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Computer hardware & software• Another industry in which the “US is different.”• Vertical specialization characterizes development

of computer industry, separating SW & HW industries and affecting the evolution of each.– Competitive dynamics shift as vertical specialization

develops.

• Composition of demand, nature and scale of “launch markets” are important. Users are important innovators.

• What was the basis for Microsoft’s allegedly anticompetitive behavior in US v. Microsoft? How will the outcome of the case affect future tech. development?

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The record of technical progress• Computer performance has benefited from progress in

component technologies, especially integrated circuits.• Figures show reductions in the cost of computing

operations (based largely on progress in ICs) of more than 100-millionfold during 1948-2000.

• Equally important for business computing is technical progress in peripherals (storage; printers; networking).

• Direct and indirect gov’t support were essential to development of computing technology.– “Spillovers” from military to civil applications were

important during 1945-70 for US, British, French computer firms.

– Large US investments in university research “infrastructure.”

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1.00E-06

1.00E-05

1.00E-04

1.00E-03

1.00E-02

1.00E-01

1.00E+00

1.00E+01

1.00E+02

1.00E+03

1940 1950 1960 1970 1980 1990 2000

$/(

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ion

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Cost of addition operations, 1940-2000

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0

1

10

100

1,000

10,000

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998

Log

Scale

(199

6=1

)

Computers Communications Software Services

All price indexes are divided by the output price index.

Relative Prices of Computers, Communications, Software, and Services, 1948-99

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Innovation in a “general purpose technology”

• Other “general purpose technologies”:– Steam power.– Electricity.

• Declines in price-performance ratio drive expansion and diversification in applications.

• Adoption of computers, development of new applications requires considerable “co-invention,” organizational adaptation, and user involvement.

• “Co-invention” advances technology more rapidly in markets with many sophisticated users. – Low-cost, abundant HW is essential.

• Innovation and adoption are linked, and technology may advance more quickly in large “launch markets” (US in packaged SW; Internet).

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Industry origins: the 1940s• Wartime and postwar development projects for

applications in computing artillery trajectories; cryptography; radar; nuclear weapons design in US, UK.

• Universities (Cambridge; Harvard; Penn; MIT) play major roles in development, as well as basic research.

• These early “scientific” computers (number-crunchers) have limited applications in business, where data input & output requirements are high.

• What firm 1st introduced this technology for business-computing applications?

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The world’s 1st business computer: LEO• Introduced in 1952, before IBM, Sperry Rand.• Conceived of and developed by Lyons Tea Shops (UK)

managers after visiting US in late 1940s.• Lyons collaborated with Cambridge University in

developing the “Lyons Electronic Office” (LEO).• LEO included an advanced operating system. Users,

including Lyons, found adoption of the LEO difficult, because of the need for significant change in internal organizational practices.

• Lyons received little or no financial support from UK government, in contrast to many other US, UK computer firms during the 1950s and 1960s.

• LEO Computers was not profitable and merged with English Electric in 1963.

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Development of US business computing, 1950-1970

• 50-60% of IBM, RCA, GE, Raytheon computer R&D during 1950-59 from DoD contracts.

• The “mainframe” dominated the 1950s & 1960s, and IBM dominated the mainframe by 1965.– IBM’s entry into business computing drew on firm’s long history

in business equipment.– 1956 antitrust consent decree mandated licensing by IBM of

extensive patent portfolio.

• The IBM 360 (1965): Based on an HW family that shared software.– 360 enabled users to “scale up” HW without having to develop or

acquire new SW.– Creation of a large library of operating systems, applications SW

“locks in” users.– “Cloners” enter (“plug-compatible” computers).

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Characteristics of HW industry’s development before the PC

• Vertical specialization.– IBM, other mainframe firms initially produced components

and systems, HW & SW.– In 1969 (facing another antitrust action), IBM “unbundled”

SW from HW.– SW/HW vertical specialization occurred earlier, was more

extensive in US than other industrial economies.– But IBM remains a major SW vendor.

• Market segmentation & encroachment.– Minicomputers, supercomputers were introduced in 1960s

for scientific users and migrated to business applications.– Another example of “user-driven innovation”—scientists &

engineers initially wrote the SW.

