1. Carl Shapiro Hal R. Varian
Information Rules: A STRATEGIC GUIDE TO THE NETWORK ECONOMY Networks and Positive Feedback
Carl Shapiro
Hal R. Varian
Modified by Ekaterina Shurkova and Gaurav Gupta

2. Important Ideas Positive feedback Network effects Economies of scale
Demand side
Supply side

3. Network Effects Real networks Virtual networks Number of users
Adds value
Metcalfe’s Law: Value of network of size n proportional to n2
Example: fax machine, Playstation Users

4. Positive Feedback Strong get stronger, weak get weaker
Negative feedback
Makes a market “tippy”
Example: VHS v. Beta
“Winner take all markets”

5. “Winner take all markets”- Positive Feedback
100
Winner
Market Share (percent) 50
Battle Zone
Loser
Time

6. Positive Feedback (Example)
Atari ↔ Nintendo

7. Adoption Dynamics
Saturation
Takeoff
Number of users
Launch
Time

8. Adoption Dynamics (Examples)
Biological world;
Fax machine; ;
The Internet;

9. Sources of Positive Feedback
Supply side economies of scale
Declining average cost
Marginal cost less than average cost
Example: information goods

10. Sources of Positive Feedback
Demand side economies of scale
Based on number of users
Does Not dissipate when the market grows
Adds more value
Example : MS Word

11. Popularity adds value in a Network industry
Virtuous cycle
Vicious
cycle
Value to user
Number of compatible users

12. Lock-In and Switching Costs
Network effects lead to substantial collective switching costs
Even worse than individual lock-in
Due to coordination costs
Example: QWERTY
Example: Metric System in the US
Cell Phone Providers (free calls)

13. Don’t Get Carried Away Network externalities don’t always apply
ISPs (but watch out for QoS)
PC production
DVD Players
Likelihood of tipping
See next slide

14. Likelihood of Tipping

15. Igniting Positive Feedback
Evolution
Give up some performance to ensure compatibility, thus easing consumer adoption
Revolution
Wipe the slate clean and come up with the best product possible

16. Evolution Offer a migration path Examples
Microsoft (WordPerfect)
Borland copies from Lotus
Apple (new Intel chip)
Build new network by links to old one
Problems: technical and legal

17. Technical Obstacles Use Creative design Think in terms of system
Converters and bridge technologies
One-way compatibility
Office 97 as an upgrade of Office 95

18. Legal Obstacles
Need IP licensing
Example: Sony and Philips CDs

19. Revolution Groves’s law: “10X rule” But depends on switching costs
Example: Records -> CDs
DVD -> new format(?)

20. What To Choose Your reward = Total added to industry x your share
Value added to industry
Depends on kind of Product and
Size of network
Your share
Royalty payments
Proprietary
Optimum
Your share of industry value
Your Reward
Open
Total value added to Industry

21. Openness v. Control Openness Control
Make interfaces and specifications available to others
Example Jabber
Control
Keeping the technology or system proprietary
Example Skype

22. Openness Full openness Alliance Anybody can make the product
Problem: no champion
Alliance
Only members of alliance can use
Example SAE (Society Of Automotive Engineers) Technology - ESP
Problem – holding the alliance together
Example AIM (Apple/IBM/Motorola)

23. Control Control standard and go it alone Usually market leaders
If several try this strategy, may lead to standards wars

24. Generic Strategies

25. Performance Play Introduce new, incompatible technology Examples
Palm Pilot
Iomega Zip
Attractive if
Great technology
Outsider with no installed base

26. Controlled Migration Compatible, but proprietary Examples Windows
Upgrades

27. Open Migration Many vendors, compatible technology Examples
Fax machines

28. Discontinuity
Many vendors, new technology
Examples
Satellite radio

29. Historical Example of Positive Feedback
RR gauges