- Is the first investment a prerequisite for the later
investment/expansion? If not, how necessary is the first
investmentforthelaterinvestment/expansion?Considerour
earlieranalysisofthevalueofa patent orthevalueofan
undevelopedoilreserveasoptions.Afirmcannotgenerate
patentswithoutinvestinginresearchorpayinganotherfirm
forthepatents,anditcannotgetrightstoanundevelopedoil
reserve without bidding on it at a government auction or
buying it from another oil company. Clearly, the initial
investmenthere(spendingonR&D,biddingattheauction)is
required for the firm to have the second investment.
Now consider the AmBev investment in a limited
introductionandtheoptiontoexpandintotheU.S.market
later. The initial investment provides Am-Bev with
information about market potential, without which
presumablyitisunwillingtoexpandintothelargermarket.
Unlike thepatent and undeveloped reserves examples, the
initialinvestmentisnotaprerequisiteforthesecond,though
managementmightviewitassuch.Theconnectiongetseven
weakerandtheoptionvaluelowerwhenwelookatonefirm
acquiringanothertohavetheoptiontobeabletoenteralarge
market. Acquiring an Internet service provider to have a
footholdintheInternetretailingmarketorbuyingaChinese
brewery to preserve the option to enter the Chinese beer
market would be examples of less valuable options.
- Does the firm have an exclusive right to the later
investment/expansion? If not, does the initial investment
providethefirmwith significantcompetitiveadvantages on
subsequentinvestments?Thevalueoftheoptionultimately
derivesnotfromthecashflowsgeneratedbythesecondand
subsequentinvestments,butfromtheexcessreturnsgenerated