1. Standards Battles and Design Dominance Avimanyu Datta, Ph.D.
Chapter 4
Standards Battles and Design Dominance
Avimanyu Datta, Ph.D.

2. Overview
Many industries experience strong pressure to select a single (or few) dominant design(s).
There are multiple dimensions shaping which technology rises to the position of the dominant design.
Firm strategies can influence several of these dimensions, enhancing the likelihood of their technologies rising to dominance. 2

3. Why Dominant Designs Are Selected
Increasing returns to adoption
When a technology becomes more valuable the more it is adopted. Two primary sources are learning effects and network externalities.
The Learning Curve: As a technology is used, producers learn to make it more efficient and effective.
There are many factors that drive a market to coalesce around a dominant design. These factors often result in a self-reinforcing process that continues to increase a technology’s dominance even if it is inferior to competing technologies. These factors include:
Learning affects the improvement rate of a technology. Greater use of the technology leads to greater knowledge accumulation. Greater knowledge accumulation enables the improvement of the technology.
Network externalities that result when there are increasing returns to adoption (i.e. a technology becomes more valuable to customers as more and more customers adopt the technology).
Complementary product creation often occurs at a faster rate as adoption becomes more widespread. 3

4. Why Dominant Designs Are Selected
Prior Learning and Absorptive Capacity
A firm’s prior experience influences its ability to recognize and utilize new information.
Use of a particular technology builds knowledge base about that technology.
The knowledge base helps firms use and improve the technology
Suggests that technologies adopted earlier than others are likely to become better developed, making it difficult for other technologies to catch up.
Learning Effectsevidence shows that the more a technology is used the more developed, effective and efficient it becomes. Learning effects have been demonstrated in a wide variety of industries including automobiles, ships, semiconductors, pharmaceuticals, and even heart surgery techniques.
Learning curves represent the cumulative impact of learning on production costs and productivity. Organizational learning scholars typically model the learning curve as a function of cumulative output: performance increases, or cost decreases, with the number of units of production.
The learning curve is formulated as y = ax-b, where y is the number of direct labor hours required to produce the xth unit, a is the number of direct labor hours required to produce the first unit, x is the cumulative number of units produced, and b is the learning rate.
Organizations learn at very different rates. Firms learn at different rates because their levels of prior learning and absorptive capacity differ. Learning rates also differ with the nature of the task and firm strategy.
Absorptive Capacity refers to the phenomenon whereby as individuals or firms learn, they also increase their future ability to learn. For example, the development of a new technology requires experimentation. Experimentation helps build a knowledge base that allows the individual or firm to identify what alternatives are most likely to be successful in the future. Firms that do not invest in technology development may not develop the absorptive capacity need to recognize or develop a new technology in the future.
Absorptive capacity also has effects at the industry level. As the number of firms learning about a technology increases and/or the number of firms creating complementary technologies increases the more effective and efficient the original technology will become. 4

5. Why Dominant Designs Are Selected
Network Externalities
In markets with network externalities, the benefit from using a good increases with the number of other users of the same good.
Network externalities are common in industries that are physically networked
E.g., railroads, telecommunications
Network externalities also arise when compatibility or complementary goods are important
E.g., Many people choose to use Windows in order to maximize the number of people their files are compatible with, and the range of software applications they can use.
What is Networks Externalities?
In economics and business, a network effect (also called network externality or demand-side economies of scale) is the effect that one user of a good or service has on the value of that product to other people. When network effect is present, the value of a product or service is dependent on the number of others using it.
The classic example is the telephone. The more people own telephones, the more valuable the telephone is to each owner. This creates a positive externality because a user may purchase a telephone without intending to create value for other users, but does so in any case. Online social networks work in the same way, with sites like Twitter and Facebook being more useful the more users join.
The expression "network effect" is applied most commonly to positive network externalities as in the case of the telephone. Negative network externalities can also occur, where more users make a product less valuable, but are more commonly referred to as "congestion" (as in traffic congestion or network congestion).
Network Externalities, or positive consumption externalities affect the adoption of a dominant design because a user’s benefit from using a good increases as the installed base increases (e.g. railroads, telecommunications, communities of practice, computer platforms). For example, many people choose a computer that uses the Windows operating system and an Intel microprocessor because the “Wintel” platform has the largest installed base, thus maximizing the number of people with which the user’s files will be compatible.
Network externalities arise when compatibility (e.g. exchanging computer files) and the availability of complementary goods (e.g. movies for a VCR , film for cameras) are important and when investments in training are high (e.g Qwerty).
For example, as Windows’ installed base increased developers became more likely to expend their efforts on developing products compatible with Windows rather than the MAC. Thus a virtuous cycle (at least from Microsoft’s perspective) begins. An increasing installed base attracts complementary goods developers and the availability of complementary goods increases the installed base, and so on. 5

