Competing in Standards Driven Markets

When can you maintain control over the use of an innovation/idea? Strong intellectual property rights First--mover advantages –– Customer lock - in –– Network effects –– Standards Market Power

Diffusion often looks quite different in a market shaped by standards Network externalities of all kinds may create lock in, so that once established, a standard can be very difficult to replaceto replace Lock - in may occur when the technology is still in its infancy e.g. VHS vs. Beta, MS Windows vs. OS/2 In markets in which standards are important, it may be impossible to survive as a small player ––

Outline Definitions Standards & Network effects Switching costs, “lock-in” and tipping Do all markets tip ? Competing in standards driven markets : Establishing a standard Making money Overturning an established standard

Definitions

What is a standard? A standard is a specification that allows for interoperability E.g.: Cup and lids Pistons and engines Telephones and sockets Speakers and amplifiers Hardware and software

Standards and Dominant Designs Dominant design –– “the way we do things,” overall look & feel Standard –– particular interface, format or system Standards or architectures allow for interoperability Not all dominant designs are standards e.g., Henry Ford and the Model T Not all standards are dominant designs… e.g., WebTV …But many successful standards embody dominant designs e.g., Apple’s operating system

An industry without a standard:

An industry with a standard:

What are the pros and cons of standards? Pros Cons Pros Cons

Standards can be “public” or “private” Public standards IP in the standards is publicly owned Often administered by an industry consortium, or by regulation Private standards IP in the standard is contralled and owned by a firm (or group of firms)

Standards can be “open” or “closed” Open standards Details are released to third parties (“complementors”) So that they can develop complementary products, service and technologies Closed standards Used within the firm, but details are not released

Privates standards may be open or closed The technology is : open closed Details of standards are available to all : no single firm has control over how they evolve: no charge for their use E.g. TCP/IP, HTML Standards are owned and controlled by the public sector but are not freely available E.g. Cryptography Public Details of standard are made available to all: but owner has control over how the standard evolves and may charge for use E.g. Nintendo, Palm OS Technology may be standard, but details are not made available beyond the firm E.g. IBM 360 Architecture Private Ownership is :

All options have both advantages and disadvantages The technology is : open closed Public Private Ownership is :

With Strong Network Effects Market Share Itself Creates Value Value to consumer Value of standards Driven product Conventional product Actual (or anticipated) size of the installed base

“Great products” vs. “Architectures” Great Products Architectures Consumers base their purchase decision on the intrinsic value of the product to them What would this be worth to me if I were the only buyer in the world? Competition on the basis of features, price etc Consumers base purchase decisions on the size of the (actual or projected) installed base and/or the (actual or projected) future availability of complementary products and services How many other people are likely to buy this product? Competition on the basis of the size of the installed base, availability of complementary products etc

Standards create value because they create network effects Direct network effects: Network size Value increases with the number of other individuals who own the same product E.g.: Telephones, fax Indirect network effects: Complementary products/services Value increases with the number of complementary products that are available: E.g: CDs, Software, VHS/Beta Modular innovation (plug and play) Value increases with innovation across the system (E.g: stereo systems) Learning by using Standards mean customers only invest once in learning to use the technology: E.g.: Qwerty Keyboard, Autocad

Tipping or Will all markets eventually converge to a single standard?

Tipping Markets “tip” when one standard becomes the Preferred choice of nearly every consumer VHS Windows on the PC Not all markets tip: in some markets multiple Standards co-exist UNIX vs. Windows on servers Nintendo vs. Sony in video games Palm vs. Windows CE in PDAs

With no netword effects, equilibrium Market share tracks consumer perferences A’s share of installed base Cornflakes gets a 30% share 30% of the population Likes cornflakes Probability the next consumer chooses to buy A

If network effects are important, markets may “tip” A’s share of installed base Probability the next consumer chooses to buy A 1

