Strategic Growth Options in Network Industries

Abstract

Performance of firms in network industries depends much on the creation of standards around their technologies, products, or services. Establishing standards requires committing large, irreversible, upfront investment while demand remains uncertain. This paper focuses on the real options involved in this investment problem. The conventional real options literature recognizes the waiting-to-invest option where firms could avoid regret by waiting until at least some of the uncertainty is resolved. However, early commitment of network investment has vital strategic effects on shaping the expectations of potential users and inducing them to adopt the standard, thus creating a strategic growth option. We develop a simple model to explore the tradeoff between this strategic growth option and the waiting-to-invest option. We solve for the optimal investment rules and find that for high uncertainty, the strategic growth option often dominates the waiting-to-invest option and reduces the investment threshold. Furthermore, the intensity of network effect enhances the strategic growth option. Our results have important implications to the strategies of firms in technology industries.

Citation

Lin, L. and Kulatilaka, N. (2007), "Strategic Growth Options in Network Industries", Reuer, J.J. and Tong, T.W. (Ed.) Real Options Theory (Advances in Strategic Management, Vol. 24), Emerald Group Publishing Limited, Leeds, pp. 177-198. https://doi.org/10.1016/S0742-3322(07)24006-9