Product Development with Value-Enhancing Options

47 Pages Posted: 23 Mar 2007

See all articles by Nicos Koussis

Nicos Koussis

University of Cyprus

Lenos Trigeorgis

University of Cyprus - Department of Public and Business Administration; King's College London; Massachusetts Institute of Technology (MIT) - Sloan School of Management

Spiros Martzoukos

University of Cyprus - Department of Public and Business Administration; George Washington University - School of Business

Date Written: March 2007

Abstract

We study path-dependent value-enhancing managerial actions with random outcome. These actions are either uncertainty revealing actions like research, experimentation, and early versions (pilot projects) or actions that are expected to increase value like attribute enhancing development options and advertising that have however an uncertain outcome. Actions are costly (costs may be partially reversible), sequential and implemented by management at optimal time. We derive two-stage analytic formulas and we use them to study product development with optimal timing of product versions and sequencing of value enhancing actions. We also analyze a multi-period version of the problem using a numerical lattice solution. Individual research/exploration actions are more important when the project is at the money (projects near zero NPV) and less important for low or high values of project value. In a multi-stage setting exploration actions are often important even in very in-the-money projects when follow on actions exist that can enhance the expected value of the project. With path-dependency, early actions can become more valuable when they enhance the impact or reduce the cost of later actions.

Keywords: Real options, economics of R&D, technical risk, path-dependency, sequential (compound) options, early versions (pilot projects) with cash multiplier, jump-diffusion

JEL Classification: G13, G31

Suggested Citation

Koussis, Nicos and Trigeorgis, Lenos and Martzoukos, Spiros Harilaos Spiridon, Product Development with Value-Enhancing Options (March 2007). Available at SSRN: https://ssrn.com/abstract=972837 or http://dx.doi.org/10.2139/ssrn.972837

Nicos Koussis (Contact Author)

University of Cyprus ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
CYPRUS
+357-22892474 (Phone)
+357-22892460 (Fax)

Lenos Trigeorgis

University of Cyprus - Department of Public and Business Administration ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
Cyprus
00357 2 338762 (Phone)
00357 2 339063 (Fax)

King's College London ( email )

Strand
London, WC2R 2LS
United Kingdom

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Ave. E62-663
Cambridge, MA 02142
United States

Spiros Harilaos Spiridon Martzoukos

University of Cyprus - Department of Public and Business Administration ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
CYPRUS
357-2-892474 (Phone)
357-2-892460 (Fax)

George Washington University - School of Business

Washington, DC 20052
United States
202-994-5996 (Phone)
202-994-5014 (Fax)

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