Network Effects, Platforms, Standards, and Complex Systems

A/Prof Jeffrey Funk

Division of Engineering and Technology

Management

National University of Singapore

Network Effects, Platforms, Standards, and

Complex Systems

5th Session in MT5016

Sources: Shapiro and Varian, Information Rules; Rohlfs, Bandwagon Technologies; Paying

with Plastic, Evans and Schmalensee: Platform Leadership, Cusumano and Gawer; Five

Timeless Lessons from Bill Gates, Any Grove, and Steve Jobs, Cusumano and Yoffie

Business Model

Value proposition: what to offer and how to differentiate

This partly depends on network effects Customer selection: whom to serve and not serve

Value capture: dominant sources of revenue

Scope of activities: what activities to carry out and what relationships to have

This partly depends on the existence of standards, particularly open standards

Strategic control: how to sustain profitability (e.g., how to control architecture and standards)

This partly depends on who controls standards

We Live in a World of Complex

Interconnected Systems

Almost everything is a system

Plastic is produced by a system, called a chemical plant

But the systems keep becoming more connected

They are connected by interface standards that are

embedded in products

Some interface standards and products become bottlenecks,

have large impact on how systems work

These types of products are called platforms, many of the

most valuable firms offer platforms and control standards

The value of many platforms is a function of network effects

What are Platforms and Standards?

Windows Platform Android Platform

Interface

Standards

Outline

What are network effects?

What are standards?

How are standards chosen?

What are “standards wars” and what impact do they

have on competition? Key issues:

Performance vs. compatibility

Open vs. closed

Key tactics and assets

Various examples

What are Network Effects (NE)?

Effect that one user of a good or service has on value of that

product for other people

Direct effects

Value of product depends on number of users

Examples: telephones, facsimile machines, Internet mail, SMS,

Social Networking (FB), Instant Messaging Sites (What’s App)

Indirect effects

Value of a product depends on number of complementary products

Old examples: Software & hardware for computers, video games,

music, video players, mobile phone standards

New examples: Mobile phone Apps (Apple, Uber), Wearable

Computing, Internet of Things, Smart Homes, Smart Cities

Number of complementary products often depends on number of

users

Other Examples of Indirect Network Effects (NE)

Industry Product Network Effects

Real

Estate

Property sales Buyer, seller

Rentals Renter, owner

Media Newspapers, Magazines Reader, advertiser

Network television Viewer, Advertiser

Portals and Web

Publications

Web surfer,

advertiser

Shopping Malls Merchant, shopper

Payment

System

Charge/debit card Cardholder,

merchant

How do NEs Impact on Purchasing Decisions?

Products competing in market segments with no NE

Consumers/customers base their purchase decision on the intrinsic value and utility of the product to them

Competition on the basis of features, price, promotion, after sales service, etc.

Products competing in market with NE

Consumers/customers base purchase decisions on the size of the installed base and/or the (actual or projected) accessibility, quality, and functionality of complementary products and services

Competition on the basis of the size of the installed base, availability of complementary products and their suppliers’ competence and support

With Strong Network Effects, Market Share Itself Creates

Value

Value toconsumer

Actual (or anticipated) size of the installed base

Value of Network EffectsDriven product

Conventional product (e.g., automobile)

While the competing products lose value

Competi-tiveness of competing standard

Installed base of products that work with yourstandard

Network Effects-Driven product

Conventional product

Winner Take-All from Network Effects

1

Probability

next consumer/

producer

chooses

technology A

Assumption:

Only two technologies,

A and B, and consumers

have same needs

0

(1) When A’s

probability is

higher than its

market share, A

tends to converge

to 1 (winner-take-

all)

(2) When A’s

probability is lower,

it tends to converge

to 0 (loser-gets-

nothing)

(1)

(2)

A’s Market Share

When Network Effects are Strong,

but not strong enough for winner-take

1

Probability

next consumer/

producer

chooses

technology A

0

The result is two

or three

technologies that

co-exist

A’s Market Share

equilibrium

Small Change in Support, Large Change in Share…

Support by movie distributors in 2007 for new movie discs

HD DVD: Paramount, Universal, Warner Brothers

Blu-ray: Sony, Disney, MGM, Warner Brothers

50-50 split in hardware sales in 2007

Warner Broth removed support for HD on Jan. 4, 2008

causing market share for Blu-ray hardware to jump to

90% in week of January 12

63% in week of January 19 despite heavy discounts by HD DVD

suppliers (Source: NY Times, Feb. 5, 2008, HBS Case)

By mid-February

Toshiba stopped production of HD DVD

Walmart and NetFlix would only supply Blu-ray

Winner Take all Markets for

Products/Platforms* and Firms

Search Google

Social networking Facebook

Phones

Apple iPhone and Android phones

Phone messaging services Depends on country: What’s App, Viber, Weibo, Line

Taxi Services Depends on country: Uber, Didi Dache

Hosted services for selling products E-bay

Amazon

*No accepted term – people

use product,

technology, platform, standard

Older Examples of Winner Take all Markets for

Standards/Firms (for a certain time period)

Computers

IBM System/360 in mainframes

Wintel in PCs (Windows and Intel microprocessor)

Oracle data base software

UNIX in workstations, Portable memory formats

Internet

HTML, URLs, etc.

