Timing of Innovation Strategies under Uncertainty: Micro foundations of risk-return profiles and first mover (dis)advantages

Strategy & Business Policy

Speaker: Peter ZEMSKY

Professor INSEAD

Conference - Jouy-en-Josas

Abstract

We consider two classic phenomena for which there are ambiguous results in the strategy literature. The first is Bowman's (1980) paradox that risk and return in real investment problems can be either positively or negatively correlated. The second are the returns to innovation strategies where there are findings of both early and late mover advantages. We develop a formal model of investment under uncertainty where firms need to choose the speed of their investment projects. The faster a firm completes its investment, the greater the returns due to a higher net present value of the expected benefits, but speed is costly due to time-compression diseconomies. Moreover, firms that delay their investments through a follower strategy can learn from the outcome of a leader’s investment and then reoptimize their investment profile. We show that allowing firms to endogenously select investment timing increases the range of parameters for which risk and return are positively correlated. We also show that, when firms are isolated in separate but equal market segments, followers always have higher profits due to the information spillover they get from observing the leader. However, when firms compete in a single market there is a first mover advantage as long as uncertainty is not too great. Finally, we highlight the implications of our model for the divergence between ex-ante expected levels of firm profits and development costs and the empirically observable ex post outcomes.