Strategic Technology Investment under Uncertainty

technology adoption;strategic interaction;investment irreversibility;timing games;information technology investment

Strategic Technology Choice and Capacity Investment Under Demand Uncertainty

This paper studies the impact of competition on a firm’s choice of technology (product-flexible or product-dedicated) and capacity investment decisions. Specifically, we model two firms competing with each other in two markets characterized by price-dependent and uncertain demand. The firms make three decisions in the following sequence: choice of technology (technology game), capacity investment (capacity game), and production quantities (production game). The technology and capacity games occur while the demand curve is still uncertain, and the production game is postponed until after the demand curve is revealed. We develop best-response functions for each firm in the technology game and compare how a monopolist and a duopolist respond to a given flexibility premium. We show that the firms may respond to competition by adopting a technology which is the same as or different from what the competitor adopts. We conclude that contrary to popular belief, flexibility is not always the best response to competition—flexible and dedicated technologies may coexist in equilibrium. We demonstrate that as the difference between the two market sizes increases, a duopolist is willing to pay less for flexible technology, whereas the decision of a monopolist is not affected. Further, we find that a firm that invests in flexibility benefits from a low correlation between demands for two products, but the extent of this benefit differs depending on the competitor’s technology choice. Our results indicate that higher demand substitution may or may not promote the adoption of flexibility under competition, whereas it always facilitates the adoption of flexibility without competition. Finally, we show that contrary to intuition, as the competitor’s cost of capacity increases, the premium a flexible firm is willing to pay for flexibility decreases

Strategic Capital Budgeting: Asset Replacement Under Uncertainty

We consider a firm's decision to replace an existing production technology with a new, more cost-efficient one.Kulatilaka and Perotti [1998, Management Science] nd that, in a two-period model, increased product market uncertainty could encourage the firm to invest strategically in the new technology.This paper extends their framework to a continuous-time model which adds flexibility in timing of the investment decision.This flexibility introduces an option value of waiting which increases with uncertainty.In contrast with the two-period model, despite the existence of the strategic option of becoming a market leader due to a lower marginal cost, more uncertainty always increases the expected time to invest.Furthermore, it is shown that under increased uncertainty the probability that the firm finds it optimal to invest within a given time period always decreases for time periods longer than the optimal time to invest in a deterministic case.For smaller time periods there are contrary effects so that the overall impact of increased uncertainty on the probability of investing is in this case ambiguous.capital budgeting;uncertainty;investment;game theory

Strategic Technology Switching under Risk Aversion and Uncertainty

Firms devising green investment strategies within a deregulated environment must take into account not only economic and technological uncertainty, but also strategic interactions due to competition. Also, further complicating green investment decisions is the fact that firms are likely to exhibit risk aversion, since alternative energy technologies entail risk that cannot be diversified. Therefore, we develop a utility-based, real options framework for pre-emptive and non-pre-emptive competition in order to analyse how economic and technological uncertainty interact with risk aversion to impact the adoption of an existing technology in the light of uncertainty over the arrival of an improved version. We confirm that greater risk aversion delays investment and show that technological uncertainty accelerates the follower’s entry, delays the entry of the pre-emptive leader, and, intriguingly, does not affect the non-pre-emptive leader’s investment decision. Also, we show how the relative loss in the leader’s value due to the follower’s entry is affected by economic and technological uncertainty as well as risk aversion, and how the risk of pre-emption under increasing economic uncertainty raises the value of direct investment in the new technology relative to stepwise investment

Can greater uncertainty hasten investment?

This paper examines irreversible investment in a project with uncertain returns, when there is an advantage to being the first to invest and externalities to investing when others also do so. We show that in a duopoly, greater uncertainty can actually hasten rather than delay investment, contrary to the usual outcome, due its effect on the equilibrium of the timing game between the players. In the presence of positive externalities, greater uncertainty can raise the leader's value more than the follower's; pre-emption then entails that the leader must act sooner. A switch in the pattern of equilibrium investment as uncertainty increases is also possible, which may hasten investment. These findings reinforce the importance of extending real options analysis to include strategic interactions and externalities between players

Internet of Things and Their Coming Perspectives: A Real Options Approach

Internet of things is developing at a dizzying rate, and companies are forced to implement it in order to maintain their operational efficiency. The high flexibility inherent to these technologies makes it necessary to apply an appropriate measure, which properly assesses risks and rewards. Real options methodology is available as a tool which fits the conditions, both economic and strategic, under which investment in internet of things technologies is developed. The contribution of this paper is twofold. On the one hand, it offers an adequate tool to assess the strategic value of investment in internet of things technologies. On the other hand, it tries to raise awareness among managers of internet of things technologies because of their potential to contribute to economic and social progress. The results of the research described in this paper highlight the importance of taking action as quickly as possible if companies want to obtain the best possible performance. In order to enhance the understanding of internet of things technologies investment, this paper provides a methodology to assess the implementation of internet of things technologies by using the real options approach; in particular, the option to expand has been proposed for use in the decision-making process

Modeling Electricity Markets as Two-Stage Capacity Constrained Price Competition Games under Uncertainty

The last decade has seen an increasing application of game theoretic tools in the analysis of electricity markets and the strategic behavior of market players. This paper focuses on the model examined by Fabra et al. (2008), where the market is described by a two-stage game with the firms choosing their capacity in the first stage and then competing in prices in the second stage. By allowing the firms to endogenously determine their capacity, through the capacity investment stage of the game, they can greatly affect competition in the subsequent pricing stage. Extending this model to the demand uncertainty case gives a very good candidate for modeling the strategic aspect of the investment decisions in an electricity market. After investigating the required assumptions for applying the model in electricity markets, we present some numerical examples of the model on the resulting equilibrium capacities, prices and profits of the firms. We then proceed with two results on the minimum value of price caps and the minimum required revenue from capacity mechanisms in order to induce adequate investments