Effects of funding and its return on product quality in new ventures

Most entrepreneurs must rely on external financing when their new venture is based on the development of a new product. External financing, however, is usually uncertain in magnitude and timing, thus creating tradeoff between the advantage of waiting-to generate more money-and improve the product versus releasing the product before competition increases. This tradeoff is investigated through a dynamic programming framework for which a simple, easy-to-implement optimal stopping rule is identified for a special class of revenue functions. The model is utilized to characterize how the amount of funding and its variability are expected to affect the quality of the product at time to market. The model also studies how the release-time strategy is affected by the expectation and the variability of the effect that each unit of funding has on the quality of the product under development. The author shows that an increment in funding does not always lead to a product of higher quality. He also shows that an improvement in the effect of investment on quality does not necessarily lead to an enhanced product.