Network Externalities and Real Option Evaluation

Abstract:     
This paper provides a conceptual framework to analyze investment projects with networks externalities. In the presence of such effects, consumers make their choice of consumption according to the number of people having already adopted the product or the service. The process of diffusion of such products or services results then in a S-curve when they are successful. The integration of these effects has to be taken into account in the evaluation investment projects because they deeply modify the structure of the cash-flows and thus hoped pro…tability. We develop a model to evaluate investment project with networks effects where the capital expenses depend on the number of users which follows a random process with a S-curve trend. Moreover, the project can be canceled at any time. The model suggested integrates this possibility through a real option approach, and discusses the project canceling parameters.

Number of Pages in PDF File: 16

Keywords: investment, externality, network effect, IT, project evaluation, real option, NPV

JEL Classification: C65, D81, G31

Accepted Paper Series