Vineet Kumar Jain08P056, Section A

PGPM 2008-10MDI, Gurgaon

Market and demand side increasing returns

We look for opportunities with network externalities – where there are advantages to the vast majority of consumers to share a common standard. We look for business where we can garner large market shares, not just 30%-35%.

Bill Gates, Former CEO of Microsoft

What is Demand side increasing returns (DSIR)For many products or services, a buyer is worse

off if everyone else wants what she wants.

There are many other goods which exhibit increasing returns to the size of user population. The more people who use them the more valuable they are.

This phenomenon is called : Demand side increasing returns (DSIR) or Demand side economies of scale or network externalities or network effects or positive feedback economics

DSIR often arise because ofCompatibility benefitsNetwork benefits

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Does DSIR provide advantage?Yes , it provides.DSIR can turn small advantages in market

share into a large, enduring positional advantage.

ReasonsThe buyer who already use a product or

technology are called its installed base of user.If a product has DSIR, potential buyer care about

how many people use it.With time, the product with a large installed base

becomes even more dominant and the market tips toward a winner.

Prerequisite : switching cost (monetary value or emotional benefit) should be high.

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Competitive strategy for building DSIRMarkets differ from conventional markets as

they tend to involve competition for the market as much as competition in the market.

Competitive strategy : PriceTo build up its future installed base each firm

has an incentive to charge less than it otherwise would. So two way

Give-Aways Penetration pricing

Why will this strategy succeed ?Unlike conventional markets it creates high

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Competitive strategy for building DSIR(continued….)Attractive technology can dislodge the firm. So

Invest in product enhancement - which will cause “cannibalism”

Delay product innovation, without loosing market share. This is done by “pre- announcing” its new product. Thus reducing consumer motivation to buy the product of new entrant.

This does not mean the end of competition.Niche firms can compete against incumbents in

markets with DSIR because some consumer will prefer the differentiation as benefit outweighs the loss in DSIR.These firms can strengthen the position by providing

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Adoption pattern

Bandwagons

Expectation

Early adopters

Intermediate adopters

DSIR benefit don’t increase forever

Marketing to create momentum

Leveraging reputation

Open standards

Winning Influential buyer

Advance Sign-ups

Winks at pirates

Leasing

Price commitments

Observed Desired

REASONS

METHODS 04/21/236 VineetKumarJain_08P056_SectionA

Standard setting processesIt is done

To provide the best technology to the customer

It is important for firmsThe firm whose technology is adopted has

first mover advantageStandards committee - Mechanism for

solving co-ordination problem

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Some real example

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Case : Microsoft 1995Different strategy to adopt the OS (although

inferior product compared to Apple and IBM OS)Larger discounts to computer manufacturersSpent more than $60 million per year and dedicated

500 engineers to support the 100,000 ISVs that wrote application for its OS

Incompatibility of developed software with OS of other vendors

Other OS lacked the breadth and depth of applicationAnnouncement of two new OSsFuture generation had managed not to cannibalize

past revenue streams (special group “Ad-tech” group was formed)

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Case : Microsoft 1995 (continued..)Applications

Support to ISVs to build application by providing free windows environment

Offer a bundle of application, called a suite, at a discount price

“competitive upgrades” a program whereby a lotus 1-2-3 or WordPerfect customer could switch to Microsoft for a significant discounted price.

Program designed for windows 95 should also run on windows NT

MSN (Microsoft network) program launched with Windows 95

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Some questions………..Currently this phenomenon is majorly seen in

technological products. Is it applicable only for technological products?Not exactly , some companies only capture the

market on emotional benefit to customers.Bureau of Indian Standards - Standards

Development Does it increase or decrease the industry

growth?Emphasis on open standardMajor determinant for profitabilityNetwo

rkEffect

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Sources and ReferencesTitle : Strategic Management, Garth Saloner, Andrea

Shepard, Joel Podolny, 2001, WilleyStrategies for two-sided markets, October 2006, HBRhttp://www.dilbert.com/strips/http://www.business-standard.com/http://www.bis.org.in/sf/sfp1.htmCase : Microsoft 1995, David B. Yoffie; Tarun Khanna;

Israel GanotBusiness Competition as a Self-organizing Process:

Toward an Increasing Returns-Based Microeconomic Theory, F. Buendia

Link : www.springerlink.com/index/w231q8784660823q.pdf

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Thank you

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