A company acquires a growth option by making an initial investment in a new market, a new product line, or a new technology. This investment often requires more initial costs than the expected revenue would justify.
In other words, the Net Present Value (NPV) gives a negative result. However, the value of this investment opportunity comes from creating future growth opportunities. If the new market proves profitable, the initial cost can be expanded into a broader geographic region. If the new product line is successful in a pilot market area, production and launch can be expanded. If initial experience in a pilot plant with a new production technology decreases costs and increases efficiency, the technology can be implemented throughout the entire corporate enterprise.
Growth options create infrastructure and opportunities for future expansion and hence are of strategic value. They are sequential options that link distinct growth and expansion steps but always preserve managerial flexibility to embark on the next expansion step, depending on prevailing market conditions. Even if the pilot project turns out to be a complete failure, the company will gain experience and insights that may be of value for the planning or implementation of other growth options in the future.
Growth options exist virtually in every industry, but they may be especially essential for high-tech, high-risk endeavors. Growth options have been valued for BioTech companies, for the development and implementation of new software, or for an entire Information Technology infrastructure, including the consideration of competitive scenarios drawing on game theory. For example, Benaroch and Kauffman apply the binomial and Black-Scholes models to evaluating IT investment, with a real case study on the Yankee-24 electronic banking network.
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