New product development flexibility in a competitive environmentEuropean Journal of Operational Research

About

Authors
Janne Kettunen, Yael Grushka-Cockayne, Zeger Degraeve, Bert De Reyck
Year
2015
DOI
10.1016/j.ejor.2015.02.016
Subject
Information Systems and Management / Management Science and Operations Research / Modelling and Simulation

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Accepted Manuscript

New Product Development Flexibility in a Competitive Environment

Janne Kettunen, Yael Grushka-Cockayne, Zeger Degraeve,

Bert De Reyck

PII: S0377-2217(15)00113-7

DOI: 10.1016/j.ejor.2015.02.016

Reference: EOR 12785

To appear in: European Journal of Operational Research

Received date: 8 April 2014

Revised date: 23 July 2014

Accepted date: 9 February 2015

Please cite this article as: Janne Kettunen, Yael Grushka-Cockayne, Zeger Degraeve, Bert De Reyck,

New Product Development Flexibility in a Competitive Environment, European Journal of Operational

Research (2015), doi: 10.1016/j.ejor.2015.02.016

This is a PDF file of an unedited manuscript that has been accepted for publication. As a service to our customers we are providing this early version of the manuscript. The manuscript will undergo copyediting, typesetting, and review of the resulting proof before it is published in its final form. Please note that during the production process errors may be discovered which could affect the content, and all legal disclaimers that apply to the journal pertain.

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Highlights • We develop models to characterize the market environment an NPD firm faces. • We examine how the value of flexibility depends on the competitive environment. • Flexibility value is non-monotonic and non-symmetric w.r.t. competition intensity. • Delaying a launch can be beneficial when competition intensity increases. • Switching options are valuable when competition is intense and incremental. 1

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New Product Development Flexibility in a

Competitive Environment

Janne Kettunen

Department of Decision Sciences, George Washington University, 2201 G Street NW, Washington, DC, 20052, USA, Tel: +1 202 994 3029, jkettune@gwu.edu

Yael Grushka-Cockayne

Darden School of Business, University of Virginia, Charlottesville, VA, 22903, USA, grushkay@darden.virginia.edu

Zeger Degraeve

London Business School, London NW1 4SA, United Kingdom

Melbourne Business School, 200 Leicester Street, Carlton VIC 3053, Australia Z.Degraeve@mbs.edu

Bert De Reyck

Department of Management Science and Innovation, University College London, London WC1E 6BT, United Kingdom, bdereyck@london.edu

Managerial flexibility can have a significant impact on the value of new product development projects. We investigate how the market environment in which a firm operates influences the value and use of development flexibility. We characterize the market environment according to two dimensions, namely (i) its intensity, and (ii) its degree of innovation. We show that these two market characteristics can have a different effect on the value of flexibility. In particular, we show that more intense or innovative environments may increase or decrease the value of flexibility. For instance, we demonstrate that the option to defer a product launch is typically most valuable when there is little competition. We find, however, that under certain conditions defer options may be highly valuable in more competitive environments. We also consider the value associated with the flexibility to switch development strategies, from a focus on incremental innovations to more risky groundbreaking products. We find that such a switching option is most valuable when the market is characterized by incremental innovations and by relatively intense competition. Our insights can help firms understand how managerial flexibility should be explored, and how it might depend on the nature of the environment in which they operate.

Keywords: project management; OR in research and development; product development; dynamic programming

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T 3 1. Introduction

Any new product development (NPD) project is susceptible to uncertainty regarding the success of its development. This uncertainty relates to the quality of the resulting product and to its commercial success, which is influenced by market conditions. An NPD firm should consider the evolution of both these uncertainties, i.e., its development success as well as the state of the market, when deciding how much to invest in the development, when to launch the product, or whether to abandon the development completely. Consider, for instance, Microsoft’s announcement of postponing the launch of its Vista operating system for consumers in late 2005 (Lohr and Flynn 2006). It is likely that this decision, while being influenced by the success of its development effort, was also influenced by the fact that Microsoft did not face harsh competition in the operating system market. A delayed launch of Vista was less likely to have a negative impact on Microsoft’s profitability.

Similarly, consider Apple’s decision to launch a compromised iPhone 4S rather than delaying the launch of the new iPhone until the iPhone 5 was fully functional, which was undoubtedly influenced by the highly intense smartphone market environment (Blodget 2011). In patent protected NPD environments such as pharmaceuticals, firms explicitly consider a set of future scenarios associated not only with their own technical success, but also with the commercial success and market conditions when evaluating their projects and related launch dates.

It is well known that managerial flexibility, also referred to as real options, can have a major impact on the value of NPD projects (Dixit and Pindyck 1994). Many have explored how this impact depends on the characteristics of the development process (Huchzermeier and Loch 2001,

Wilhelm and Xu 2002, Santiago and Vakili 2005, Cui et al. 2011). What is not yet fully known, however, is how the value of flexibility in NPD is influenced by the competitive environment in which a firm operates. Some of the previous works (Canbolat et al. 2012, Chronopoulos et al. 2014) have employed game theoretical approaches to account for the competitive market environment when valuing NPD flexibilities. Whilst game theoretical approaches can be effective in dealing with duopoly markets with homogenous players, they may not be easily extendable for markets with several firms that are heterogeneous in their development capabilities, assets, and strategic