Today’s class 6. Technological competition 6.1 Management of innovation 6.2 Network effects and standards/IM takeaways

IM update since early /05: Google introduces Google Talk; stated goal is interoperability using open standard (Jabber) 08/05: Google introduces Google Talk; stated goal is interoperability using open standard (Jabber) Agreements to get systems to work together: Agreements to get systems to work together: –Yahoo and Microsoft since 09/06 (announced 10/05) –Google and AIM: announced 12/05 following Google’s 5% investment in AOL, not yet implemented –12/06: IBM Lotus Sametime can chat with AIM, Google Talk Market shares (users) in August 2005: AOL 52%, Yahoo 24%, MSN 18%, Other 6% Market shares (users) in August 2005: AOL 52%, Yahoo 24%, MSN 18%, Other 6% Enterprise IM market largely separate & growing Enterprise IM market largely separate & growing

Network effects When value for buyer increases with number of others who use the same product or standard. Distinguish When value for buyer increases with number of others who use the same product or standard. Distinguish 1.Direct: ability to use the product, e.g. IM 2.Indirect: through supply of complementary products, e.g. computer OS & applications software, videos, DVDs As installed base of users grows, value to new buyers increases. As installed base of users grows, value to new buyers increases. With strong enough network effects, tendency towards one standard: “tipping” of market With strong enough network effects, tendency towards one standard: “tipping” of market –Limited opportunities for niche players, e.g. Apple in computers

How strong are the network effects? How strong are forces toward standardization? How strong are forces toward standardization? –How much do consumers have to invest? Compare IM, DVDs, Word Compare IM, DVDs, Word –How strong are direct network effects? E.g. Word processing –Indirect effects: how costly is it for producers of complementary good/service to support different standards? Compare DVDs (hardware vs. studios, retail/rental), digital camera memory cards (stores) Compare DVDs (hardware vs. studios, retail/rental), digital camera memory cards (stores) Difficult to tell if use of product is unknown in advance Difficult to tell if use of product is unknown in advance –E.g. VCRs: time-shift viewing or movie rentals?

The best of all worlds: owning the standard Best example: Wintel Best example: Wintel Bill Gates in 1995: “We look for opportunities with externalities – where there are advantages to the vast majority of consumers to share a common standard. We look for businesses where we can garner large market shares, not just 30-35%” Bill Gates in 1995: “We look for opportunities with externalities – where there are advantages to the vast majority of consumers to share a common standard. We look for businesses where we can garner large market shares, not just 30-35%” Otherwise, three basic options: Otherwise, three basic options:

1. Agree with others on a standard Standard-setting bodies, mutual agreements: DVDs in mid-90s Standard-setting bodies, mutual agreements: DVDs in mid-90s Key questions: How will you make money? What advantage do you have? Key questions: How will you make money? What advantage do you have? Firms with small market shares much more likely to push for standard: Microsoft, Yahoo vs. AOL Firms with small market shares much more likely to push for standard: Microsoft, Yahoo vs. AOL Even if both sides want standard because pie bigger: hard to agree on how to divide pie Even if both sides want standard because pie bigger: hard to agree on how to divide pie

2. License your standard to others Or “open standard”: Jabber in IM, IBM in PCs Or “open standard”: Jabber in IM, IBM in PCs Advantage: higher probability of acceptance by market Advantage: higher probability of acceptance by market Problem: you may create your own competition. How will you make money? Problem: you may create your own competition. How will you make money? Example: Philips’ introduction of CDs in early 1980s Example: Philips’ introduction of CDs in early 1980s –No or small advantage in player production or CD pressing –Probably made most of its money through royalties

3. Go alone Multiple standards can coexist if network effects weak Multiple standards can coexist if network effects weak –IM, music downloads –Big difference for Apple between Mac and iPod/iTunes Problem: Problem: –Hard to tell in advance how strong network effects will be –Consumers don’t want to be stranded with loser technology Even more reluctant when a better version of existing technology arrives, e.g. new-generation DVDs Even more reluctant when a better version of existing technology arrives, e.g. new-generation DVDs Very difficult if complementary product (e.g. software) will be provided by other firms Very difficult if complementary product (e.g. software) will be provided by other firms –Difference between Sony in DVDs and Apple in music

“War of attrition” Situation in which two or more parties struggle until all but one quit, concede, run out of money, or die Situation in which two or more parties struggle until all but one quit, concede, run out of money, or die –Like the $20 auction –Idea introduced by evolutionary biologist John Maynard Smith (1974): animals fighting for prey In business, occurs when two firms/standards fight for market where only one fits In business, occurs when two firms/standards fight for market where only one fits –Markets with large EOS (natural monopolies) –Markets with strong network effects

Logic of the war of attrition War continues as long as expected value of winning ≥ costs of continuing fight War continues as long as expected value of winning ≥ costs of continuing fight Even if past losses large, fighting continues because costs are sunk Even if past losses large, fighting continues because costs are sunk Uncertainty essential: no point in wasting money if eventual winner is known Uncertainty essential: no point in wasting money if eventual winner is known –If A has committed to stay in, it’s best for B to quit, and vice versa –Problem: commitment is difficult. What costs are truly sunk, what decisions truly irreversible? While fighting continues, each tries to influence rivals’ and customers’ perceptions about who will win While fighting continues, each tries to influence rivals’ and customers’ perceptions about who will win

Tactics in standards wars Be first! AOL in IM Be first! AOL in IM Penetration pricing: low/zero introductory price Penetration pricing: low/zero introductory price –IM, Netscape, Adobe, cell phones Leverage existing installed base Leverage existing installed base –AOL, Yahoo: ISP users; Microsoft: integration with OS Expectations management Expectations management –Public statements about commitment, financial strength, superiority of product, new complementors on board, etc. –Spread fear, uncertainty, doubt about rivals: Microsoft vs. AIM

Classic example of war of attrition: U.K. Satellite TV market in late 80s 1986: British Satellite Broadcasting obtains license to start satellite TV in : British Satellite Broadcasting obtains license to start satellite TV in : Rupert Murdoch announces entry of Sky Television 1988: Rupert Murdoch announces entry of Sky Television High sunk/fixed costs => only room for one firm High sunk/fixed costs => only room for one firm Before and after start of service: Before and after start of service: –Advertising/PR campaigns to persuade buyers –Escalation of bids on film rights (high sunk costs) –Frantic efforts to sell dishes, to lock in buyers and build installed base Actual entry dates: Sky in February ‘89, BSB in April ’90 Actual entry dates: Sky in February ‘89, BSB in April ’90 Demand well below expectations due to buyer reluctance Demand well below expectations due to buyer reluctance 10/1990: Sky loses £2M/week, BSB £6-7M/week 10/1990: Sky loses £2M/week, BSB £6-7M/week 11/1990 Both merge to form BSkyB; before collectively lost £1.25B 11/1990 Both merge to form BSkyB; before collectively lost £1.25B