Strategic technology investment under uncertainty

In this paper the technology investment decision of a firm is analyzed, while competition on the output market is explicitly taken into account. Technology choice is irreversible and the firms face a stochastic innovation process with uncertainty about the speed of arrival of new technologies. The innovation process is exogenous to the firms. For reasons of market saturation and the fact that more modern technologies are invented as time passes, the demand for a given technology decreases over time. This implies that also the sunk cost investment of each technology decreases over time. The investment decision problem is transformed into a timing game, in which the waiting curve is introduced as a new concopt. An algorithm is designed for solving this (more) general timing game. The algorithm is applied to an information technology investment problem. The most likely outcome exhibits diffusion with equfal payoffs for the firms. Received: December 16, 1999 / Accepted: February 7, 2001     

A financial model of flexible manufacturing systems planning under uncertainty: identification,valuation and applications of real options

Flexible manufacturing systems (FMS) have been considered to be essential for manufacturers to succeed in the uncertain market place. Flexibility typically comes at a price and is only valuable as a hedge against environmental uncertainty. It is important to determine an appropriate level of flexibility in the production system while considering the tradeoffs between its costs and benefits. This paper proposes to apply a real option theoretic approach to the modeling and analysis of various types of uncertainty involved in an FMS's operational environment. In comparison with financial options, real options in the context of an FMS, namely, production options, are identified and accordingly a pricing model for production options is proposed based on the option theory. Based on the valuation of production options, a general framework of flexibility planning is formulated. The real option approach surmounts traditional discounted cash flow analysis based valuation methods that tend to ignore the upside potentials to an investment from management flexibility. The proposed model is tested in a refrigerator company that deals with high product variety and uncertain demand.