©2009 prentice hall 12-1 mgmt 738 management of technology lecture 6 technical standards and...

©2009 Prentice Hall12-1

MGMT 738 Management of Technology

Lecture 6

Technical Standards and Network Externalities

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.


Technical Standards

• Specifications that ensure that different components are compatible

• Permit independent companies to produce different components for the same product

• Standards are of particular importance to start-up firms, which generally cannot, due to capital, produce all of the components needed to make a product


The Development of Technical Standards and Dominant Designs

• Technical standards develop because: Of chance occurrence One technology is superior to another Governments mandate them Industry trade associations or standards-

setting bodies establish them Companies take strategic action


Not Always the Best Technology

• Industries sometimes converge on standards that are technically inferior to other alternative

• Often because a technology achieves a large installed base and the cost to change is too high


Technical Standards and Customer Adoption

• Technical standards influence customer adoption because: Customers don’t want to adopt products that

might be abandoned Customers desire compatibility, particularly for

systemic products Makes products more functional Facilitates creation of complementary

products


Standards Battles

• Companies often battle to control technical standards because: Products that conform to the technical standard can

be sold at a premium therefore create a higher profit margin

Suppliers will have to adhere to the company’s technology, giving leverage over them, and allowing to capture a large portion of industry profits

Competitors will have to adopt the technology if it is the industry standard, which puts them at a competitive disadvantage


Increasing Returns Businesses

• Some industries, particularly knowledge-intensive ones, are subject to increasing returns, which means that profit margins increase with the volume of production


Direct Network Effects

Metcalfe’s Law


Increasing Versus Decreasing Returns


Increasing Returns at eBay


Why Industries Display Increasing Returns

• Industries display increasing returns when: They have high up-front costs and low

marginal costs Producer learning is high Network externalities, when the purchase of a

product by a new customer creates additional value for existing customers

Positive Feedback in Demand


Positive Feedback in the Development of Linux

Theory in Action

A Standards Battles in Digital Audio Formats In 1996, record companies and electronics companies joined

together to form the DVD Audio Consortium to create a new high-fidelity audio format.

In 1999, Sony and Philips unveiled their own high-fidelity audio format, Super Audio CD, setting the stage for a standards battle similar to the VHS versus Beta battle in video recorders.

Fearing a format war that would select one standard as dominant (and one as failed), many manufacturers decided to bear the extra cost of producing “Universal players” that would support both formats.


Technical Standards and Competition Between Systems

• Technical standards often lead to competition between systems of companies, rather than between individual organizations

• Must decide to support one standard or all standards


Open Versus Closed Standards

• Open standard: a standard for which specifications are known by other companies

• Closed standard: a system for which those specifications are not known by other companies

• Open systems are valuable because they: Facilitate the availability of complementary products

that create a positive feedback effect Encourage other companies to adopt your technology Permit the rapid creation of a large installed base


Open Standard Disadvantages

• The loss of control over the technology, which could lead to a loss in sales

• That licensees might change your technology in a way that makes it unnecessary for them to pay you royalties

• An open standard demonstrates to competitors how the technology works, making it easier for them to imitate it


Types of Open Systems

• Proprietary – help providers by reducing competition, giving them control over the development of the technology, and providing a strong incentive to support the system

• Non-proprietary – have the advantage of being more attractive to customers; they are neutral, don’t require royalty payments, and are easier for customers to use

Why Dominant Designs Are Selected

• Increasing returns to adoption occurs when a technology becomes more valuable the more it is adopted. Two primary sources are:

• Learning Effects• The Learning Curve: As a technology is used,

producers learn to make it more efficient and effective.

Experience and Learning Curves


• 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.


• 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.


• 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:


• 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 Natural monopolies

• Firms supporting winning technologies earn huge rewards; others may be locked out.


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.

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.


• Kim and Mauborgne developed a “Buyer Utility Map” that is useful for identifying elements of a technology’s stand-alone value:

Buyer Utility Map


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.


• 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

Components of Utility


• Subjective information (perceptions and expectations) can matter as much as objective information (actual numbers)

• Value attributed to each dimension may be disproportional

Actual and Perceived Utility

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:

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.

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.


Types of Network Effects

• Network externalities come in two varieties: direct effects and indirect effects

• Direct network effects are network externalities that come from the direct interaction of users

• Metcalfe's law: the value of a network is proportional to the square of the number of devices in it

• Indirect network effects are network externalities that develop when the presence of complementary goods – products that are used along with the focal product – increases a product’s value


Strategic Issues with Networked Industries

• Industries subject to network effects face important strategic issues that do not confront other industries, including: The maintenance of the network The possibility of sustaining more than one

network The use of strategic action to exploit network

effects Competition from other networks


Multiple Networks?


How to Win a Standards Battle

• To win a standard battle, companies may: Gain the support of producers of complementary

products Have a complementary “killer application” making one

technology much more attractive than another Make the product backward compatible so that it

works with a previous generation of products Manage customer and competitor expectations


Defending a Technology Standard

• Defend against the efforts of other firms by keeping customer switching costs high: Make the products more functional, by adding

features, or by making peripheral components available

Set up long-term supply of complementary products or services

Make future generations of the product backward compatible

Make the products or services incompatible with the alternatives offered by competitors


Strategy for Increasing Returns

• In increasing returns industries, you need to: Establish large-scale operations Build your installed base quickly Create customer lock-in Be a first mover


Start Large

• Because increasing returns businesses are winner-take-all, firms need to make large bets


Amount Raised and Ownership in Biotechnology


Build a Large Installed Base Quickly

• Firms in increasing returns industries need to build a large installed base, the number of current users of a product or service, quickly because customer adoption decisions are affected by the size of the installed base

• A large installed base: Helps to make the product the industry standard, which gives

long-lasting leverage over other firms in the value chain Makes the product more attractive to the providers of

complementary products Pushes the company down the learning curve Improves the economics of developing new technologies Will keep out competition by creating a positive feedback loop

that is hard for competitors to break


How to Build an Installed Base Quickly

• Penetrating pricing – but it comes at the risk of lack of profitability

• Bundling the product with other products that are already popular with customers

• Targeting the mass market


The Effect of a Big Initial Installed Base


Get Customers to Ignore Lock-in

• Customer lock-in occurs when customers view the costs of switching suppliers as too high to justify doing so

• Firms in increasing returns industries use the razor-razor blade model to minimize customer lock-in to attract customers


Be a First Mover

• First mover advantages are large in industries subject to increasing returns because the likelihood of new customer adoption increases with the size of the installed base

• Getting to market quickly is more important than having superior technology in industries subject to increasing returns because customers will not switch products to superior technology if the inferior technology has already been adopted by a large installed base

• Contracting, rather than owning the different parts of the value chain, facilitates getting to market quickly, and is a valuable approach in industries based on increasing returns


Limitations to a Strategy Based on Increasing Returns

• Companies have to evaluate whether increasing returns are really present in their industry before they set their strategy because industries do not always show increasing returns when theory says that they should

Theory in Action

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?

Theory in Action 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.

Network Externality Benefits versus Monopoly Costs

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.

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!


Complementary Products in the High-Definition DVD War


What If You Lose?

• If a standards battle is lost: Companies can exit the market Conform to the standard and compete on

another dimension Focus on a niche and meet its needs without

conforming to the standard


Fighting A Standard

©2009 prentice hall 12-1 mgmt 738 management of technology lecture 6 technical standards and...

Documents

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