A Real Options Logic for Initiating Technology Positioning Investments Rita Gunther McGrath Academy of Management Review, 1997 Youngsoo Kim, October 9, 2013

Objective Specify how boundary conditions and uncertainty influences the value of technology options Take a strategic perspective on uncertainty itself, arguing that value can be amplified by investments to shift boundaries

Technology Positioning Projects Generate Real Options Financial options vs. Technology options Difference: core assumptions for pricing Similarity: volatility and option price Technical and External uncertainty Timing dilemmas: early mover or second follower Technical uncertainty makes option approach more attractive to the firm

Technology Positioning Projects Generate Real Options Value of the Option to Wait

Technology Positioning Projects Generate Real Options Uncertainty and Value of Option to Wait Conventional NPV rule 0.5 * 180 – 100 = –10 Wait and see 0.5 * (180 – 100) = 40 Amplifying Pre-investments If the lobbyists could guarantee favorable rules 180 – (0.5 * 50 + 0.5 * 100) – 10 = 95 Firms need to influence key legal boundary conditions rather than by investing in technology itself

Effects of Boundary Conditions on Variance of Net Returns and Option Value

Boundary Conditions and Uncertainty – Two Factors to Determine the Cumulative Returns Size of Rent Demand: Hard to predict ex ante, but possible to identify attractive demand structures Ameliorate widespread vs. Cure 1 over 100,000 Speed of adoption: The slower the adoption rates, the smaller the cumulative returns Delay in revenue inflow, Much room for competitors Blocking: Blocking reduces the value of the option Expropriation: Similar effects as blocking

Boundary Conditions and Uncertainty – Two Factors to Determine the Cumulative Returns Sustainability of Rent Matching: Rent streams are appropriated under matching – not through imitation but through substitution Likelihood of matching are influenced by three factors: (1) motivation and capacity of rivals, (2) customer immobilities, and (3) order of entry and lock-out effects Imitation: Increases supply of a product, thereby decreasing its scarcity and, thence, price One solution to imitation problem: Take tight appropriability regimes for organizational assets as patents, trademarks, and copyrights

Boundary Conditions and Commercialization Costs Costs for commercialization of technology Investments in production assets: The more asset intensive the project, the more expensive it is likely to be (Greer & Moses, 1992) Accessibility to necessary infrastructure: To the extent that the availability of such infrastructures is uncertain, expected costs of commercialization and their variance will be greater, setting a lower boundary on the option value Availability of parallel technologies: Creating complementary assets can be both costly and uncertain, increasing the variance of the cost

Factors Influencing Price of the Option: Development Cost Spillover effects Investments intended to create new knowledge for the firm often have important spillover effects A firm amplifies spillover benefits when it utilizes the developing technology as a springboard to target other markets Life cycle During periods of incremental change, learning is “exploited”; however, during periods of disruption, investments in “exploration” must be made

Rent streams, commercialization cost, and their relationship to technology option value