cmis 520 april 11, 2005 information rules chapter 7 networks and positive feedback
TRANSCRIPT
CMIS 520 April 11, 2005
Overview Positive Feedback Demand Side Economies of Scale Network Externalities Collective Switching Costs Is your industry subject to positive
feedback Igniting positive feedback Evolution: offer a migration strategy Revolution: offer compelling performance Generic Strategies in Network Market Lessons
CMIS 520 April 11, 2005
Positive Feedback
Difference between old economies and new economies Economies of Scale vs. Economies of
Networks
The value of connecting to a network depends on the number of people on the network
CMIS 520 April 11, 2005
Positive Feedback
Positive feedback allows the strong to get stronger and the weak to get weakerNegative feedback allows the strong to get weaker and weak get strongerWhen two firms compete in a market where there is positive feedback only one winner can emergeThis is driven by the fact that users want to be connected to the network that has (or will have) the most users
CMIS 520 April 11, 2005
Positive FeedbackThe positive feedback system follows a predictable S-Shaped curve Flat during launch A steep rise during takeoff as positive
feedback kicks in Leveling off
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Supply/Demand-Side Economies of Scale
Supply-Side Economies of Scale Declining average unit cost (ex: cars) As quantity increases marginal unit cost <
average unit costs (ex: information goods)
Demand Side Economies of Scale Value to the user increases as the number
of compatible user increases Network effect Examples cellular phones
CMIS 520 April 11, 2005
Demand-Side Economies of Scale
Valu
e t
o U
ser
Number of Compatible Users
Vicious C
ycle
Virtuous Cycle
Popularity Adds Value in a Network Industry
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Demand-Side Economies of Scale
Supply-side and demand-side economies of scale combine to make positive feedback in the network economy specially strong.
Example: cellular phones Marketing (demand-side) Strategy
CMIS 520 April 11, 2005
Network ExternalitiesThe term that describes the effect that large networks are more attractive to users than small ones areNetwork: view info technologies in terms of virtual networks, which share many properties with real networks such as communications and transportation networks
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Network ExternalitiesExternalities: arise when one market participant affects others without compensation being paid
Like feedback, externalities come in 2 flavors: negative & positive
Negative externality is pollution my sewage ruins your pool or drinking water
Normally externalities are positive I join your network & it gets bigger and
better to your benefit
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Network ExternalitiesPositive externalities give rise to positive feedback
when I buy a fax machine, the value of your fax machine is enhanced since you can now send faxes to me and receive faxes from me
CMIS 520 April 11, 2005
Network ExternalitiesMetcalfe’s Law: named after the inventor of Ethernet
The value of a network goes up as the square of the number of users
If there are “N” number of people in a network, and the value of the network to each of them is proportional to the number of other users, then the total value of the network is proportional to N x (N-1) = N^2 – N
CMIS 520 April 11, 2005
Network ExternalitiesMetcalfe’s Law Continued
If the value of a network to a single user is $1 for each other user on the network, then a network of size 10 has a total value of roughly $100.
In contrast, a network of size 100 has a total value of roughly $10,000.
A tenfold increase in the size of the network leads to a hundredfold increase in its value.
CMIS 520 April 11, 2005
Collective Switching CostsNetwork externalities make it virtually impossible for a small network to thrive
Every network has to start from scratch The challenge to companies seeking to
introduce new but incompatible technology into the market is to build network size by overcoming COLLETIVE SWITCHING COSTS (the combined switching costs of all users)
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Collective Switching CostsIn many information industries, these are the biggest single force working in favor of incumbentsThey work in a non-linear way, convincing 10 people connected in a network to switch to your incompatible network is more than 10 times as hard as getting one customer to switchBut you need all 10, or most of them: no one will want to be the first to give up the network externalities and risk being strandedBecause various users find it so difficult to coordinate to switch to an incompatible technology, control over a large installed base of users can be the greatest asset you can have
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Collective Switching Costs: Example
QWERTY Keyboard (1870s : Type Writer brand of machines)
Awkward configuration of letters, mainly to slow down typists and reduce incidence of jamming of the machines.
Dovark Layout (patented 1932) Much superior .. All vowels on the same
row
Why, then, are we still using QWERTY keyboard (computer Keyboards rarely jam) ?
CMIS 520 April 11, 2005
Positive Feedback Not all information infrastructure markets are dominated by the forces of positive feedbackEX: Internet Service Providers A high tech industry that currently does not
experience large network effects At one time, were attempts by ISPs for
proprietary systems Changed by the commercialization and
standardization of the Internet
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Positive FeedbackThink carefully about the magnitude and significance of network externalities in your industry Don’t let the idea of positive feedback
carry you away; not every market tips
Will your market tip toward a single dominant technology or vendor? Depends on the balance between two
fundamental forces: economies of scale & variety
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Not every market tips!Likelihood of Market Tipping to a Single
Technology
Low Demand for VarietyHigh Demand for Variety
Low Economies of Scale
High Economies of Scale
Unlikely
Low
High
Depends
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Igniting Positive Feedback: Performance Vs.
Compatibility
What does it take for a new technology to succeed in the market?
Building your own base of users for a new technology in the face of an established network can be daunting
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Igniting Positive Feedback: Performance Vs.