Cisco’s IOS for operating systems in routers

Paypal for online micropayments

Documents – e.g., Adobe

Vector Graphics – e.g., Flash

Other Old Examples

Telecommunication

GSM for second generation mobile phone systems

WCDMA for third generation mobile phone systems

Various facsimile and modem standards

Transportation Railroad gauge

Specific airports as airline hubs (to a lesser extent)

Container sizes, Automobile fuels, i.e., gasoline

Consumer Electronics B&W and Color Television standards

Music: records, cassette tapes, CDs, MP3

Movie/Video: VHS, DVD (both 1G and 2G)

Video game consoles

In Future

To what extent will there be winner take all for

following?

Transportation companies (e.g., Uber)

Other sharing economy examples: grocery (Instacart) or

restaurant (Zomato)

Wearable Health: Jawbone

Internet of Things: Hortonworks (supplier of Hadoop software)

Smart Homes

Smart Cities

Automated Vehicles: Google

Electric Vehicles: Tesla

Massively Open Online Courses

Winner Take All is Most Common when There

are High Switching Costs

The costs that a user incurs when they change products – high switching costs can lead to lock-in

Can’t sell your product because users are locked in

Can’t use other products because you are locked in

Highest switching costs for enterprise products

Wintel computers

SAP or Oracle software

Smaller switching costs for consumer products, but can be large when they are summed over all users

Thus, were large for music and movie technologies/standards

Why are there high switching costs for telephone numbers?

What about Uber and other demand-based economy apps?

Implications of Winner Take All

Investors are willing to invest heavily on products or services with strong network effects Facebook is classic example

Also Twitter, What’s App, other messaging and Internet services

Many members of billion dollar startup club have strong network effects

Investors don’t expect early profits Instead, they want many users

They believe that money can be extracted later, small amounts per user

Extracting value is seen as different skills than creating value

Suppliers Shouldn’t Overestimate Importance of

Network Effects and Lock-In

Internet Bubble broke in 2000

One reason bubble occurred

is because firms thought that

Network effects were very strong

Users were willing to pay

a higher price for services

from the leaders and would be “locked-in” to early leaders

And thus firms needed to obtain market share quickly

Lock-in hasn’t occurred to this extent

In fact, leading Internet firms became successful after

bubble burst (now they benefit from NEs and lock-in)

Is there a bubble now in billion dollar startup club?

NASDAQ

Composite

http://en.wikipedia.org/wiki/File:Nasdaq2.png

http://en.wikipedia.org/wiki/File:Nasdaq2.png

Network Effects are Easy to Misunderstand!

Even the experts make mistakes

Just remember critical questions:

What emphasis do consumers/customers base their

purchase decision on the

intrinsic value and utility of the product to them

size of the installed base and/or the (actual or projected)

accessibility, quality, and functionality of complementary

products and services?

What are the extent of the switching costs?

Outline


What are standards?





Open vs. closed


Various examples

What are Standards

A Standard is a set of technical

specifications adhered to by a producer,

either tacitly or as a result of a formal

agreement

Source: David and Greenstein, The Economics Of Compatibility Standards: An Introduction To

Recent Research, Economics of Innovation and New Technology, Volume 1, Issue 1-2, 1990

Types of Standards

Reference and minimum quality standards

Provides a signal that a given product conforms to the content and level of certain defined characteristics (e.g., ISO 9000)

Today’s focus: Interface or compatibility standards

Assures user that intermediate product or component can be successfully incorporated in larger system

What will be the composition of the system and the interfaces between the components

Think of puzzles or Lego blocks

Examples of Interface Standards

Mobile phones: between

Phones and base stations

Operating systems and apps

Music and video systems: between

phonograph record and stylus,

magnetic tape and read-write head

optical disk and read-write system

(laser and photodiode)

MP3 player and Internet

Computer systems: between hardware, operating system and

application programs

Transportation systems: between train wheels and rail gauge

Trading systems: money

Examples of Interface Standards (continued)

Wireline Communication systems, between modems and computers

facsimile machines and telephone system

Broadcasting systems between transmitters and receiver (e.g., television, radio)

Electric power: between power station, transmission system, and home appliances

Automobiles and fueling station between fuel source and method of propulsion

between nozzle and fuel tank

In future: Internet of Things, Wearable Health, Messaging Apps, Smart Homes, Smart Cities, Automated Vehicles, Sharing Economy,

Data acquisition:

sensors, ICs

Data transport:

cellular, satellite,

Wi-Fi, Bluetooth,

Zigbee,

Data analysis

and

interpretation:

Big Data

What will be the Standards for the Internet of Things?(e.g., what will be the application programming interfaces between each block)

Example of Usage-Based Insurance for Automobile

Decision

Making by User

Firms

Data acquisition:

Speeds,

acceleration,

location and thus

type of road

Data transport:

cellular

Data analysis

and

interpretation:

Characterize

Driving

Behavior

Decision

Making by User

Firms:

Determine rates

Will they capture most of the value?