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The PC and desktop computing• The microprocessor, the basis for the PC, was a

“bottleneck-breaker” innovation.– Based on Intel’s search for a processor that could support

multiple applications.

• Combination of circumstances produced an “open design” for PC in US, supporting entry into systems and “commoditization” of the PC.– Rapid establishment of two “dominant designs” based on

IBM, Apple in large market (US) were critical to subsequent explosion in the SW industry.

– Cheap hardware in US drove rapid adoption.– PC accelerated vertical specialization in HW.– Profits shifted from system-level hardware (IBM) to

components (Intel) and SW (Microsoft). – PC encroached on other segments (mini, mainframe).

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Development of the US software industry

• 1945-68: Software largely produced by systems manufacturers.

• 1969-75: “Unbundling” of software and hardware pricing and sales begins; ISVs enter.

• 1978-93: Development & adoption of the desktop personal computer creates a mass market for “packaged” or “standard” software.

• 1994-present: The Internet becomes an important market and an important channel for distribution and application of software and business methods.

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Software and the Web

• The Internet has created low-cost distribution, marketing channels for packaged software.

• “Business methods” software: Much of it is not a “standalone” product sold in shrinkwrap or through the Internet, but instead a process complement to a service or product. But “hits” remain important in a mass market.

• But the Internet also expands possibilities for “open-source” software.

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US & Non-US firms' market share by product class and consuming region, packaged SW, 1993

0

10

20

30

40

50

60

70

80

90

100

US Non-US US Non-US US Non-US

Tools Apps Op systems

Product category/firm

Mar

ket s

hare

US

W. Europe

Japan

US firms’ offshore market share is lowest in applications.

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SW investment in the US, 1970-95 (US Commerce Dept)

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SW competition in the PC era

• “Dominant designs” (Wintel, Apple) drove profitability.– Based on availability of library of complementary

applications software and compatibility with other users. Similar to the IBM 360, but separate firms now are involved.

– “Tipping” among independent developers of apps. SW toward dominant operating systems, hardware architectures occurs quickly.

• Strong “bandwagon” effects.

– Market competition quickly creates de facto standards that tend to endure.

• Users find switching costly and difficult.

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The rise of SW patents• Diffusion of the PC means that the economics of

packaged SW resemble those of publishing.– “hits” are hugely profitable.– Protection of IPR becomes crucial.– IPR & vertical specialization are complements.

• SW patents were strengthened in a 1980 Supreme Court decision; other court decisions during the 1980s weakened value of SW copyrights.

• During the 1980s and 1990s, SW patenting increased significantly, copyright declined.– US patent system has difficulties in new fields of inventive

activity—lack of patent-based “prior art.”– Weak quality control mechanisms.– Uncertainty remains over the actual validity of these

patents, but they may impede “cumulative” innovation.

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Packaged Software Patents as Share of All Patents 1987-1997

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

87 88 89 90 91 92 93 94 95 96 97

FIGURE 1

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Large Packaged-Software Firms’ Software Patents,

Share of all Software Patents, 1987 - 97

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

87 88 89 90 91 92 93 94 95 96 97

FIGURE 2

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Copyright Propensity, 15 Largest Packaged SW Firms (1997), 3-year moving average, 1987 - 97

010203040506070

1988

1989

1990

1991

1992

1993

1994

1995

1996

FIGURE 17

Registered copyrights per $100M R&D (1992 $)

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International production networks in SW: The case of India

• During 1995-2000, Indian SW firms’ sales grew at 56% CAGR. Employment has grown from 160K in 1997 to more than 400K in 2000.

• Industry focused on exports, upgrading, maintaining existing SW products for foreign firms, rather than developing packaged SW that requires close interaction with domestic users.

• SW industry and Indian technical workforce are well-suited:– Low capital, infrastructure requirements.– High quality, low-wage, English-speaking engineering

workforce.– Strong links with US high-tech firms.

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Red Hat case: Business models in open-source SW (OSS)

• What strategy has Red Hat been following (up to the time the case is written) to profit from OSS?

• What role does Red Hat’s own intellectual property play in the firm’s strategy?

• What are Red Hat’s future strategic alternatives in product or services development?

• What strategy do you recommend for Red Hat and why?