Onno Lint

R&D as an Option on Market Introduction

Discounted cash flow methods for making R&D investment decisions cannot properly capture the option value in R&D. Since market and technology uncertainties change expectations about the viability of many new products, the value of projects is frequently adjusted during the R&D stages. Capturing the adjustment in expectations has an option value that may significantly differ from the Net Present Value of R&D projects. However, there are no historic time series for estimating the uncertainty of the value of R&D projects. As a result, the standard Black and Scholes model for financial option valuation needs to be adjusted. The aim of this paper is to report the application of a particular option pricing model for setting the budget of R&D projects. The option value of the model captures jumps or business shifts in market or technology conditions. The approach originates from applying current insight into the valuation of R&D projects to the field of multimedia research at Philips Corporate Research. This way, the gap between real option theory and R&D practice is further diminished.

The option value of advanced R & D

Existing tools for making R&D investment decisions cannot properly capture the option value in R&D. Since many new products are identified as failures during the R&D stages, the possibility of refraining from market introduction may add a significant value to the NPV of the R&D project. This paper presents new theoretical insight by developing a stochastic jump amplitude model in a real setting. The option value of the proposed model depends on the expected number of jumps and the expected size of the jumps in a particular business. The model is verified with empirical knowledge of current research in the field of multimedia at Philips Corporate Research. This way, the gap between real option theory and the practice of decision making with respect to investments in R&D is diminished.

Market entry, phased rollout or abandonment? A real option approach

This paper proposes a model to value a phased rollout, and to determine the optimal time of a phased rollout as well as the optimal rollout area. Since a phased rollout of new products can be considered as an option on a worldwide launch, real option theory is applied to enhance decision making about entry strategy. We derive the analytical properties and illustrate the model with a case on phasing the rollout of CD-I at Philips Electronics. Under the assumptions made, we found that the value of a phased rollout strategy mainly depends on market and technology uncertainty and the expected net present value of the investment. The maximum value of phasing the rollout of CD-I was nearly 23% of the investment cost.

Finance and strategy: Time-to-wait or time-to-market?

Determining the optimal time to enter a market for technology-based products is paramount for the profitability and competitive position of an industrial company. Finance theory and strategic marketing theory seem to differ fundamentally in the answer to the question of how to determine the optimal timing of an investment. Finance theory focuses on the value of waiting to invest, whilst strategic marketing theory stresses early market entry in order to leapfrog competition and gain competitive advantage. We discuss both points of view and synthesize different approaches in order to develop an optimal timing framework for market entry for product innovations. Recent literature on investment under uncertainty, which suggests that a company should invest when the value of a project passes a certain threshold, forms the basis of our attempt to integrate finance and strategic marketing theory.

Chapter 4 – An options approach to new product development: experience from Philips Electronics

Publisher Summary This chapter discusses the new product development (NPD) process as a series of real options with reducing uncertainty over time. A classic redesign of NPD process in such a way that management can better deal with market and technology uncertainty is the phase review process. Phase review processes divide NPD into a predetermined set of stages with checkpoints (gates). Each gate is characterized by a set of deliverables or inputs, a set of criteria, and an output. The inputs of the functional area at each stage are the deliverables from the functional area at the preceding stage. The criteria are the hurdles that the project must pass at the gate to have it opened to the next stage. At these stages, management can perform different kinds of assessment such as market, technical, financial, and legal. By dividing the NPD process into different stages at which a go/no-go decision is made, this approach deals effectively with market and technology uncertainty surrounding the new product. By treating NPD as an incremental process, the option approach gives explicit decision rules for the trade-off between validating the project or market preemption.Publisher Summary This chapter discusses the new product development (NPD) process as a series of real options with reducing uncertainty over time. A classic redesign of NPD process in such a way that management can better deal with market and technology uncertainty is the phase review process. Phase review processes divide NPD into a predetermined set of stages with checkpoints (gates). Each gate is characterized by a set of deliverables or inputs, a set of criteria, and an output. The inputs of the functional area at each stage are the deliverables from the functional area at the preceding stage. The criteria are the hurdles that the project must pass at the gate to have it opened to the next stage. At these stages, management can perform different kinds of assessment such as market, technical, financial, and legal. By dividing the NPD process into different stages at which a go/no-go decision is made, this approach deals effectively with market and technology uncertainty surrounding the new product. By treating NPD as an incremental process, the option approach gives explicit decision rules for the trade-off between validating the project or market preemption.

