Technology innovations and product rollover strategies: A real options approach

As technological innovations emerge, firms with the capacity to invest in new products must determine the optimal timing for such investments and decide the future of their existing products. Upon deciding to invest in the innovative product, the firm faces a choice: a single rollover, replacing the established product entirely, or a dual rollover, where the firm produces both products temporarily before eventually phasing out the established one. This paper presents a theoretical framework to evaluate the optimal timing and product rollover strategies in response to technological progress. Technological advancements enhance the quality of the latest available technology over time, implying that later investments yield higher-quality products. This dynamic creates a strategic tradeoff: investing early offers immediate but modest profit gains, while waiting leads to potentially larger payoffs due to the superior quality of later innovations. However, delaying investment means the firm must continue with the established product for a longer period. Our findings indicate that a highly uncertain economic environment encourages firms to delay discontinuing the established product. In contrast, a more volatile innovative market prompts earlier entry provided the firm maintains some presence in the established market. Furthermore, if initial demand in the innovative market is low, higher product quality becomes essential for product innovation to be viable. We also show that a higher interest rate makes the firm more inclined to choose a single rollover strategy.