Strategic Dynamic R&D Investments

In this paper we present a model, which describes firms’ strategic R&D investment under technological uncertainty. It assumes two symmetric firms making strategic decisions about undertaking two-stage R&D subject to uncertainty in the outcome of the first exploratory stage. The model concludes that using real options to evaluate the R&D investments allows the firm to undertake larger investment projects when uncertainty is large. Also using the real options creates more complex strategic interactions between the competing agents in a duopoly. If the R&D is profitable for both agents, they will invest symmetrically and compete later in production. But the technological uncertainty together with the strategic interaction between two agents can lead to the outcome when it is profitable for one agent to invest in R&D only when another agent does not. The leader gets a larger market share and is capable of conducting the R&D in amounts, which otherwise are nonprofitable under regular symmetric conditions or if the first-stage exploratory R&D did not succeed.