Timing the Start of Material Substitution Projects: Creating Switching Options under Volatile Material Prices

Abstract

Firms developing new products often face the challenge of making investment decisions under uncertain input-cost conditions due to the price volatilities of the materials they use. These decisions need to be made long before the final products are launched on the market. Therefore, firms who invest in the opportunity to switch materials in a timely manner will have the flexibility to react to material price changes and realize competitive advantages. However, volatile material prices may also cause a firm to delay investment. Using real-options reasoning, this article studies the influence of input-cost fluctuations on the timing decision to start new product development (NPD) and thus create the follow-on opportunity to later replace an existing product. A model that combines waiting and switching options to derive influencing factors of the flexibility value which triggers the investment is developed and tested on a sample of material substitution projects from manufacturing firms. The results show how price uncertainty of the new and the old material, their joint price development, the expected project duration, and competitive preemption are related to the propensity to delay the start of NPD. The findings provide new insights on how timing in adopting materials can be used to hedge exposure to volatile material prices. The insights are relevant for adopters and producers of new materials, as well as for policy makers who strive for supporting the diffusion of new materials.

How Does Material Resource Adequacy Affect Innovation Project Performance? A Meta‐Analysis

“…While the availability and cost of raw materials and physical production is an important determinant in the development of new tangible products (Fisch and Ross, ), this aspect is of minor importance for intangible products and extant research has shown how influential constraints in raw materials can be for innovation outcomes (Gibbert and Scranton, ). It is therefore argued that the lack of adequate material resources is more problematic for innovation projects working on the development of tangible goods, since shortages of essential materials and of equipment for product‐testing and prototype‐building are particularly difficult to overcome or bypass by alternative work arrangements or creative ideas (Gibbert and Scranton, ).…”

Effects of Switching Costs on Innovative Investment

“…Haj-Salem and Chebat (2014) pointed two effects of switching costs. Fischer and Ross (2014) examined the switching costs in material substitution projects. Jabarnejad and Valenzuela (2016) remarked that the switching costs exist in electric transmission systems.…”

Valuing switching options in international grain marketing

“…To successfully expand networks, models are necessary to value optionality embedded in assets allowing trading firms to participate in spatial arbitrage. Recent studies have sought to empirically determine the value of switching options (Fisch & Ross, ; Gitelman, ; Siclari & Castellacci, ).…”