an integration of real options with game theory. We analyze multi-stage investment decisions facing a firm under uncertainty, both under a proprietary setting and when facing exogenous or endogenous competition (both in the last stage of commercialization as well as in the innovation or R&D stage). Competitive strategies may differ, e.g., depending on the type of investment (proprietary or shared) and the nature of competitive reactions (strategic substitutes or complements). The benefits of cooperation (via joint R&D ventures) vs. direct R&D competition (innovation races) are also discussed. Finally, we analyze multiperiod option games with endogenous volatility and discuss various other extensions.