chung-cheng lee department of business administration, chaoyang university of technology

Adoption Timing of Technology Innovative Adoption Timing of Technology Innovative

Investment Project Investment Project

in Economic Rents Perspective in Economic Rents Perspective ──

The New-Generation TFT-LCD Panel Makers CasesThe New-Generation TFT-LCD Panel Makers Cases

Chung-Cheng LeeChung-Cheng Lee

Department of Business Administration,Department of Business Administration,Chaoyang University of TechnologyChaoyang University of Technology

May 8May 8thth, 2009, 2009

The Previous Version Had Been Presented at ACME 2008 Annual Meeting, Toronto, The Previous Version Had Been Presented at ACME 2008 Annual Meeting, Toronto, Canada, July 25Canada, July 25thth, 2008, 2008

ACME Annual Meeting, July 25, 2008ACME Annual Meeting, July 25, 2008 22

OutlinesOutlines

• Introduction

• Analytical Tool: Economic Rents

• Using Real Option Approach for Investment Timing Strategy

• Numerical Examples

• Conclusions


Introduction Introduction (1)(1)

• In today’s hyper-competitive marketplace, many products like those that memory chipsmemory chips and TFT-LCD TVsTFT-LCD TVs are characterized by short life cyclesshort life cycles andrapidly-declining sales pricesrapidly-declining sales prices.



• An effective strategic management for the

technology innovative technology innovative investment projects

involves various decisions such as

which new technologywhich new technology to be adoptedto be adopted and

when to implement. when to implement.


Analytical Tool : Economic RentAnalytical Tool : Economic Rent

Innovative Rents are understood here in their Schumpeterian sense of being reward for the first commercialization of an invention

Under rivalry, Rents would exist if the firm has a competitive advantage in realizing the project



• Economic rentsEconomic rents occur only if

comparative competitive advantagecomparative competitive advantage exists.

• A hi-tech firm can capture the economic rentseconomic rents

(the above-normal returnthe above-normal return) if the position with

strategic benefit of technology innovative

activities has been implemented.



• There is a decided preference for the

maximization of product revenues maximization of product revenues under

the innovative technology adoption timingthe innovative technology adoption timing

as an important objectiveas an important objective.


Investment Timing Problem Investment Timing Problem (1)(1)

Deciding on the appropriate investment timing is a critical issue which raises the substantial questions coming from:

• the intrinsic uncertainty surrounding each new technology

• the inherently intangible nature of many of expected benefits


Investment Timing Problem Investment Timing Problem (2)(2)

• the current and future availability of technical and economic information about new technology

• the need to develop new competences and skills

• the role played by learning process

• the partial or complete irreversibility of innovative investment


Real Option - Real Option - Uncertainty Embedded ValuesUncertainty Embedded Values

Real Option View

Traditional View

Inve

stm

ent o

ppor

tuni

ty v

alue

Uncertainty

Mnagerial Options Increase Values


Real Option - Real Option - expected project value might evolve over timeexpected project value might evolve over time

Pos

sibl

e Fu

ture

Val

ues

Time Horizon

Range of Possible Future Values

Now Future


Using Real Option Approach for Using Real Option Approach for Investment Timing StrategyInvestment Timing Strategy

• The Investment Timing Investment Timing of

Technology Innovation Project

is Analogous tois Analogous to

the TimingTiming of Exercising of An

American Call Option on a Dividend Paying Stock


Analytical Tool : Economic RentAnalytical Tool : Economic Rent

T h e e x p e c t e d n e t o p e r a t i n g c a s h i n f l o w e s t i m a t i o n i s a st h e o p p o r t u n i t y c o s t o f c a p i t a l p l u s t h e e c o n o m i c r e n t :( S m i t a n d A n k u m , 1 9 9 3 )

C F I k E Rt t ( 1 )

C F t = t h e e x p e c t e d n e t o p e r a t i n g c a s h f l o w

I = t h e i n v e s t m e n t c a s h o u t f l o w

k = t h e o p p o r t u n i t y c o s t o f c a p i t a l

E R t = t h e e x p e c t e d e c o n o m i c r e n t

Considering the yearly change rate of economic rent is x which is expected to decline exponentially. The expected economic rent of the innovation project：

txt eERER 0 ,3,2,1t (2)

txt eERkICF 0 ,3,2,1t (3)

ER0 = the initial value of the economic rent x = the yearly change rate of economic rent

Let the innovation project value will be (V0)：

1

0

10 )1()1( t

t

tx

tt

t

k

eERkI

k

ERkIV ,3,2,1t (4)

We begin by assuming that the project follows a

multiplicative binomial process over discrete periods.

We consider the option to defer investment in

technology innovation project analogous to a

call option with a changing dividend payout ratio:δ t,s

t st s

t s

CF

V ss d or u,

,

,

, 1

(5)

CF I kk

e V s k It sx

t s, ,(( )

)( ( ) )

1

1

111 (6)


The investment Timing Decision Tree for The investment Timing Decision Tree for Technology Innovation ProjectTechnology Innovation Project

V V uu u u4 3 41 1 11 ( )*

V V uu u u3 2 31 1 11 ( )* C Max V Iu u4 41 1

0 [ , ]

C Max abandon V I investu u3 31 10 [ ,( ); ,( );

( ) / r, (p C p C deferu d 4 41 11( ) )] V V dd u d4 3 41 1 1

1 ( )*

V V uu u u2 1 21 11 ( )* C Max V Id d4 41 1

0 [ , ]

C Max abandon V I investu u2 21 10 [ ,( ); ,( );

