“The Art of Standard Wars” Carl Shapiro & Hal R. Varian (1999) California Management Review, 41(2), winter, 8-32 Summarized by Prof. Lee Woonghee School of Business Hanyang University

Please visit the authors’ homepage and find more about the authors and their excellent work!!!  Shapiro:  Varian: Historical Examples of Standard War  We can learn from history Standard war in railroad gauges  By 1860, seven different railroad gauges were in use in America  North vs. South in railroad gauge − North 4 8 ½ standard, South 5 gauge  Standardization was gradually achieved… How? − In moving Western grain to east, 4 8 ½ standard was adopted − During the civil war, Union army had influence on adopting the standard line − Finally, Congress specified the standard gauge and the Southern states seceded

Edison vs Westinghouse in Electric Power  Edison promoted DC (Direct Current) system − One mile limit between the generating station and the user, but was more efficient in generating power − Had first mover advantage  George Westinghouse developed AC (Alternating Current) technology − More useful in small towns  Edison’s attact on AC − Infringement action against Westinghouse − Asserted that AC was unsafe  Went so far as patent the electric chair using AC  Demonstrated the electric chair using AC to electrocute a large dog  Three factors ended the “Battle of the Systems” − Advances in Polyphase AC ( 다상전류 ) made it clear that AC was superior − Introduction of rotary converter allowed DC to be integrated into AC system − By 1890, Edison sold his interest, leading to formation of GE, which was no longer a DC only company

RCA vs. CBS in color TV  In 1940s, RCA (the owner of NBC) was leading in black and white TV − But, Bell lab demonstrated the possibility of color TV  CBS began pushing mechanical color TV system − RCA was busy selling B&W TV sets, improving on its existing technology − It also worked on its own all-electronic color TV system − As CBS took the lead in color TV performance, RCA urged the FCC to wait for an electronic system.  Weakness of CBS system : Not backward-compatible!! − Not able to receive existing black and white broadcasts without a special attachment  But FCC adopted the CBS system in 1950 − RCA system was just not ready − A political triumph for CBS

 RCA’s counter-attack − RCA continue to criticize the CBS system to slow its adoption − RCA intensified its efforts to place B&W sets ti build up an installed base of users whose equipment would be incompatible with CBS − RCA intensified its R&D on its color TV system  Weakness of CBS − CBS had no manufacturing facility at that time, and had no allies to solve this problem − Only a few could receive CBS color broadcasting − The role of luck: Korean war broke out and production of color TV was banned  Emergence of RCA system − After the ban was removed, the RCA system was ready − NTSC (National Television System Committee) supported RCA system − CBS system still had backward compatibility problem − FCC finally reversed its decision and adopted RCS as standard in 1953

 However, political victory did not lead to success so easily − In 1954, RCA predicted it would sell 75,000 color TV sets, but actually sold only 5,000 sets − Why?  $1,000 for 12 ½ color TV vs. $300 for 21 B&W TV  Not many color programs were available!! (Complementors are important!!)  By 1963, only 3% of TV household had color TVs  By 1959, RCA spent $130M to develop color TV with no profit − The Content was missing  The killer app arrived in 1960s: “Walt Disney’s Wonderful World of Color”

Lessons from old standard wars  Network markets tend to tip towards the leading player − Railroad example  First mover advantage can be overcome by superior tech. − AC vs. DC  Building alliance is needed to win − NTSC in color TV system  Backward compatibility is important − The case of CBS  Adapters can be the salvation of the losing technology − Rotary converter for DC  A large buyer can have more influence than suppliers − eg. US government in railroad war  Customer expectations can easily become self-fulfilling in standards battles − That’s why Edison fought hard to convince consumers that DC was safer

Not all technology should go through standard war  Sony vs. Philips in CD − They pooled together and openly licensed their CD patents to establish their new CD technology Three possible results of Standard War  Truce − Color TV, 56k modem − Common standard are adopted  Duopoly − Video game (Nintendo vs. Sony),  Fight to the death − Railroad gauges, DC vs. AC, VHS vs. Betamax − Usually involves positive feedback based on strong network effects