Strong network effects & high switching costs may create “lock in” All consumers might prefer to adopt a different standard If it is expensive to switch between standards, (high Switching costs) and network effects are important and Costly to create, then markets may become “locked in” To particular standards “Lock in” has dramatic competitive implications

Will all markets “tip”? Value to consumer Size of the installed base

Will all markets will tip? A’s share of installed base Probability the next consumer chooses to buy A

Competing in Standards Driven Markets

Competing in standards driven markets Establishing a standard Making money: exploiting a standard Overturning a standard

A Caveat: Standards can destroy value Standards may reduce choice: Any color so long as its black” Standards may reduce the rate of innovation: Innovation is confined to subsystems: no “systemic” change is possible Standards may sustain monopoly rent extraction: “Microsoft is making minor changes in its business model…” (Of a plan to discontinue the practice of charging for the estimated number of employees using a program and replace it with a contract tht charges for every employee)

Thus: The adoption of a standard standard is not inevitable and once established, any particular standard is always under threat

So standards are established by driving the adoption of critical mass... Both adopter types choose A Both adopter types choose B Lock in To B Adoption Rate A leads B leads 0

Standards in action: Sun Sun founded in 1982 to focus on the workstation market “Open” standard: Standard components, UNIX operating system

Sun: Establishing the standard 1980: Apollo founded 1983: Sun has $1m in sales, mostly to universities What should Sun do? 1983: Apollo has $18m in sales, dominates the Workstation market – uses a proprietary operating system Lead customer, computervision “likes the technology But doesn’t find the company credible” – “we love your technology but there is no way you can supply it. Apollo is the standard in the industry, well financed And well managed.”

How are standards established? Standards “win” when a critical mass of consumers have adopted them. When a critical mass of key players believe that the standard will be adopted. OR

Or by: The sheer power of the concept, design or delivery of the product Coming to market ahead of competition Building expectations Very aggressive pricing: “giving the product away” Developing, or encouraging the development of, Complementary products and services

Two main routes to capture value Control – Point competition Level – Ground Competition Benefit directly from ownership from a free or thru a mark-up on products using the standard (e.g., Wintel) Only possible when the standard is privately held. Make money by competing on “level ground” through competing via manufacturing, service, delivery or other capabilities (e.g., Ericsson & Bluetooth) Standard may be public or private.

Positioning a standard requires grappling with this fundamental tension The Technology Is: Ownership is: Open No opportunity for monopoly rents BUT easier to get accepted & may be able to extract rents thru other superior information Open interfaces allows for creation of complements; may also increase acceptance of standard BUT may increase competition Complete monopoly rent extraction BUT all complementary products must be produced by the firm – hard to get accepted. Closed Public Private

Displacing an Established Standard

Displacing an Established standard (Overcoming switching costs) Raise the benefits: Introduce an “insanely great” product Build network effects: Invest in complementary goods & services Build market share Reduce the costs: Make your standard “backwards compatible” Lower the cost of your product

How are standards renewed in the face of incumbents? Step One - Evolution vs. Revolution Evolution Give up some performance to ensure compatibility, thus easing consumer adoption (e.g., Microsoft, Intel) Migrating existing users Revolution Wipe the slate clean and come up with the best product possible (e.g. Nintendo) Gathering new users or innovators who want to own every gadget

How are standards renewed in the face of incumbents? Step Two - Openness vs. Control Openness hastens adoption, signals commitment but Foregoes control of the standard

Generic Renewal Strategies Control Controlled Migration Open Compatible Incompatible Performance Play Open Migration Discontinuity

Take Aways Successful Strategies in Standards-Oriented Markets Are often a “Hard” Sell“ Giving away profits to customers and competitors Profits are in the future — losses are upfront! “Tipping” the Market Key is to create customer value by first building the “right” type of installed base (lead users, encouraging complements, etc…) Ensure Complementary Technologies, Necessary “Software,” and the Potential for Future Competition Debate the Product Development Tradeoffs — Earlier and Oftener