1. Competition and Strategy
Lenos Trigeorgis
Executive Training & Conferences
© 2016 Real Options Group

2. Stages in Evolution of Valuation Models
Static DCF models
Projects completely described by a specified stream of cash flows
with given characteristics
Option models
Projects managed actively in response to resolution of exogenous
uncertainties about price and other variables
Game-theory or industry equilibrium models
Projects managed actively to also account for (re)actions of outside
agents/competitors

3. OPTIONS & GAMES/STRATEGY 1
OPTIONS & GAMES/STRATEGY 1. High-tech firm with 1-yr license to wait for commercial production 2. Impact of exogenous competitive entry (“dividends”) 3. Early investment to preempt (two-stage investment) 4. Should it invest in R&D to acquire proprietry option to invest in more cost-effective commercial production in stage 2? 5. Impact of endogenous competition in production (stage 2) What difference if proprietary vs. shared benefits, contrarian vs. reciprocating competitive reaction? 6. What if compete in R&D (stage 1) sequentially (innovation race with first-mover advantage?). What if both invest simultaneously and get hurt? 7. Benefits of cooperating in R&D?

4. OPTIONS & GAMES/STRATEGY Passive NPV
Invest Now (based on expected)
V+=180
q=0.5
V=100
1-q=0.5
V-=60
I=80
Invest now (commitment value) = NPV = V – I = 100 – 80 = 20 (>0)
Investment cost: I = Risk neutral prob.:
Discount rate: k = 0.20
(Gross)Project value:
Risk-free rate: r =0 .08
Actual probability: q = 0.5

5. Proprietary Opportunity (License)
Wait to invest under uncertainty
C+= Max(V+-I, 0) (Invest)
V+=180
q=0.5
=180 – 80 = 100
V=100 C
1-q=0.5
V-=60
C-= (Do not invest)
t = t =1
I=80
Opportunity to invest provided by license (call option = 37)

6. Shared Opportunity
A. Impact of exogenous competitive entry: reduced option value (50% cash-flow “dividends”)
V+=180
p=0.4
(C+)’=90-40=50
(V+)’=90
V=100
1-p
V-=60
(C-)’=Max(30-40,0)=0
(V-)’=30
Wait (call option with “dividends”):
(18.5 or half of 37)

7. Shared opportunity Invest now if can preempt competition
B. Invest now/ exercise early (e.g., build excess plant capacity) to preempt competitive erosion or capture cash-flow “dividends”
V+=180
V=100
V-=60
Invest now: V - I = = 20 (> 18.5)

8. Simultaneous Investment Timing Game Compete/invest early (prisoners’ dilemma)
Firm B
Invest
Extensive form
Wait
Invest
(10,10)*
(18.5,18.5)
(0,20) B
(share NPV=20)
Wait
Invest
(20,0)
Wait A
Firm A
Invest
(0, 20)
Wait
(20,0)
(10,10)* B
Invest
(18.5,18.5)
Wait
(share 37)
A: Invest regardless of B (dominant)
B: Invest regardless of A (dominant)
But better if wait!

9. Two-stage (Growth) Investment R&D/ infrastructure/ growth option
II = 30
III = 80
V-- = 36
Stage I
Stage II
t = 0
t = t = 2

10. Competitive Strategies (Dog)
Depend on type of investment (proprietary vs. shared) and competitive reaction (contrarian vs. reciprocating)

11. Proprietary (2/3) / Contrarian (1) Invest in R&D (offensive strategy to preempt )
High Demand (V+=180) Low Demand (V-=60)
Firm B
Invest
Wait
Invest
Wait
(81, 25) 1
(0,100) 2
(10,0)* 1
(0,-20) 2
Wait
Wait
Firm A
(100,0) 3
(80,20)* 4
(-20,0) 3
(0,-20) 4
Invest
Invest
Nash (A invest, B invest) ;
IIA = 30; IIIA = 40; III = IIIA + IIIB = 80 (if preemption IIIA = IIIB = 80)

12. Proprietary (2/3) / Reciprocating (-1/4) Do not invest in R&D (avoid rivalry and price war)
High Demand (V+=180) Low Demand (V-=60) B
Invest
Wait
Invest
Wait
(61,15) 1
(0, 100) 2
(10,0)* 1
(0,-20) 2
Wait
Wait A
(100,0) 3
(50,5)* 4
(-20,0) 3
(-10,-25) 4
Invest
Invest

13. Shared (1/2) / Reciprocating (+1/4) Invest in R&D (expanded pie from coordination)
High Demand (V+=180) Low Demand (V-=60) B
Invest
Wait
Invest
Wait
(75,75) 1
(0, 100) 2
(10,10)* 1
(0,-20) 2
Wait
Wait A
(100,0) 3
(73,73)* 4
(-20,0) 3
(-3,-3) 4
Invest
Invest
Nash (A invest, B invest) Shared (coordination): wait

14. Shared (1/2) /Contrarian (1) Do not invest (avoid subsidizing aggressive rival)
High Demand (V+=180) Low Demand (V-=60)
Invest B
Wait
Invest
Wait
(53,53) 1
(0, 100) 2
(5,5)* 1
(0,-20) 2
Wait
Wait A
(100,0) 3
(50,50)* 4
(-20,0) 3
(-10,-10) 4
Invest
Invest
(< 0);

15. Sequential R&D Investment Race Invest to preempt (first mover 2/3 or time-to-market)
Firm B
Invest
Invest
Wait
(22,-17) 4 B
(16,16) 1
(0, 35) 2
Invest
(35,0)
Wait
Wait 3 A
Invest
(0, 35)
Firm A
Wait 2
(35,0)* 3
(22,-17) 4 B
(16,16)
Invest 1
Wait
A invests; given that, B waits
Winner takes all

16. both get hurt (worse than wait)
Simultaneous R&D Investment Battle Invest prematurely (prisoners’ dilemma)
Firm B
Invest
Wait
(16, 16) 1
(0, 35) 2
Wait
Firm A
(35, 0) 3
(2, 2)* 4
Invest
Invest prematurely;
both get hurt (worse than wait)

17. Cooperate in Technology Investment Joint R&D Ventures
Firm B
Invest
Wait
(22,22)* 1
Wait
Firm A
(17,17) 4
Invest
Save (share) costs; better appropriate (jointly)
option value of waiting