© 2013, published by Flat World Knowledge 6-1 Information Systems: A Manager’s Guide to Harnessing Technology, version 2.0 John Gallaugher

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© 2013, published by Flat World Knowledge Chapter 7 Understanding Network Effects: Strategies for Competing in a Platform-Centric, Winner-Take-All World 6-3

© 2013, published by Flat World Knowledge Section 1 - Learning Objectives 1.Define network effects 2.Recognize products and services that are subject to network effects 3.Understand the factors that add value to products and services subject to network effects 6-4

© 2013, published by Flat World Knowledge Network Effects When the value of a product or service increases as its number of users expands – Referred to as network externalities or Metcalfe’s Law Most products are not subject to network effects Presence of network effects influences the choice of one product or service over another 6-5

© 2013, published by Flat World Knowledge Section 2 - Learning Objectives 1.Identify the three primary sources of value for network effects 2.Recognize factors that contribute to the staying power and complementary benefits of a product or service subject to network effects 3.Understand how firms like Microsoft and Apple each benefit from strong network effects 6-6

© 2013, published by Flat World Knowledge Where’s All That Value Come From? Exchange – Creates value – Every product or service subject to network effects fosters some kind of exchange Staying power: Long-term viability of a product or service – Suggested by networks with greater numbers of users 6-7

© 2013, published by Flat World Knowledge Where’s All That Value Come From? – Switching costs: Consumer incurs when moving from one product to another Directly related to staying power Strengthen the value of network effects as a strategic asset Increases with the higher friction available to prevent users from migrating to a rival – Total cost of ownership (TCO): Economic measure of the full cost of owning a product 6-8

© 2013, published by Flat World Knowledge Where’s All That Value Come From? Complementary benefits: Products or services that add additional value to the primary product or service that makes up a network – Platforms: Allow for the development and integration of software products and other complementary goods 6-9

© 2013, published by Flat World Knowledge Where’s All That Value Come From? Value-adding sources work together to reinforce one another to make network effect even stronger – Each add-on of an iOS product, like the iPod, enhances the value of choosing it over a rival like the Microsoft Zune 6-10

© 2013, published by Flat World Knowledge Section 3 - Learning Objectives 1.Recognize and distinguish between one-sided and two-sided markets 2.Understand same-side and cross-side exchange benefits 6-11

© 2013, published by Flat World Knowledge One-Sided or Two-Sided Markets? 6-12 One-sided market Market that derives most of its value from a single class of users Same-side exchange benefits: Benefits derived by interaction among members of a single class of participant Two-sided market Network markets comprised of two distinct categories of participant Needed to deliver value for the network to work Cross-side exchange benefit: An increase in the number of users on one side of the market

© 2013, published by Flat World Knowledge Section 4 - Learning Objectives 1.Understand how competition in markets where network effects are present differ from competition in traditional markets 2.Understand the reasons why it is so difficult for late- moving, incompatible rivals to compete in markets where a dominant, proprietary standard is present 6-13

© 2013, published by Flat World Knowledge How Are These Markets Different? Network markets experience early, fierce competition – Caused by positive-feedback loop inherent in network effects Firms are aggressive in the early stages because once a leader becomes clear new adopters begin to favor the leading product over rivals – Tips the market in favor of one dominant firm or standard 6-14

© 2013, published by Flat World Knowledge How Are These Markets Different? Markets exhibit monopolistic tendencies – One firm dominates all rivals Monopoly: Market where there are many buyers but only one dominant seller Oligopoly: Market dominated by a small number of powerful sellers 6-15

© 2013, published by Flat World Knowledge Figure 5.1. Battling a Leader with Network Effects is Tough 6-16

© 2013, published by Flat World Knowledge Section 5 - Learning Objectives 1.Plot strategies for competing in markets where network effects are present, both from the perspective of the incumbent firm and the new market entrant 2.Give examples of how firms have leveraged these strategies to compete effectively 6-17

© 2013, published by Flat World Knowledge Strategies for Competing in Markets with Network Effects Move early – Yahoo! Auctions in Japan Subsidize product adoption – PayPal Leverage viral promotion – Skype; Facebook feeds Expand by redefining the market to bring in new categories of users or through convergence – iPhone and Nintendo Wii 6-18

© 2013, published by Flat World Knowledge Strategies for Competing in Markets with Network Effects – Convergence: When two or more markets, once considered distinctly separate, begin to offer features and capabilities – Envelopment: When one market attempts to conquer a new market by making it a subset, component, or feature of its primary offering Form alliances and partnerships – NYCE vs. Citibank 6-19

© 2013, published by Flat World Knowledge Strategies for Competing in Markets with Network Effects Establish distribution channels – Java with Netscape – Microsoft bundling Media Player with Windows Seed the market with complements – Blu-ray – Nintendo Encourage the development of complementary goods – Facebook fbFund 6-20

© 2013, published by Flat World Knowledge Strategies for Competing in Markets with Network Effects Maintain backward compatibility – Apple’s Mac OS X Rosetta translation software for PowerPC to Intel – Backward compatibility: Ability to take advantage of complementary products developed for a prior generation of technology – Adaptor: Product that allows a firm to tap into the complementary products, data, or user base of another product or service 6-21

© 2013, published by Flat World Knowledge Strategies for Competing in Markets with Network Effects Rivals - Be compatible with larger networks – Apple’s move to Intel Incumbents - Close off rival access and constantly innovate – Apple’s efforts to block access to its own systems Large firms with well-known followers - Make preannouncements – Microsoft 6-22

© 2013, published by Flat World Knowledge Strategies for Competing in Markets with Network Effects – The Osborne Effect: Firm experiencing a sharp and detrimental drop in the sales of current offerings due to its preannounces of forthcoming products – Congestion effects: Increasing numbers of users to lower the value of a product or service 6-23