information rules: a strategic guide to the network economy lock-in effect & networks...
TRANSCRIPT
Information Rules:
A Strategic Guide to the Network Economy
Lock-In effect &
Networks externality
Seungkyoon Shin
Information Rules Spring 20002
Recognizing Lock-In
• Cost of switching
• Compare– Ford v. GM– Mac v. PC
Information Rules Spring 20003
What’s the Difference?
• Durable investments in complementary assets– Hardware– Software– Netware
• Switching cost and lock-in are ubiquitous in information systems
• Supplier wants to lock-in customer• Customer wants to avoid lock-in• Basic principle: Look ahead and reason back
Information Rules Spring 20004
Examples of lock-in
• Bell Atlantic and AT&T– 5ESS digital switch used proprietary operating
system– Large switching costs to change switches
• Computer Associates– Vender Level Locking– System Level Locking
Information Rules Spring 20005
Small Switching Costs Matter• Look at lock-in costs on a per customer basis• Phone number portability• Email addresses (Mail Forwarding issue)• Hotmail (advertising, portability)
– $400 mil for 9.5 mil subscribers
• ACM, CalTech– Provide forwarding service to approach possible donors
Information Rules Spring 20006
Valuing an Installed Base
• Customer C switches from A to "same position" w/ B– Total switching costs = customer costs + B's costs
• Example– Switching ISPs costs customer $50 new ISP $25
– New ISP make $100 on customer, switch
– New ISP makes $70 on customer, no switch
• In a competitive market, Profit=switching costs
Information Rules Spring 20007
Profits & Switching CostsIn General:
• Profits from a customer =
total switching costs + quality/cost advantages• In commodity market like telephony, profit per
customer = total switching costs per customer• Use of this rule of thumb
– How much to invest to get locked-in base– Evaluate a target acquisition (e.g., Hotmail)– Product and design decisions that affect switching
costs
Information Rules Spring 20008
Classification of Lock-In
• Durable purchases and replacement: declines with time
• Brand-specific training: rises with time• Information and data: rises with time• Specialized suppliers: may rise• Search costs: learn about alternatives• Loyalty programs: rebuild cumulative usage• Contractual commitments: damages
Information Rules Spring 20009
Durable Purchases
• Telephone switches, Mainframe, OS • After-market sales (supplies, maintenance)• Depends on (true) depreciation• Usually fall with time due to depreciation• Watch out for multiple pieces of hardware
– Supplier will want to stagger vintages
– Contract renewal
• Technology lock-in vs. vendor lock-in
Information Rules Spring 200010
Brand-specific Training
• When personnel are trained
• General training/brand specific training
• How much is transferable?
• Software, an obvious example
• Competitors want to lower switching costs– Borland’s Quattro Pro help for Lotus 123 users– MS Word and WordPerfect help
Information Rules Spring 200011
Information & Databases
• Data files– Insist on standard formats– S/W and database– Whether information can be easily ported over
to another system
• Zip - CD - DVD Transition
Information Rules Spring 200012
Specialized Suppliers
• If durable equipment or S/W is highly specialized, it will be hard to find alternatives
• Pentagon: Joint strike fighter project– Structuring competition among suppliers– Boeing, Lockheed Martin, McDonald
• IBM– Dual sourcing– Intel and AMD
Information Rules Spring 200013
Search Costs• Consumers’ Search Cost
– Psychological costs of change– Time and efforts– Risk to customers
• Suppliers’ Search Cost– Promotional cost– Cost of actually closing the deal– Cost of setting up a new account
– Risk to suppliers• Example of Risk: Credit Cards
– $100 million in receivables is worth about $120 million– Market valuation of “loyalty”
Information Rules Spring 200014
Loyalty Programs• Constructed by firm (artificial lock-in)
– Frequent flyer programs– Getting more popular in E-Commerce– Keep track of history sales: consumer information
• Personalized Pricing– Gold status
• Example: Amazon and Barnes and Noble– Amazon Associates Program v. B&N's Affiliates
program
• Add nonlinearity?
