Reading: Implementing Real Option Valuation

The second question is whether the option in question has significant economic value.

For a real option to be valuable, there must be a restriction on competition. Put differently, a real option should give the firm some sort of exclusivity to pursue a project. The reason is very simple: If there is no restriction on competition, other companies can pursue similar projects so that the value added of the project will erode quickly.

In fact, this is often a major problem for startup companies. Many startups exhaust all their resources to bring a product to market success. A large incumbent player could simply wait on the sideline and see how the project evolves. If the project looks promising, the incumbent player then "simply" mimicks the startup and pushes the product on a scale that is unaffordable by the small player.

The key takeaway here is that opportunities are not (necessarily) real options. Only if the opportunity is somewhat unique, in the sense that it restricts competition, it constitutes a real option with potentially significant economic value.