The valuation of product introduction time strategies using a real options approach

Abstract

In today’s economy, new technologies rapidly emerge in the durable goods market. Therefore, it is paramount for manufacturing companies to optimize product introduction time for their second-generation product (SGP), which is an upcoming product in the production line, when profitability is at stake. The main factors affecting this timing are technology advancements and changes in customer tastes, which make determining an optimal introduction time for a product a challenging task. The main goal of this research is to find the optimal product introduction time for the SGP that maximizes the net present value (NPV) over a given period while product life cycle (PLC), pricing, and advertising are explicitly being taken into consideration. Demand for each product contains two regimes life cycle, and each regime is defined by a geometric Brownian motion (GBM). Each GBM has a drift rate and volatility. Moreover, there is a correlation between different regimes for different products. Correlated GBMs are discretized using a lattice approach. The Bass model is used to determine demand parameters including drift, volatility, and correlation, while dynamic programming is used to optimize NPV. Flexibilities, such as expansion, contraction, and switching, are identified between two products. Examples are provided to show the applicability of the developed models. Accordingly, the results show as the drift rate, volatility, and initial demand for a first-generation product (FGP) increase, the SGP introduction time has to be delayed. Furthermore, results demonstrate that in decreasing pricing policy, the SGP has to be introduced as early as the FGP. In increasing-decreasing pricing policy, as the increasing pricing rate is increasing, the SGP introduction time is delayed. When the advertising budget percentage increases, the NPV increases up to a certain level and then it will be saturated. Major contributions of this thesis are as follows: first, investigating the product introduction time by integrating marketing and manufacturing aspects; second, developing a model to incorporate the flexibility and production cost of the system for determining the optimal product introduction time. Third, the value of the product introduction time is expressed in terms of dollar value and this would help managers to make decisions easily. The models developed in this research can be used as practical tools for manufacturers to find the optimal product introduction time (PIT) and also the research can be used as a guideline to introduce the second-generation PIT.