6. Why Dominant Designs Are Selected
A technology with a large installed base attracts developers of complementary goods; a technology with a wide range of complementary goods attracts users, increasing the installed base. A self-reinforcing cycle ensues: 6

7. Theory In Action The Rise of Microsoft
In 1980, Microsoft didn’t even have a personal computer (PC) operating system – the dominant operating system was CP/M.
However, in IBM’s rush to bring a PC to market, they turned to Microsoft for an operating system and Microsoft produced a clone of CP/M called “MS DOS.”
The success of the IBM PCs (and clones of IBM PCs) resulted in the rapid spread of MS DOS, and an even more rapid proliferation of software applications designed to run on MS DOS. Microsoft’s Windows was later bundled with (and eventually replaced) MS DOS.
Had Gary Kildall signed with IBM, or had other companies not been able to clone the IBM PC, the software industry might look very different today! 7

8. Why Dominant Designs Are Selected
Government Regulation
Sometimes the consumer welfare benefits of having a single dominant design prompts government organizations to intervene, imposing a standard.
E.g., the NTSC color standard in television broadcasting in the U.S.; the general standard for mobile communications (GSM) in the European Union.
The Result: Winner-Take-All Markets (Is it Good??)
Natural monopolies
Firms supporting winning technologies earn huge rewards; others may be locked out. (Apple Vs. Microsoft)
De facto or De Jure Standards.
Government Regulationin addition to the market forces that encourage the adoption of a dominant design sometimes government regulation plays a role in the selection of a dominant design. Governments are most likely to intervene when there is a societal or consumer welfare benefit to having compatible technologies. This has often been the case for the utilities, telecommunications and television industries. For example,
in 1953 the FCC approved the National Television Systems Committee color standard in television broadcasting to ensure that individuals with monochrome television sets would be able to receive the color television programs broadcast by networks.
in 1998, the European Union adopted a single wireless telephone standard to avoid the proliferation of incompatible standards and to facilitate exchange both within and across national borders.
The most superior products do not necessarily win. When all of the above forces are at work, the result can be a natural monopoly (though some alternatives may survive in niche markets) and winner-take-all markets.
The winning firm enjoys high returns and is well positioned to affect the development trajectory of the technology thereby further enhancing its dominant position in the industry.
Losing firms, not only have to play catch up after they adopt the dominant design they also lose the capital, learning and brand equity invested in their original technology.
Are winner-take-all markets good for consumers? This is a complex question, made more complicated by traditional economics emphasis on the advantages of competitive markets. What makes this a complex question is the issue of increasing returns (of course the antitrust suits brought against Microsoft are a good example to use here). To answer this question the benefits accrued by customers when a larger portion of the market adopts the same technology (s-curve) must be compared with the corresponding monopoly (exponentially increasing) costs (e.g. higher prices, less product variety, flatter technology improvement trajectory, etc.) 8

9. Why Dominant Designs Are Selected
Increasing returns indicate that technology trajectories are characterized by path dependency:
End results depend greatly on the events that took place leading up to the outcome.
A dominant design can have far-reaching influence; it shapes future technological inquiry in the area.
Winner-take-all markets can have very different competitive dynamics than other markets.
Technologically superior products do not always win.
Such markets require different firm strategies for success than markets with less pressure for a single dominant design.
The influence of a dominant design can be far reaching. Dominant designs affect knowledge accumulation after their adoption primarily because firms have a tendency to build on their existing knowledge base rather than build new ones. This means that a dominant design will influence the technological discontinuity that will replace it.
Path dependency often characterizes technology trajectories with increasing returns to adoption. Path dependency means that small historical events may have a large effect on the form of the technology adopted as the dominant design. For example,
Early entrants and their technology may become so entrenched that subsequent, superior technologies, may be unable to gain a foothold in the market.
Sponsorship by a large powerful firm can help a technology gain a controlling share of the market, locking out alternative and potentially superior technologies. 9

