Copyright © 2011 by Professor D. J. Lee, Kyung Hee Univ. All rights reserved. Chapter 4 Standards Battles and Design Dominance

4-2 Please watch the video-clip! Prologue 1: VHS and Betamax - A dominant design in VCR industry

4-3 Prologue 2: Blu-Ray versus HD-DVD - A Standards Battle in High-Definition Video Please watch the video-clip!

4-4 1.Why do most industries adopt a dominant design? 2.What are the benefits and demerits of being a dominant design? 3.Why a particular firms’ technology is adopted as the dominant design? 4.How can a firm win the standard battle to possess design dominance? Questions

4-5 Overview Many industries experience strong pressure to select a single (or few) dominant design(s). There are multiple dimensions shaping which technology rises to the position of the dominant design. Firm strategies can influence several of these dimensions, enhancing the likelihood of their technologies rising to dominance.

4-6 Concept of dominant design Dominant Design: the one that wins the market competition, the one that competitors and innovators must adhere to if they hope to command significant market following (Ex. IBM- PC in personal computer market, DOS and Windows OS in operating system)

4-7 Standard Battle

4-8 Why Dominant Designs Are Selected Why do many markets come together a single dominant design rather than supporting a variety of technological options? Increasing returns to adoption When a technology becomes more valuable the more it is adopted. Two primary sources are learning effects and network externalities.

4-9 Why Dominant Designs Are Selected Learning Effects - evidence shows that the more a technology is used the more developed, effective and efficient it becomes. Learning effects have been demonstrated in a wide variety of industries including automobiles, ships, semiconductors, pharmaceuticals, and even heart surgery Learning curves represent the cumulative impact of learning on production costs and productivity. Organizational learning scholars typically model the learning curve as a function of cumulative output: performance increases, or cost decreases, with the number of units of production.

4-10 Why Dominant Designs Are Selected

4-11 Why Dominant Designs Are Selected Network Externalities In markets with network externalities, the benefit from using a good increases with the number of other users of the same good. Network externalities are common in industries that are physically networked E.g., railroads, telecommunications Network externalities also arise when compatibility(exchanging computer files) or complementary goods (movies for a VCR, film for cameras) are important E.g., Many people choose to use Windows in order to maximize the number of people their files are compatible with, and the range of software applications they can use.

4-12 Why Dominant Designs Are Selected A technology with a large installed base attracts developers of complementary goods; a technology with a wide range of complementary goods attracts users, increasing the installed base. A self-reinforcing cycle ensues:

4-13 The Rise of Microsoft In 1980, Microsoft didn’t even have a personal computer (PC) operating system – the dominant operating system was CP/M. However, in IBM’s rush to bring a PC to market, they turned to Microsoft for an operating system and Microsoft produced a clone of CP/M called “MS DOS.” The success of the IBM PCs (and clones of IBM PCs) resulted in the rapid spread of MS DOS, and an even more rapid proliferation of software applications designed to run on MS DOS. Microsoft’s Windows was later bundled with (and eventually replaced) MS DOS. Had Gary Kildall signed with IBM, or had other companies not been able to clone the IBM PC, the software industry might look very different today! Theory In Action

4-14 Why Dominant Designs Are Selected Government Regulation Sometimes the consumer welfare benefits of having a single dominant design prompts government organizations to intervene, imposing a standard. E.g., the NTSC color standard in television broadcasting in the U.S.; the CDMA standard for mobile communications in Korea. The Result: Winner-Take-All Markets Natural monopolies Firms supporting winning technologies earn huge rewards; others may be locked out.

4-15 Why Dominant Designs Are Selected Winner-Take-All Markets Natural monopolies Firms supporting winning technologies earn huge rewards; others may be locked out. The winning firm enjoys high returns and is well positioned to affect the development trajectory of the technology thereby further enhancing its dominant position in the industry. Losing firms, not only have to play catch up after they adopt the dominant design they also lose the capital, learning and brand equity invested in their original technology.

4-16 Why Dominant Designs Are Selected The influence of a dominant design can be far reaching. Dominant designs affect knowledge accumulation after their adoption primarily because firms have a tendency to build on their existing knowledge base rather than build new ones. This means that a dominant design will influence the technological discontinuity that will replace it. Winner-take-all markets can have very different competitive dynamics than other markets. Technologically superior products do not always win. Such markets require different firm strategies for success than markets with less pressure for a single dominant design.

4-17 Multiple Dimensions of Value In many increasing returns industries, the value of a technology is strongly influenced by both: Technology’s Standalone Value Network Externality Value A Technology’s Stand-alone Value Includes such factors as: The functions the technology enables customers to perform Its aesthetic qualities Its ease of use, etc.

4-18 Multiple Dimensions of Value Network Externality Value Includes the value created by: The size of the technology’s installed base The availability of complementary goods A new technology that has significantly more standalone functionality than the incumbent technology may offer less overall value because it has a smaller installed base or poor availability of complementary goods. E.g., NeXT Computers were extremely advanced technologically, but could not compete with the installed base value and complementary good value of Windows-based personal computers.

4-19 Multiple Dimensions of Value To successfully overthrow an existing dominant technology, new technology often must either offer: Dramatic technological improvement (e.g., in videogame consoles, it has taken 3X performance of incumbent) Compatibility with existing installed base and complements

4-20 Multiple Dimensions of Value Subjective information (perceptions and expectations) can matter as much as objective information (actual numbers) Value attributed to each dimension may be disproportional

4-21 Competing for Design Dominance in Markets with Network Externalities We can graph the value a technology offers in both standalone value and network externality value: Multiple Dimensions of Value Value to Users Installed Base Tech. Value Value accrued from network externalities Value accrued from network externalities + Technology utility Installed Base Value to Users

4-22 Multiple Dimensions of Value We can compare the graphs of two competing technologies, and identify cumulative market share levels (installed base) that determine which technology yields more value.

4-23 Multiple Dimensions of Value When customer requirements for network externality value are satiated at lower levels of market share, more than one dominant design may thrive.

4-24 Winning the standard or dominant design Improved chance of winning standard or dominant design Chance Capabilities Size Reputation Installed base Strategy Alliance Free giveaways Scale Environment Standards bodies Government policies Related industries

4-25 Winning the standard or dominant design Combined Effect It is important to note that although we have listed these factors separately, more often than not it is a combination of them that helps a firm’s chances of winning a standard.