MD240 - Management Information Systems Oct. 25, 2005 Network Externalities: The Kingmaker of Tech Industry Competition

Topics Covered Network Externalities –Defined, Strategic Importance, Examples Operating Systems & Hardware Markets –Competition Among Operating Systems and Computing Platforms –The Linux Challenge –Dell vs. the World –The Video Game Industry: Xbox Reloaded & strategies for competing with new platforms

Network Externalities (a.k.a. Network Effects, Metcalfe’s Law) A product or service becomes more valuable as its installed base expands Why do consumers care about installed base? –Exchange opportunities –Stability –Extrinsic, complementary benefits More Exchange Opportunities More Members

Why are Markets for Network Goods Different? Market competition occurs very early and is particularly fierce Markets are ‘tippy’ and subject to bandwagons Markets exhibit monopolistic tendencies The ‘best’ technology or highest quality product doesn’t always win

Software Operating Systems control hardware and provide an environment in which applications execute Application Programs end-user program that performs a specific function Individual examples: word processor, spreadsheet. Collections of apps: Office (suite), SAP R/3 (ERP) Applets small application programs which execute within a larger environment (e.g. Java applets within browser) operating system applications

Competition in the OS Space Personal Computers Windows XP Apple Mutli-User Systems Windows 2000 Windows Server 2003 Unix (Sun, IBM, HP / Compaq) Linux Consumer Devices Windows Mobile Ultimate TV Xbox Tablet PC Windows XP Media Center Edition Palm (handheld) Liberate (set top) Sony Linux Microsoft Competition

A Growth Stock No More?

The Microsoft Stimulus Package In ’04 Microsoft returned $9 billion to individual investors that hold the stock (excluding all the institutions & funds). The Bush child tax credit returned $14 billion. Bill Gates has pledged all $3.4 billion to his charitable foundation.

Comments from Windows Source Code private\genx\shell\inc\prsht.w: // we are such morons. Wiz97 underwent a redesign between IE4 and IE5 private\shell\ext\ftp\ftpdrop.cpp: // We have to do this only because Exchange is a moron. private\shell\shdoc401\unicpp\desktop.cpp: // We are morons. We changed the IDeskTray interface between IE4 private\shell\browseui\itbar.cpp: // should be fixed in the apps themselves. Morons!.

Fear the Penguin? Server MarketDesktop Market

16 Bit Game Consoles Source: Schilling 2003

32/64 Bit Game Consoles (failed) Source: Schilling 2003

32/64 Bit Game Consoles Source: Schilling 2003

128 Bit Game Consoles Source: Schilling 2003

Components of Consumer Value for Network Goods Technological Functionality Installed base (exchange) Complementary Goods Availability (extrinsic benefits) Panel A Incumbent product Switching Costs (stability) Panel B New entrant, compatible with existing installed base and complementary goods Switching Costs (stability) Technological Functionality Installed base (exchange) Complementary Goods Availability (extrinsic benefits) Compatible technologies can tap into the same installed base and complementary products as the incumbent. This dramatically lowers (or eliminates) switching costs, leaving the products to compete on technical functionality.

Components of Consumer Value for Network Goods Technological Functionality Installed base (exchange) Complementary Goods Availability (extrinsic benefits) Switching Costs (stability) Panel A Incumbent product Panel C New, incompatible entrant Technological Functionality Radical innovation may be necessary if an incompatible technology is to overthrow an established standard. The technical benefits of the new innovation must exceed the exchange, extrinsic, and stability benefits of the incumbent.

Competing in a Standards Battle Tactics for New Entrants Complementary Products –Develop own complementary goods –Develop through third-parties (subsidize, exclusives) Attract Consumers –lower price, subsidize adopters, money back guarantee, free trial Distributors –Subsidies / guarantees (consoles on consignment) –Alliances (Sun & Netscape to distribute Java) Tactics for Incumbents Continuous innovation within the standard –Create a moving target Backward compatibility –Problem with Intel Itanium Create Switching Costs –Exclusive products –iTunes –AIM Signaling can be used by both: Pre-announcements, credible commitments (Xbox=$500 million marketing budget, 3DO = $37 million)