10. Multiple Dimensions of Value
In many increasing returns industries, the value of a technology is strongly influenced by both:
Technology’s Standalone Value
Network Externality Value
A Technology’s Stand-alone Value
Includes such factors as:
The functions the technology enables customers to perform
Its aesthetic qualities
Its ease of use, etc.
So if technological superior products don’t always win, what determines which technology and which firm wins? The company that wins usually is able to effectively manage the multiple dimensions that comprise total customer value. Customers compare the value of two or more competing technologies based on each technologies standalone and network externality value. 10

11. Multiple Dimensions of Value
Kim and Mauborgne developed a “Buyer Utility Map” that is useful for identifying elements of a technology’s stand-alone value:
Standalone Value Chan Kim and Renee Mauborgne developed the “Buyer Utility Map” to help managers determine what aspects of a new technology will be valued by potential customers (e.g. the functions it enables the customer to perform, its aesthetic qualities, its ease of use, etc.). They recommend considering six utility levers and the six stages of a buyers experience cycle (purchase, delivery, use, supplements, maintenance, and disposal) in order to fully understand a new technologies standalone value to a customer. Of course, each benefit has to be considered in light of its cost.
For example, a new online ordering system alters the value proposition offered to the customer by simplifying the purchasing process (i.e. a change in a single cell) while the Honda Insight hybrid-electric vehicle offered customers greater benefits in the use and maintenance stages of the buyers experience cycle (i.e. change in multiple cells). 11

12. Multiple Dimensions of Value
Network Externality Value
Includes the value created by:
The size of the technology’s installed base
The availability of complementary goods
A new technology that has significantly more standalone functionality than the incumbent technology may offer less overall value because it has a smaller installed base or poor availability of complementary goods.
E.g., NeXT Computers were extremely advanced technologically, but could not compete with the installed base value and complementary good value of Windows-based personal computers.
Network Externality Value is a function of the size of the installed base and the availability of complementary goods.
The value of the Windows operating system, for example is due to the ability of the system to make it easy for consumers to use the computer (standalone value) plus two sources of network externality value: 1) its large installed base which translates into a large number of computers with which the user can easily interact, and 2) the availability of compatible software developed for Windows as its installed base increased.
An incumbent technology may thwart the adoption of a new technologically superior technology because the total value (standalone + network externalities) it offers is higher (NeXT computers are a good example to use here).
In order for a new technology to compete on only standalone value, that value must exceed the total value offered by the incumbent technology or the new technology must be compatible with the incumbent’s installed base and complementary goods. 12

13. Multiple Dimensions of Value
To successfully overthrow an existing dominant technology, new technology often must either offer:
Dramatic technological improvement (e.g., in videogame consoles, it has taken 3X performance of incumbent)
Compatibility with existing installed base and complements 13

14. Multiple Dimensions of Value
Subjective information (perceptions and expectations) can matter as much as objective information (actual numbers)
Value attributed to each dimension may be disproportional
All of the above has been based on the consumer’s reliance on objective information. But consumer choice is also affected by subjective information (i.e. perceptions of value). So each value component has a corresponding perceived or anticipated value component that can be considerably different from the actual value.
Firms can take advantage of consumer reliance on perceptions by creating a large ‘mindshare’ through heavy advertising that makes the installed base appear larger than it actually is and/or make the availability of complementary goods appear greater than they actually are (Sega and Nintendo’s battle for dominance in the 16-bit video game console market is a great example to use here).
Another tactic firms use to capitalize on consumer reliance on perceptions is preadvertising. Preadvertising markets “vaporware” (a product that is not yet on the market and may not even exist) in an attempt to persuade customers to wait for the new product instead of buying a competitor’s product that is already available (here again the game console industry is a good example to use with your students). 14

15. Multiple Dimensions of Value
Competing for Design Dominance in Markets with Network Externalities
We can graph the value a technology offers in both standalone value and network externality value:
Value to Users
Installed Base
Tech. Value
Value accrued from network externalities
Value accrued from network externalities + Technology utility
Externalities―Do network externalities create pressure for a dominant design or a few dominant designs? How large of an installed base is necessary before most of the network externality benefits are captured? The answers to these questions can be demonstrated to your students by examining the graphs in transparency seven. 15