Classification of Standard War  Based on compatibility with old technology Compatible Incompatible Compatible Incompatible Your Technology Rival Technology Rival Evolutions (DVD vs. Divx) Evolution vs. Revolution (Color TV) Revolution vs. Evolution Rival Revolution (Nintendo vs. Sony, AC vs. DC)

7 Key Assets in Network Markets  Control over installed base of users − MS has a large base of locked in customers − Evolution strategy offering backward compatibility is effective  Intellectual property rights − Qualcomm’s primary asset was its patent portfolio  Ability to innovate − HP’s engineering skills are legendary in Silicon Valley  HP tend to compromise on standards and out-engineer their competition  First-mover advantage − Take advantage of learning curve  Manufacturing capabilities − Low cost producer can survive on any standard − HP, Compaq, Dell

 Strength in complements − Intel’s CPU and other PC components  Brand name and reputation − Where expectations are important, brand name and reputation are pivotal − You have to convince consumers that you will win − Marketing is important!!! On Preemption  Two types of positive feedback − Learning curve (Supply side: lower cost) − Network externality (Demand side: provide more value)

 Just be the first to market − Need strong R&D skills  Use penetration pricing − Useful in building an installed base − Sometimes, “pay” customers to use the product (“Negative Pricing”)  Some cable programmers “pay” cable operators to distribut their programming  Netscape paid OEMs to load it on new PCs Expectation Management  Utilize Vaperware − Announce upcoming product so as to freeze your rival’s sales − May get involved in antitrust issues  But it is difficult to distinguish between “predatory product pre- announcement” and simply being late bringing a product to market − More effective when allies support behind the announcement

Once you’ve won (what’s your defensive strategy?)  Staying on your guard − Keep looking for next generation technology − Watch out for the revolutionary strategy against you  Apple pioneered PDA, but U.S. Robotics perfected the idea with Palm Pilot − There is hazards of moving early and lacking flexibility  Milking installed base can be fruitful, but can also increase switching cost − Need flexible migration path  Offer customers a migration path − To fend off any revolutionary strategy, anticipate the next generation tech and co-opt it − “Embrace and Extend” strategy − Offer free or inexpensive upgrades to your existing installed base  MS window

 Commoditize complementary products − You should try to maintain a competitive market in complementary products − Avoid the temptation to meddle  MS attempt to buy Intuit blocked by the Department of Justice  Competing against your own installed base − One answer: drive innovation ever faster − The problem of competing one’s own installed based was explored among some economists  Dilemma of durable goods monopoly  They tend to offer lower price to increase sales  When this is done regularly, consumers expect them and wait − One solution is renting the product rather than selling it  Protecting your position − Vulnerable to antitrust regulations

 Leveraging your installed base − Diversification, vertical integration to adjacent areas − Should be pursued with caution  Avoid antitrust issues  Need true synergy − Geographic expansion is a good idea  Staying a leader − Use an openness approach while keeping tight control over the critical technology and its extentions  If you know how the tech may evolve, use this informational advantage to preserve important future rights − (ex) IBM’s failure to preserve its advantage  IBM set first standard in MGA CGA VGA (1987) It began to lose its control to SVGA (1988) Then it completely lost control with the arrival of VESA interface

− How can you keep this informational advantage?  At Cisco, “we don’t do research, - we buy research!” Rear-Guard Actions: What happens if you fall behind?  Adapters and Interconnection − Add adapters or interconnect with the larger network (winner) − But you need intellectual property rights to add adapter  Atari lacked it to include an adapter in their machines to play Nintendo cartridges (because of Nintendo’s lock-out chip) − Converting files is an example of adapter  MS word file vs. MordPerfect files − The biggest problem is “performance degradation”  Digital’s Alpha chip far superior to Intel chips  Digital offered an emulator (=adapter) to let its Alpha chip run like an Intel chip, but performance advantages were gone

 Survival pricing − Survival pricing is unlikely to work  “Simple Money” offered at $6.95 but Quicken and Money dominated the market  This is because of high switching cost  Legal Approaches − If all else fails, sue!!!!