Today’s classToday’s class

6. Technological competition6. Technological competition6.1 Management of innovation6.1 Management of innovation

6.2 Network effects and standards/IM takeaways6.2 Network effects and standards/IM takeaways

IM update since early 2005IM update since early 2005

08/05: Google introduces Google Talk; stated goal is 08/05: Google introduces Google Talk; stated goal is

interoperability using open standard (Jabber)interoperability using open standard (Jabber) Agreements to get systems to work together:Agreements to get systems to work together:

– Yahoo and Microsoft since 09/06 (announced 10/05)Yahoo and Microsoft since 09/06 (announced 10/05)

– Google and AIM: announced 12/05 following Google’s 5% Google and AIM: announced 12/05 following Google’s 5%

investment in AOL, not yet implementedinvestment in AOL, not yet implemented

– 12/06: IBM Lotus Sametime can chat with AIM, Google Talk 12/06: IBM Lotus Sametime can chat with AIM, Google Talk

Market shares (users) in August 2005: AOL 52%, Market shares (users) in August 2005: AOL 52%,

Yahoo 24%, MSN 18%, Other 6%Yahoo 24%, MSN 18%, Other 6% Enterprise IM market largely separate & growing Enterprise IM market largely separate & growing

Network effectsNetwork effects

When value for buyer increases with number of others When value for buyer increases with number of others

who use the same product or standard. Distinguishwho use the same product or standard. Distinguish1.1. Direct: ability to use the product, e.g. IMDirect: ability to use the product, e.g. IM

2.2. Indirect: through supply of complementary products, e.g. Indirect: through supply of complementary products, e.g.

computer OS & applications software, videos, DVDscomputer OS & applications software, videos, DVDs As As installed baseinstalled base of users grows, value to new buyers of users grows, value to new buyers

increases. increases. With strong enough network effects, tendency towards With strong enough network effects, tendency towards

one standard: “tipping” of marketone standard: “tipping” of market– Limited opportunities for niche players, e.g. Apple in Limited opportunities for niche players, e.g. Apple in

computerscomputers

How strong are the network How strong are the network effects?effects?

How strong are forces toward standardization?How strong are forces toward standardization?– How much do consumers have to invest? How much do consumers have to invest?

Compare IM, DVDs, WordCompare IM, DVDs, Word

– How strong are direct network effects? E.g. Word processingHow strong are direct network effects? E.g. Word processing

– Indirect effects: how costly is it for producers of complementary Indirect effects: how costly is it for producers of complementary

good/service to support different standards?good/service to support different standards? Compare DVDs (hardware vs. studios, retail/rental), digital camera Compare DVDs (hardware vs. studios, retail/rental), digital camera

memory cards (stores)memory cards (stores)

Difficult to tell if use of product is unknown in advanceDifficult to tell if use of product is unknown in advance– E.g. VCRs: time-shift viewing or movie rentals?E.g. VCRs: time-shift viewing or movie rentals?

The best of all worlds: The best of all worlds: owningowning the the standardstandard

Best example: WintelBest example: Wintel Bill Gates in 1995: “We look for opportunities with Bill Gates in 1995: “We look for opportunities with

externalities – where there are advantages to the vast externalities – where there are advantages to the vast

majority of consumers to share a common standard. majority of consumers to share a common standard.

We look for businesses where we can garner large We look for businesses where we can garner large

market shares, not just 30-35%”market shares, not just 30-35%” Otherwise, three basic options:Otherwise, three basic options:

1. Agree with others on a standard 1. Agree with others on a standard

Standard-setting bodies, mutual agreements: DVDs in Standard-setting bodies, mutual agreements: DVDs in

mid-90smid-90s Key questions: How will you make money? What Key questions: How will you make money? What

advantage do you have?advantage do you have? Firms with small market shares much more likely to Firms with small market shares much more likely to

push for standard: Microsoft, Yahoo vs. AOLpush for standard: Microsoft, Yahoo vs. AOL Even if both sides want standard because pie bigger: Even if both sides want standard because pie bigger:

hard to agree on how to divide piehard to agree on how to divide pie

2. License your standard to others2. License your standard to others

Or “open standard”: Jabber in IM, IBM in PCsOr “open standard”: Jabber in IM, IBM in PCs Advantage: higher probability of acceptance by marketAdvantage: higher probability of acceptance by market Problem: you may create your own competition. How Problem: you may create your own competition. How

will you make money?will you make money? Example: Philips’ introduction of CDs in early 1980sExample: Philips’ introduction of CDs in early 1980s

– No or small advantage in player production or CD pressingNo or small advantage in player production or CD pressing

– Probably made most of its money through royaltiesProbably made most of its money through royalties

