Keywords: real options, valuation, product development, intellectual property, joint ventures, research and development
Valuing new product development and analysing license agreements for intellectual property
Strategic investments in research and development (R&D) possess challenging features for valuation: the relationship between research effort and a marketable product is highly uncertain and there is always the possibility for some exogenous event or competitor behaviour to render the whole effort valueless. The R&D project studied here concerns the breeding of new fruit varieties in a programme jointly funded by a research provider and an international marketing company. The breeding programme is modelled on the premise that the R&D comprises a series of lotteries – in the sense that the outcome in each evaluation phase is probabilistic – and that the final prize in this lottery is a call option, in this case the option-to-market accorded the marketing company. The model provides a framework for optimising contractual arrangements between the joint venture parties and encouraging profit maximisation.