V V uu u1 0 11 ( )* ( ) / r, (p C p C deferu d 3 31 11( ) )] V V uu d u4 3 42 1 2

1 ( )*

C Max abandon V I investu u1 10 [ ,( ); ( ); , V V dd d d3 2 31 1 11 ( )* C Max V Iu u4 42 2

0 [ , ]

( ) / r, ( p C p C deferu d 2 21 11( ) ) ] V V dd u d2 1 21 1

1 ( )* C Max abandon V I investd d3 31 10 [ ,( ); , ( );

V0 C Max abandon V I investd d2 21 1

0 [ ,( ); ,( ); ( ) / r, (p C p C deferu d 4 42 21( ) )] V V dd d d4 3 42 1 2

1 ( )*

C Max (abandon)0 0 [ , ; ( ) / r, (p C p C deferu d 3 32 21( ) )] : C Max V Id d4 42 2

0 [ , ]

V I invest0 , ); ( : : : ( ( ) )/ ( )p C p C r deferu d 1 11 , ] : : :

V V dd d1 0 11 ( )* : : :

C Max abandon V I investd d1 10 [ ,( ); ,( ); : : :

( ) / r, ( p C p C deferu d 2 22 21( ) ) ] V V dd d u2 1 22 2

1 ( )* : :

C Max abandon V I investd d2 22 20 [ ( ), ( ), : :

( ) / r ( p C p C deferu d 3 34 41( ) ) ] : V V uu d u4 3 48 4 8

1 ( )*

V V dd d d3 2 34 2 41 ( )* C Max V Iu u4 48 8

0 [ , ]

C Max abandon V I investd d3 34 40 [ ( ), ( ),

( ) / r ( p C p C deferu d 4 48 81( ) ) ] V V dd d d4 3 48 4 8

1 ( )*

C Max V Id d4 48 80 [ , ]

Figure 1. The investment Timing Decision Tree for Technology Innovation Project


Numerical ExampleNumerical Example

• A global top-five TFT-LCD panel company in Taiwan, has planned to invest the eighth-generation (8G)eighth-generation (8G) production lines to upgrade the technology positionupgrade the technology position.

• Together with the current 7G, the start of what is considered to be the world’s most advanced (8G) line will enable to expand production of large screen LCD panels for 50 inch class LCD

TVs


Numerical Example Numerical Example (2)(2)• The first 8G production line investment project in

Taiwan was announced in the beginning of 2006; however, there was no 8G production line has been constructed in the end of 2007.

• Considering the mainstream sizes of LCD TVs in the global market, which keep getting bigger even as LCD TV prices continue going down.

• These imply that the amount of revenue generated These imply that the amount of revenue generated may be decreasing because of completing a product may be decreasing because of completing a product as its adoption timing is delayed as its adoption timing is delayed


Numerical Example Numerical Example (3)(3)

The Estimated Cash Flows of the 8G TFT-LCD Panel Production Line Investment Project (Unit: Million US$ (Unit: Million US$ Dollars)Dollars)

Time 00 11 22 33 44 55 66 77 88 99 1010 1111 1212

I*k 205205 205205 205205 205205 205205 205205 205205 205205 205205 205205 205205 205205

ERt 315315 241241 185185 142142 187187 8383 6464 4949 3737 29 29 22 22 1717

CFt -2,400-2,400 520520 446446 390390 347347 313313 288288 269269 254254 242242 234234 227227 222222

NPV: 68.1813 ( k : WACC=8.5341%)

IRR: 9.2544% ( ) ,,3,21 , 315117735 2663.00 ,teeERER ttx

t


The investment Timing Decision Tree for The investment Timing Decision Tree for Technology Innovation Project with Technology Innovation Project with σσ=0.2=0.2

V2u1=2,988,196,939.17C2u1=588,196,939.17

“Invest”

V2d1=2,058,014,480.40C2d1=50,637,719.97

“Defer”

V2u2=2,251,725,644.21C2u2=104,928,162.7

“Defer”

V2d2=1,564,343,008.05C2d2=0

“Abandon”

V1u1=2,694,338,132,36C1u1=321,091,508.78

“Defer”

V1d1=1,911,051,573.42C1d1=53,046,035.05

“Defer”

V0=2,473,999,955.09C0=187,074,175.64

“Defer”


The investment Timing Decision Tree for The investment Timing Decision Tree for Technology Innovation Project with Technology Innovation Project with σσ=0.4=0.4

V2u1=4,216,973,372.35C2u1=1,816,973,372.35

“Invest”

V2d1=1,986,619,373.66C2d1=220,632,044.26

“Defer”

V2u2=2,381,816,010.45C2u2=344,399,918.46

“Defer”

V2d2=1,162,030,017.25C2d2=0

“Abandon”

V1u1=3,166,643,415.27C1u1=890,732,389.08

“Defer”

V1d1=1,731,844,938.37C1d1=145,866,142.97

“Defer”

V0=2,473,999,955.09C0=457,317,625.52

“Defer”


Conclusions Conclusions (1)(1)

• With the advantage of option pricing approach, decision maker can evaluate the project value and decide the optimal investment timing base on different degree of uncertainty analysis.

• The results not only extend the advantage of keeping the future uncertain information simple but also provide the decision maker references to make decision under different level of uncertainty.


Conclusions Conclusions (2)(2)

• If the hi-tech firm is confident inis confident in its own management ability as well as future technology development process of the project,this firm will be more talent to take higher uncertainty.

chung-cheng lee department of business administration, chaoyang university of technology

Documents

appropriate investment

timing of exercising

technology position

tftlcd tvs

economic rents perspective

economic rentinnovative

economic information

g line