Abstract

Several previous research papers investigate the positive impacts of the brand extension by using the traditional Net Present Value (NPV) approach, which neglects the irreversibility of the specific investments in the brand identification system (BIS) and the brand extension activities. Even though there are some discussions of the optimal entry time for the brand extension in the previous works, it is seldom analyzed that how a company uses the real option approach to deal with the managerial flexibility in marketing strategy under uncertainty. This work extends the model of the single-stage real option for the brand extension in the context of the continuous time (Dias & Ryals, 2002) to the two-stage growth option embedded in the BIS and the brand extension. The comparative static and the sensitivity analyses are performed in this work. The results show that when the positive effects of brand association occur, the demand elasticity for brand extension will be lowered, representing the higher market power in the extended market and the higher value for growth option. Moreover, more market demand volatility encourages the companies to choose the optimal timing for brand extension and bring in more value of the growth option. Furthermore, entering the market too early will cause the investment become irreversible, thus only when the growth of option value derived from the marketing investment expenditures for brand extension excesses the investment threshold, the enterprise will adopt the brand extension strategy. In addition, the marginal operation cost for brand extension is lower than that for BIS stage, and thus increases the growth option value.