Strategic technology adoption taking into account future technological improvements: A real options approach

This paper studies a dynamic duopoly in which firms compete in the adoption of new technologies. The innovation process is exogenous to the firms. It is assumed that there are two technologies. Technology 1 already exists at time zero and can be adopted any time at a given one-time cost. This is standard and leads to a preemption game. What is new in the paper is the presence of technology 2 that becomes available for adoption at some unknown time in the future. Technology 2 is superior to technology 1 but firms cannot adopt it if they have adopted technology 1 before technology 2 arrives. The motivation to analyze a setup like this is that it provides a framework where firms take into account technological progress in making their investment decisions. Clearly this topic is important and also the results show that the addition of a superior technology appearing somewhere in the future can have substantial implications for the optimal investment decision. Adding technology 2 to the model delays investment, and could, in case of a high arrival probability, turn the preemption game into a war of attrition. Another main result is that revenue uncertainty induces the adoption of the more modern technology 2.