Real options and the management of R&D investment: an analysis of comparative advantage, market structure, and industry dynamics in biotechnology
Real options are used to analyze the US comparative advantage in biotechnology R&D and production, and the pattern of biotechnology industry dynamics characterized by start-ups’ early entry and multinationals’ lagged entry. The fundamental economic problem is to explain asymmetric R&D investment behavior across types of firms, differentiated by country or organizational structure. R&D investment decision-making is formulated as an option management problem; heterogeneity across firm types within the investment process motivates asymmetric strategies for managing the option to invest. US firms invest at a faster per-period rate, and face a less uncertain domestic regulatory regime, than European firms. This heterogeneity motivates a more aggressive strategy for managing the option to invest in biotechnology R&D for US firms compared to European firms. Simulated R&D investment behavior based on this result indicates US firms, on average, initiate more R&D projects, commence investment sooner, innovate more rapidly, persevere longer in the face of mounting costs, are less selective about projects based on expected return, and successfully complete more projects, than European firms. These results are consistent with a scenario where biotechnology R&D and production concentrates in the US. Heterogeneity distinguishing start-ups and multinationals leads to option management strategies specific to each type of firm. Start-ups can reduce irreversibility by selling their proprietary knowledge stocks. Multinationals can resolve technical uncertainty while still preserving the option to invest. Under a range of investment conditions, availability of the type-specific strategies leads multinationals to delay full commitment to R&D in favor of a limited commitment to resolve technical uncertainty, while start-ups exercise the option to invest with a full commitment to R&D immediately. The type-specific strategies enhance R&D investment opportunity valuations, and increase the range of economically feasible R&D investments, for both types of firms, relative to the case where these strategies are not available. These results are consistent with a pattern of industry dynamics reflecting early entry by start-ups, and lagged entry by multinationals.
School:The Ohio State University
School Location:USA - Ohio
Source Type:Master's Thesis
Keywords:real options r d investment comparative advantage market structure industry dynamics start up multinational biotechnology
Date of Publication:01/01/2004