CompatibilityTwo approaches for dealing with the problem of consumer inertia1) Evolution strategy of compatibility2) Revolution strategy of compelling performance
Evolution strategy offers a smooth migration pathRevolution strategy offers compelling performance
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Igniting Positive Feedback: Performance Vs.
Compatibility
Performance
Com
pati
bili
ty
Performance
Evolution
Improved Design or Adaptors
Performance Vs. Compatibility
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Evolution: Offer a Migration Path
Reducing switching costs to entice customers to try your new technologyRequires compatibility with existing productsTwo Obstacles Technical Obstacles Legal Obstacles
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Technical Obstacles
Develop a technology that is both Compatible with existing technology Superior to existing technology
Keeps switching costs low with backward compatibility and improved performanceCompatibility/Performance Tradeoff3 Strategies to combat tradeoff Use creative design Think in terms of the system Consider converters and bridge technologies
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Legal Obstacles
Need to obtain the legal right to sell products that are compatible with existing products
Intellectual Property Rights over older generation technology
Incumbents may use property rights to block competition or to license product
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Revolution: Offer Compelling Performance
Offer a superior product to persuade enough users to switch to it
Revolution Strategy
Challenges
Revolution Strategy is riskyAndy Grove’s ’10X’ rule of thumb
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Igniting Positive Feedback: Openness Vs. Control
Anyone launching a new technology must face a fundamental control/openness trade off.Open: Offering to make the necessary interfaces and specifications available to others.Control: Maintain control by keeping your system Proprietary.
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Igniting Positive Feedback: Openness Vs. Control
Control Proprietary control will be
exceedingly valuable if your product or system takes off.
Your network will be more valuable if you can control the ability of others to interconnect with you.
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Igniting Positive Feedback: Openness Vs. Control
Openness Failure to open your technology can spell
its demise. If customers fear lock-in or if you face a
strong rival whose system offers comparable performance but is non-proprietary.
Openness ups your chance of success by attracting allies and assuring customers that they can turn to other suppliers down the road.
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Igniting Positive Feedback: Openness Vs. Control
Which route is best? There is no right or wrong choice. The answer depend on the market
and your position in the market. Ultimate goal is to maximize the value
of your technology, not your control over it.
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Igniting Positive Feedback: Openness Vs. Control
Your Reward = Total value added to Industry X Your share of industry value
Total value added to the industry depends on the inherent value of the technology and how widely the technology is adopted.
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OpennessThe openness strategy is critical when no one firm is strong enough to dictate technology standards.Openness also arises naturally when multiple products must work together, making coordination in product design essential.Openness is more cautious than control. Idea is to forsake control to get the bandwagon rolling.
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Generic Strategies in Network Markets
4 Generic strategies for companies seeking to introduce new technologies into the market place.These strategies follow logically from the two basic trade-offs Performance/Compatibility trade off Openness/Control trade off
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Generic Strategies in Network Markets
Control Openness
Compatibility Controlled migration Open migration
Performance Performance play Discontinuity
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Generic Strategies in Network Markets
Controlled Migration Consumers are offered a new and
improved technology that is compatible with their existing technology, but is proprietary.
Upgrades and updates of software programs tend to fall into this category.
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Generic Strategies in Network Markets
Controlled Migration Cont. If you have secure domination in
your market, you can introduce the new technology as a premium version of the old technology.
Thus, controlled migration often is a dynamic form of the versioning strategy described in chapter 3.
CMIS 520 April 11, 2005
Generic Strategies in Network Markets
Open Migration The new product is supplied by
many vendors and requires few switching costs.
Open migration makes the most sense if your advantage is primarily based on manufacturing capabilities.
You will benefit from a large total market and an agreed upon set of specifications.
CMIS 520 April 11, 2005
Generic Strategies in Network Markets
Discontinuity A new product or technology is
incompatible with existing technology but is available from multiple suppliers.
Ex.- introduction of CD audio systems, 3 ½ floppy disks
Like the open migration strategy, discontinuity favors suppliers that are efficient manufacturers.
CMIS 520 April 11, 2005
Generic Strategies in Network Markets
Performance Play Boldest and riskiest of the four strategies. Involves the introduction of a new,
incompatible technology over which the vendor retains strong proprietary control.
Makes the most sense if your advantage is primarily based on the development of a striking new technology that offers advantages over existing technology.
Examples – Nintendo, Palm pilot, Zip Drive How about Google?
CMIS 520 April 11, 2005
Lessons
Positive Feedback - The Dynamic Process by which the Strong get Stronger and Weak get Weaker.
Adoption Dynamics – In the Presence of Positive Feedback tend to follow a predictable “S” pattern, or logistic growth path (slow start, rapid growth, the saturation)
CMIS 520 April 11, 2005
LessonsConsumers Value Information Technologies that are widely used, just as they value communications networks with broad reach. Positive Feedback works to the advantage of large networks and against small networks. Consumer Expectations are vital to obtaining the critical mass necessary to fuel growth.
CMIS 520 April 11, 2005
Lessons
Firms introducing new products and technologies face a fundamental trade-off between performance and compatibility.Firms Introducing new products and technologies also face a fundamental trade-off between openness and control.Many of the tactics for dealing with positive feedback and network externalities have been used in the past.
CMIS 520 April 11, 2005
Lessons
There are four generic strategies for innovators in network markets Performance Play Controlled Migration Open Migration Discontinuity