1. Network Externalities and Open Innovation
Supporting Innovation Education Reloaded: Nurturing Skills for the Future. The Open Innovation Teaching Handbook
teaching slides proposed by Carl Kock

2. Network Externalities
Some technologies have a tendency to create a lock-in, i.e. one particular product or technology variant will tend to dominate the whole market.
Similar effects to economies of scale on production side occur on the demand side when the value of a product to a customer increases with the number of other customers who have adopted the same product (increasing returns to adoption).
© Carl Joachim Kock

3. Types of Network Externalities
Direct
if product (network) allows for interconnection of users
Value of network: n(n - 1)
E.g. Phones, fax, etc.
Indirect
If product attributes are strengthened due to increased user base
E.g. Availability of more software for most popular operating system
© Carl Joachim Kock

4. Network Externalities
Help to shape structure of the game – or the industry!
Exist in principle anytime 1 transaction partner is better of because others also do business with firm
Supplier
Sale of product/services
Firm
Sale of product/services
Customer
© Carl Joachim Kock

5. Network Externalities
…but act even more strongly in “Multi-sided Platforms”
Complementor
Supplier
“affiliation” with the MSP
“Sale” or other form of direct interaction
MSP
“affiliation” with the MSP
GOOGLE – EBAY – ITUNES – B2B SITES – FACEBOOK – MICROSOFT
Preferred source of Advantage for High Tech & Internet
Customer
Source: Hagiu, 2009
© Carl Joachim Kock

6. Network Races…
Consider 2 competing technologies, lets call them VHS and Beta – after one reaches a critical share of the market, it basically takes the whole market while the other product disappears…
# customers
sales
Key: market size at maturity!
e.g., iTunes, Internet Explorer
e.g., Napster, Netscape t
© Carl Joachim Kock

7. % of potential customers buy...
The Race…
Brand A
100 % 0%
% of potential customers buy...
Critical share for each brand
Brand B
0 %
100% t
After Arthur, 1994
© Carl Joachim Kock

8. Key logics of NE Identify nature of market
Multiple sides? Which?
Do ‘sides’ have ‘increasing returns’?
Self-reinforcing cycles vs. Chicken & Egg problem
Need to invest/subsidize network!
Define monetization logic
‘bind’ network to you!
Build switching costs for all sides

9. Open Innovation
Innovation = new combination of existing and new resources and knowledge to create new products, services, markets etc. (Alois Schumpeter, 1911)
Do YOU (does your firm) have all the best existing and new resources in-house?
P&G: several thousand R&D scientists in-house vs. >1million in related areas outside… (Dodgson et al. 2006)
So,
Lots of ideas, knowledge etc. located OUTSIDE
Also, lots of ideas WITHIN firms lie dormant
Open Up!
Combine sources & uses of knowledge – sounds familiar?

10. Group Presentation…

11. InnoCentive Typical 2-sided market
Bring together innovation source (inventor) and seeker (firm)
Overcome Arrow- information paradox
How sustainable is the model – will they become a monopoly (network lock-in)?
Innovation seeker
InnoCentive
Innovation source

12. Winner take all? 3 conditions
(Indirect) Network externalities are strong
Why do seekers and sources gain?
Are there Cross-side increasing returns?
Negative cycles?
Innovation seeker
InnoCentive
Innovation source
© Carl Joachim Kock

13. Winner take all? 3 conditions
(Indirect) Network externalities are strong
‘Multi-homing’ costs are high
Switching costs
Inventors?
Firms?
Innovation seeker
InnoCentive
Innovation source
© Carl Joachim Kock

14. Winner take all? 3 conditions
(Indirect) Network externalities are strong
‘Multi-homing’ costs are high
No significant special needs/tastes
Otherwise no lock-in or segment lock-in
Innovation seeker
InnoCentive
Innovation source
© Carl Joachim Kock

15. To sum up… Network Externalities Open Innovation InnoCentive
Powerful and pervasive dynamics that underlie many of today’s most successful business models
Need to understand these dynamics thoroughly to craft effective strategy
Open Innovation
Emergent logic of hypercharging research productivity & prime example of network externalities
Bringing together innovation sources and innovation users creates multi-sided platform & large social value
InnoCentive
provides a platform to involve enough actors to make OI feasible and start self-reonforcing cycle
© Carl Joachim Kock

16. Thank you!
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Innovation Education Reloaded: Nurturing Skills for the Future. The Open Innovation Teaching Handbook
This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.
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