16. Multiple Dimensions of Value
We can compare the graphs of two competing technologies, and identify cumulative market share levels (installed base) that determine which technology yields more value.
Consider the rate at which value increases with the size of the installed base, and how large of an installed base is necessary before most of the network externality benefits are achieved. These graphs are usually characterized by a threshold level of adoption below which the externality benefits are very low and above which the benefits increase significantly. This type of graph “shifts up” when the base level value of a technology is greater.
This graph shows that at every point where A has less than 50% market share (and thus B has greater than 50% market share), B will yield greater overall value, making B more attractive to customers and vice versa. However, when one technology offers greater standalone value the indifference point is shifted in its favor. 16

17. Multiple Dimensions of Value
When customer requirements for network externality value are satiated at lower levels of market share, more than one dominant design may thrive.
The customer has a greater region of indifference between the two technologies (a good example here are video game consoles) and firms in these markets may compete very successfully with multiple dominant designs. 17

18. Are Winner-Take-All Markets Good for Consumers?
Economics emphasizes the benefits of competition.
However, network externalities suggest users sometimes get more value when one technology dominates.
Should the government intervene when network externalities create a natural monopoly? 18

19. Are Winner-Take-All Markets Good for Consumers?
Network externality benefits to customers rise with cumulative market share
Potential for monopoly costs to customers (e.g., price gouging, restricted product variety, etc.) also rise with cumulative market share.
Curve shapes are different; Network externality benefits likely to grow logistically, while potential monopoly costs likely to grow exponentially.
Where monopoly costs exceed network externality benefits, intervention may be warranted. Optimal market share is at point where lines cross. 19

20. Blu-Ray versus HD-DVD: A Standards Battle in High-Definition Video
From 2003 to 2008, Sony and Toshiba waged a high-stakes war for control over the next generation video format.
Sony’s Blu-Ray technology was backed by a consortium that included Philips, Matsushita, Hitachi, and others.
Toshiba’s HD-DVD had the backing of the DVD Forum, making it the “official” successor to the DVD format.
Both companies lined up major movie studios and video game consoles to promote their standards (Sony’s Playstation 3 and Microsoft’s Xbox 360).
In January 2008, Time Warner’s announcement that it would support Blu- Ray instead of HD DVD triggered a chain reaction that collapsed the support for HD-DVD. Toshiba announced it would cease production of HD-DVD equipment in February of 2008. 20

21. Blu-Ray versus HD-DVD: A Standards Battle in High-Definition Video
Discussion Questions:
What factors do you think influenced whether a) consumers, b) retailers, or c) movie producers supported Blu-Ray versus HD-DVD?
Why do you think Toshiba and Sony would not cooperate to produce a common standard?
If HD-DVD had not pulled out of the market, would the market have selected a single winner or would both formats have survived?
Does having a single video format standard benefit or hurt consumers? Does it benefit or hurt consumer electronics producers? Does it benefit or hurt movie producers?
1. What factors do you think influenced whether a) consumers, b) retailers, or c) movie producers supported Blu-Ray versus HD-DVD?
This is a great question to apply the idea of multiple dimensions of value framework and to think about which dimensions would matter most to which stakeholders. Consumers, for example, are likely to have been very influenced by a combination of technology standalone value, and expected availability of complementary goods. Retailers and movie producers, on the other hand, are mostly interested in supporting the standard they believe will win, thus much of their decision making hinges on expected installed base, which in turn would be influenced by current sales trends, their beliefs about which competitor (Sony or Toshiba) would strategically manage the deployment of the technology better, and by observing which other retailers and movie producers were backing each standard.
2. Why do you think Toshiba and Sony would not cooperate to produce a common standard?
This likely goes back to Sony and Phillips’ domination over the CD standard. Sony and Phillips invented the CD, and collected royalties on every disk and every player ever sold. This was a tremendous cash cow for the two companies, and inspired considerable industry opposition about the next generations of media standards being owned by a single company or partnership. As a result, a coalition of other electronics producers banded together to promote the DVD standard (which displaced Sony and Phillips’ CD), and HD-Audio (which competed with Sony’s Super Audio CD).
3. If HD-DVD had not pulled out of the market, would the market have selected a single winner or would both formats have survived?
Clearly the availability of complements is extremely important here (it is a highly analogous situation to the original Betamax vs. VHS battle), so unless there was a move to make the players cross-compatible (so that they could play both formats of media), there would have been very strong pressure to select a dominant design.
4. Does having a single video format standard benefit or hurt consumers? Does it benefit or hurt consumer electronics producers? Does it benefit or hurt movie producers?
Having a single video format standard greatly increases the network externality value to consumers, and reduces the costs and uncertainty to electronics and movie producers. However, whether they are better off overall depends on the owner of the standard (e.g., Sony or Toshiba) and how they would exploit their dominant position. If the controller of the dominant design decides to dramatically increase the costs of the standard (for example, through very high licensing fees to complements providers), this could hurt the industry considerably. Furthermore, the firm that controls the dominant standard typically has significant control over innovative activities related to the standard, and can thus facilitate, or hinder, the further development of the technology and related goods. 21

