Market Entry, Pricing Decisions and Options Contracts

This paper bridges the literature on real options in strategy with that on financial options. It uses insights from both literatures to show how the use of options contracts can encourage innovators to enter markets by mitigating the effects of uncertainty and permitting the capture of greater value from innovation. The dilemma facing a firm trying to secure the successful launch of its innovation is how to set price to achieve market penetration yet still receive an adequate return. The traditional view is that the low price necessary for penetration may yield such poor returns that the innovator is dissuaded from launch. This problem is exacerbated when the innovator is an entrant and faces retaliatory reactions from incumbents. We explore how financial options can mitigate these effects and recapture the "lost" added value. Using financial options can encourage commitment, overcome delay in launch and allow innovators to capture value quickly. Finally, we explore some of the impediments to executing our ideas, discuss when they might be useful to managers and suggest ways in which they can be tested empirically.