3. Go alone3. Go alone

Multiple standards can coexist if network effects weakMultiple standards can coexist if network effects weak– IM, music downloadsIM, music downloads– Big difference for Apple between Mac and iPod/iTunesBig difference for Apple between Mac and iPod/iTunes

Problem:Problem:– Hard to tell in advance how strong network effects will beHard to tell in advance how strong network effects will be– Consumers don’t want to be stranded with loser technology Consumers don’t want to be stranded with loser technology

Even more reluctant when a better version of Even more reluctant when a better version of existingexisting

technology arrives, e.g. new-generation DVDstechnology arrives, e.g. new-generation DVDs Very difficult if complementary product (e.g. software) Very difficult if complementary product (e.g. software)

will be provided by other firmswill be provided by other firms– Difference between Sony in DVDs and Apple in musicDifference between Sony in DVDs and Apple in music

““War of attrition” War of attrition”

Situation in which two or more parties struggle until all Situation in which two or more parties struggle until all

but one quit, concede, run out of money, or diebut one quit, concede, run out of money, or die– Like the $20 auctionLike the $20 auction

– Idea introduced by evolutionary biologist John Maynard Smith Idea introduced by evolutionary biologist John Maynard Smith

(1974): animals fighting for prey(1974): animals fighting for prey

In business, occurs when two firms/standards fight for In business, occurs when two firms/standards fight for

market where only one fitsmarket where only one fits– Markets with large EOS (natural monopolies)Markets with large EOS (natural monopolies)

– Markets with strong network effectsMarkets with strong network effects

Logic of the war of attritionLogic of the war of attrition

War continues as long as expected value of winning War continues as long as expected value of winning ≥ ≥ costs of costs of

continuingcontinuing fight fight Even if past losses large, fighting continues because costs are Even if past losses large, fighting continues because costs are

sunksunk Uncertainty essential: no point in wasting money if eventual winner Uncertainty essential: no point in wasting money if eventual winner

is knownis known– If A has committed to stay in, it’s best for B to quit, and vice versaIf A has committed to stay in, it’s best for B to quit, and vice versa

– Problem: commitment is difficult. What costs are truly sunk, what Problem: commitment is difficult. What costs are truly sunk, what

decisions truly irreversible?decisions truly irreversible? While fighting continues, each tries to influence rivals’ and While fighting continues, each tries to influence rivals’ and

customers’ perceptions about who will wincustomers’ perceptions about who will win

Tactics in standards warsTactics in standards wars

Be first! AOL in IMBe first! AOL in IM Penetration pricing: low/zero introductory pricePenetration pricing: low/zero introductory price

– IM, Netscape, Adobe, cell phonesIM, Netscape, Adobe, cell phones

Leverage existing installed baseLeverage existing installed base– AOL, Yahoo: ISP users; Microsoft: integration with OSAOL, Yahoo: ISP users; Microsoft: integration with OS

Expectations managementExpectations management– Public statements about commitment, financial strength, Public statements about commitment, financial strength,

superiority of product, new complementors on board, etc.superiority of product, new complementors on board, etc.

– Spread fear, uncertainty, doubt about rivals: Microsoft vs. AIMSpread fear, uncertainty, doubt about rivals: Microsoft vs. AIM

Classic example of war of attrition: Classic example of war of attrition: U.K. Satellite TV market in late 80sU.K. Satellite TV market in late 80s

1986: 1986: British Satellite BroadcastingBritish Satellite Broadcasting obtains license to start satellite obtains license to start satellite

TV in 1989TV in 1989 1988: Rupert Murdoch announces entry of 1988: Rupert Murdoch announces entry of Sky TelevisionSky Television High sunk/fixed costs => only room for one firmHigh sunk/fixed costs => only room for one firm Before and after start of service:Before and after start of service:

– Advertising/PR campaigns to persuade buyersAdvertising/PR campaigns to persuade buyers– Escalation of bids on film rights (high sunk costs)Escalation of bids on film rights (high sunk costs)– Frantic efforts to sell dishes, to lock in buyers and build installed baseFrantic efforts to sell dishes, to lock in buyers and build installed base

Actual entry dates: Sky in February ‘89, BSB in April ’90Actual entry dates: Sky in February ‘89, BSB in April ’90 Demand well below expectations due to buyer reluctanceDemand well below expectations due to buyer reluctance 10/1990: Sky loses 10/1990: Sky loses ££2M/week, BSB 2M/week, BSB ££6-7M/week6-7M/week 11/1990 Both merge to form BSkyB; before collectively lost 11/1990 Both merge to form BSkyB; before collectively lost ££1.25B 1.25B