A value-oriented approach to new product development using real options

TLDR: In this paper, a binomial option tree is introduced that incorporates the flexibility and the risks inherent in the NPD process into its evaluation in theoretically correct way, which leads to more defensible valuations and allows powerful insights for the value-based management of technology-intensive companies.

Abstract: This paper provides a valuation framework that links central concepts from technology and innovation management (TIM), sequential models of the new product development (NPD) process, and the valuation technique of "real options", for use in value-based management of technology-intensive companies. A binomial option tree is introduced that incorporates the flexibility and the risks inherent in the NPD process into its evaluation in theoretically correct way. The proposed options-based approach ties the valuation of hitech and life sciences companies closer to the underlying growth opportunities and incorporates much of the "gut feel" of experienced industry practitioners into the valuation. As a consequence, the approach leads to more defensible valuations and allows powerful insights for the value-based management of technology-intensive companies. Finally, a real life situation from the biotechnology industry is described where the options-based approach was successfully applied in practice and added considerable insight and value for the company.