Information Rules Spring 200015
Suppliers and partners
• Bilateral, or two-sided lock-in
• Railroad spur lines
• Customized software– Game for the Nintendo 64 platform– S/W for Apple computer
Information Rules Spring 200016
Follow the Lock-in cycle
Brand Selection
SamplingLock-In
Entrenchment
Information Rules:
A Strategic Guide to the Network Economy
Networks and Positive Feedback
Information Rules Spring 200018
Old and New
• Industrial Economy– Populated with oligopolies– Economies of Scale
• Information Economy– Temporary monopolies– Economies of Networks
Information Rules Spring 200019
Important Ideas
• Positive feedback
• Network effects
• Returns to scale– Demand side– Supply side
Information Rules Spring 200020
Positive Feedback
• Strong get stronger, weak get weaker
• Negative feedback: stabilizing
• Makes a market “tippy”
• Examples: VHS v. Beta, Wintel v. Apple
• “Winner take all markets”
Information Rules Spring 200021
Sources of Positive Feedback
• Supply side economies of scale– Declining average cost
– Marginal cost less than average cost
– Example: information goods, Automobile industry
• Demand side economies of scale– Network effects
– In general: fax, email, Web
– In particular: Sony v. Beta, Wintel v. Apple
Information Rules Spring 200022
Network Effects
• Real networks: – Fax machines, compatible modems, email
• Virtual networks– Mac users, CD-ROM driver, Nintendo 64– Computer (both S/W and H/W) buyers are picking a
network, not simply a product. E.g. user group
• Number of users– Metcalfe’s Law: Value of network of size n
proportional to n2
• Importance of expectations
Information Rules Spring 200023
Lock-In and Switching Costs
• Network effects lead to substantial collective switching costs
• Even worse than individual lock-in
• Due to coordination costs
• Example: QWERTY
Information Rules Spring 200024
Don’t Get Carried Away
• Network externalities don’t always apply– ISPs (but watch out for QoS)– PC production
• Likelihood of tipping– See next slide
Information Rules Spring 200025
Likelihood of Tipping
Low ScaleEconomies
High ScaleEconomies
Low DemandFor Variety
Unlikely High
High DemandFor Variety
Low Depends
Information Rules Spring 200026
Chicken & Eggs
• Fax and fax machines
• VCRs and tapes
• Internet browsers and Java
Information Rules Spring 200027
Igniting Positive Feedback
• Evolution– Give up some performance to ensure
compatibility, thus easing consumer adoption
• Revolution– Wipe the slate clean and come up with the best
product possible
Information Rules Spring 200028
Evolution
• Offer a migration path– Failure of CBS
• Examples– Microsoft– Borland v Lotus
• Build new network by links to old one
• Problems: technical and legal
Information Rules Spring 200029
Technical Obstacles
• Compatibility/Performance Trade-off
• Use Creative design
• Think in terms of system (NBC/CBS)
• Converters and bridge technologies– One-way compatibility– Office 97/95– Boland Q-pro/Lotus 1-2-3
Information Rules Spring 200030
Legal Obstacles
• Need IP licensing
• Example: – Sony and Philips CDs– Amazon.com’ banner ad
Information Rules Spring 200031
Revolution
• Users will bear the switching cost when production is so much better than what people are currently using
• Groves’ law: “10X rule”
• But depends on switching costs
• Example: Nintendo vs. Sega
Information Rules Spring 200032
Openness v. Control
• “Open” approach: offering to make the necessary interfaces and specifications available to others
• “Control” approach: keeping your system proprietary
• The goal is to maximize the value of your technology, not control
Information Rules Spring 200033
To maximize the value…
• Your reward = Total value added to industry x your share of industry value
• Value added to industry– Depends on product and– Size of network
• Your share– Depends on how open
Information Rules Spring 200034
Openness
• More cautious strategy than control
• Full openness– Anybody can make the product– Problem: no champion
• Alliance– Only members of alliance can use– Problem: holding alliance together
Information Rules Spring 200035
Control
• Control standard and go it alone
• A strategy for Market leaders: AT&T, MS, and Intel
• If several try this strategy, it may lead to standards wars
Information Rules Spring 200036
Generic Strategies
Control Open
Compatible ControlledMigration
OpenMigration
Incompatible PerformancePlay
Discontinuity
Information Rules Spring 200037
Performance Play
• Introduce new, incompatible technology
• Examples– Palm Pilot– Iomega Zip
• Attractive if– Great technology– Outsider with no installed base
Information Rules Spring 200038
Controlled Migration
• Compatible, but proprietary
• Examples– Windows 98– Pentium chips– Upgrades and update of S/W programs
Information Rules Spring 200039
Open Migration
• Many vendors, compatible technology
• Little switching cost for customers
• Examples– Fax machines– Modems
Information Rules Spring 200040
Discontinuity
• New technology, but incompatible with existing technology
• Supplied by many vendors
• Examples– CD audio– 3 1/2” disks
Information Rules Spring 200041
Lessons on Lock-in
• Switching costs are ubiquitous
• Customers may be vulnerable
• Value your installed base
• Watch for durable purchases
• Be able to identify 7-types of lock-in
Information Rules Spring 200042
Lessons on Network and Positive feedback
• Positive feedback means strong get stronger and weak get weaker
• Consumers value size of network• Works for large networks, against small
ones• Consumer expectations are critical• Fundamental tradeoff: performance and
compatibility
Information Rules Spring 200043
Lessons, continued
• Fundamental tradeoff: openness and control
• Generic strategies– Performance play– Controlled Migration– Open Migration– Discontinuity
• Lessons of history