22. Discussion Questions
1.   What are some of the sources of increasing returns to adoption?
2.   What are some examples of industries not mentioned in the chapter that demonstrate increasing returns to adoption?
3.   What are some of the ways a firm can try to increase the overall value of its technology, and its likelihood of becoming the dominant design?
4.   What determines whether an industry is likely to have one or a few dominant designs?
5.   Are dominant designs good for consumers? Competitors? Complementors? Suppliers?
What are some of the sources of increasing returns to adoption?
A self-reinforcing cycle begins when increases in the adoption of a technology: leads to greater knowledge accumulation, that supports the making of improvements in the technology’s performance,increases the value of the technology for the consumer because they can more readily interact with others if everyone is using the same technology (compatibility), and increases the likelihood that developers of complementary assets will focus on one technology over its alternatives.
What are some examples of industries not mentioned in the chapter that demonstrate increasing returns to adoption?
Additional industries demonstrating increasing returns to adoption are typewriters with the Qwerty keyboard and the adoption of VHS over Beta. The standard keyboard on a typewriter was initially designed to slow typists down because otherwise the machine would jam. Today jamming is not a problem but typists who have put in the effort to learn Qwerty do not want to invest more time to learn a new keyboard. The battle between VHS and Beta is a good example of how the development of complementary goods (players/recorders) played a large role in the establishment of a dominant design. Students may also point out that instant messaging software exhibits strong network externalities, as does short messaging services on cellular phones.
What are some of the ways a firm can try to increase the overall value of its technology, and its likelihood of becoming the dominant design?
Firms can increase the likelihood that their technology will become the dominant design by: increasing the technologies’ standalone value to the customer (e.g. superior functionality at a competitive cost), increasing the technologies’ network externalities value by encouraging developers of complementary assets to create products for their technologies, advertising heavily to create a perception that the installed base is larger than it is or that a new product with superior capabilities will be launched soon (so that consumers do not buy a product already available),
leveraging an incumbent technology’s complementary assets and installed base by making their technology compatible with the incumbent technology.
What determines whether an industry is likely to have one or a few dominant designs?
Whether an industry will have one dominant design or a few is a function of the following:
The level of market share at which consumers get their network externality needs met. If consumers network externality needs are met at low levels of market share then more than one dominant design may develop.
Path dependency can affect the trajectory of technology development that in turn affects the number of dominant designs.
Success of early entrants can prevent challengers from gaining a foothold in the market.
Sponsorship of a technology by a powerful firm can help the technology attain a controlling share of the market that locks out alternative technologies.
Whether a government intervenes to ensure that technologies are compatible so that societal benefits are attained.
Are dominant designs good for consumers? Competitors? Complementors? Suppliers?
With regard to consumers this question can be rephrased as: Are winner-take-all markets good for consumers? The answer is yes if the benefits accrued by consumers through widespread adoption of a technology outweighs the costs associated with a monopoly (e.g. higher prices, less product, variety, etc.). Of course the answer is no if the benefits accrued do not outweigh the costs.
With regard to competitors the answer is no unless the technology is “open” (not protected by intellectual property rights) or your firm is the owner of the technology that becomes the dominant design. Firms that do not have their technology adopted lose their investment in their technology and also have to play catch up in order to compete with the firm that owns the dominant design. The firm that owns the technology that becomes the dominant design benefits from high returns and their ability to affect the technologies development trajectory further supporting their dominant position in the industry.
With regard to complementors and suppliers the establishment of a single dominant design is likely to reduce their power as suppliers, but also reduces the market uncertainty they face and the eliminates the cost of trying to support multiple competing technologies. Complementors often require support from the firm that owns the technology (such as the releasing of computer code). Complementors can benefit from the establishment of a dominant design by not wasting resources developing for other platforms that do not thrive and from an expanded market for their products. Other suppliers could have pricing power reduced unless they themselves are a monopoly. 22