An options approach to new product development

Publisher Summary This chapter discusses the new product development (NPD) process as a series of real options with reducing uncertainty over time. A classic redesign of NPD process in such a way that management can better deal with market and technology uncertainty is the phase review process. Phase review processes divide NPD into a predetermined set of stages with checkpoints (gates). Each gate is characterized by a set of deliverables or inputs, a set of criteria, and an output. The inputs of the functional area at each stage are the deliverables from the functional area at the preceding stage. The criteria are the hurdles that the project must pass at the gate to have it opened to the next stage. At these stages, management can perform different kinds of assessment such as market, technical, financial, and legal. By dividing the NPD process into different stages at which a go/no-go decision is made, this approach deals effectively with market and technology uncertainty surrounding the new product. By treating NPD as an incremental process, the option approach gives explicit decision rules for the trade-off between validating the project or market preemption.Publisher Summary This chapter discusses the new product development (NPD) process as a series of real options with reducing uncertainty over time. A classic redesign of NPD process in such a way that management can better deal with market and technology uncertainty is the phase review process. Phase review processes divide NPD into a predetermined set of stages with checkpoints (gates). Each gate is characterized by a set of deliverables or inputs, a set of criteria, and an output. The inputs of the functional area at each stage are the deliverables from the functional area at the preceding stage. The criteria are the hurdles that the project must pass at the gate to have it opened to the next stage. At these stages, management can perform different kinds of assessment such as market, technical, financial, and legal. By dividing the NPD process into different stages at which a go/no-go decision is made, this approach deals effectively with market and technology uncertainty surrounding the new product. By treating NPD as an incremental process, the option approach gives explicit decision rules for the trade-off between validating the project or market preemption.

An options approach to new product development: experience from Philips Electronics

Publisher Summary This chapter discusses the new product development (NPD) process as a series of real options with reducing uncertainty over time. A classic redesign of NPD process in such a way that management can better deal with market and technology uncertainty is the phase review process. Phase review processes divide NPD into a predetermined set of stages with checkpoints (gates). Each gate is characterized by a set of deliverables or inputs, a set of criteria, and an output. The inputs of the functional area at each stage are the deliverables from the functional area at the preceding stage. The criteria are the hurdles that the project must pass at the gate to have it opened to the next stage. At these stages, management can perform different kinds of assessment such as market, technical, financial, and legal. By dividing the NPD process into different stages at which a go/no-go decision is made, this approach deals effectively with market and technology uncertainty surrounding the new product. By treating NPD as an incremental process, the option approach gives explicit decision rules for the trade-off between validating the project or market preemption.Publisher Summary This chapter discusses the new product development (NPD) process as a series of real options with reducing uncertainty over time. A classic redesign of NPD process in such a way that management can better deal with market and technology uncertainty is the phase review process. Phase review processes divide NPD into a predetermined set of stages with checkpoints (gates). Each gate is characterized by a set of deliverables or inputs, a set of criteria, and an output. The inputs of the functional area at each stage are the deliverables from the functional area at the preceding stage. The criteria are the hurdles that the project must pass at the gate to have it opened to the next stage. At these stages, management can perform different kinds of assessment such as market, technical, financial, and legal. By dividing the NPD process into different stages at which a go/no-go decision is made, this approach deals effectively with market and technology uncertainty surrounding the new product. By treating NPD as an incremental process, the option approach gives explicit decision rules for the trade-off between validating the project or market preemption.

The V-shaped value evolution of R&D projects

On average the expected value at the moment of commercialization of an R&D project should remain constant during the different stages of new product development. Contrary to this intuition however, a systematic, non-constant pattern is found in the average expected value of an R&D project. First, the value declines after the initial screening, then rises after the first market analysis, but on average does not reach the initial level at the final stage of development when resources for market introduction are approved. Moreover, uncertainty about the project value declines over time. The findings suggest a V-shaped value function of R&D projects. The study seems to be the first attempt to make direct measurements of valuing R&D projects through time in a real managerial setting.