Standards for IoT

Still not yet determined

But IBM, G.E. and others announced standard for core

elements of technology framework for data analysis in IoT

They will develop products and services based on Hadoop

method for distributing, managing and processing very large and often

disparate amounts of data

open-source software http://nyti.ms/1vbzWEK

several startups (HortonWorks and Cloudera are or have been

members of billion dollar startup club) have released products

If Hadoop becomes standard,

competition will shift to another interface

Hortonworks or Cloudera may release closed versions of standard

Who will be the big winner(s)?

Standards in Wearable Health

Many stand-alone products exist (Apple iWatch and Apple Health, Google Nest Android Wear, Samsung Live Gear, InfraV, Jawbone, Body Media)

But stand-alone devices will probably not win

Which standards will connect products and win?

May depend on which products attract final users and suppliers of complementary products

Standards for Wearable Health (2)

Attracting final users will partly be determined by

good design choices

Body media focuses on the body because more data can be

collected

Jawbone focuses on the wrist because the wrist device

seems more aesthetically appealing

Which will attract the most data analyzers, e.g., hospitals,

clinics, insurance companies? And other suppliers,

including those of integrated circuits and sensors

Later parts of the battle will be determined by alliances,

compatibility, and openness (more on this later)

Standards for Messaging Apps

Messaging Apps have become important platforms for additional services Not just messaging

Other services particularly in China and Japan: send and receive money, make payments, check into hotel, buy train tickets

Thus, income from messaging apps may become large

How much larger? How many more services?

This is one reason why FB paid $19 billion for What’s App

Which messaging app will become the global standard?

The more users, the more valuable to Other users

businesses

What About Taxi Apps?

Can they become platforms for other services?

Truly ride sharing apps? Uber calls its service ride sharing, but usually just one passenger

Can someone offer cheaper services that involve multiple passengers?

Can these services be more convenient than conventional bus or train services?

Will supplier’s knowledge of starting and ending points enable it to devise better bus services?

Logistics Can taxi apps be used for delivering packages?

Or having third parties do other work?

Part of high valuations for taxi companies and for other sharing economy and demand-based services come from logic of network effects and expanded services

Standards Impact on Many of the Firms

in the Billion Dollar Startup Club

Software(33)

cloud, big data, ads,

security, database

e-commerce (25)

fashion related sites

Consumer internet (22)

taxis, social networking, food

Financial services (11)

Hardware: phones, wearable

computing (10)

Other (13)

Large impact, how

will software fit

together?

Will impact on

some of these

Large impact:

Payments, P2P lending

require standards

Hardware will probably

not be stand-alone

The Ultimate Standard

Have you seen the movie “In Time”

http://www.ifc.com/fix/2011/08/in-time-

trailer-justin-timberlake (up to 1:00)

What does this have to do with standards and

making money?

http://www.ifc.com/fix/2011/08/in-time-trailer-justin-timberlake

Outline


What are standards?





Open vs. closed


Various examples

Types of Interface Standards and

How they are Chosen

1. Unsponsored standards

The originator nor any subsequent sponsoring agency

holds a proprietary interest (e.g., to some extent UNIX,

Linux, Hadoop)

Disadvantage of open source software

2. Sponsored standards

Where one or more sponsoring entities holding a direct

or indirect interest, creating incentives for other firms to

adopt particular sets of technical specifications (e.g.,

www consortium, CDs, DVDs, Wintel PCs, facsimiles)

Types of Standards and How they are Chosen

3. Standards agreements

These are arrived at within and published by voluntary

standards-writing organizations (ANSI, ISO, IEEE, etc.)

Sponsored standards (CDs, DVDs, and those for telecom,

Internet) are sometimes addressed in these agreements

4. Mandated standards

These are implemented by government agencies that have some

regulatory authority

Few interface standards are mandated anymore (some

telecommunication and broadcasting standards but many other

standards (building, accounting, environmental, safety) are

mandated

Another way to Classify Standard Setting:

De facto vs. de Jure Standards (1)

Defacto

Both unsponsored (1) and sponsored (2) standards emerge

from market-mediated processes

Dejure

Both standards agreements (3) and mandated standards (4)

are a consequence of political/committee deliberations or

administrative procedures which may be influenced market

processes without reflecting them in any simple way

De facto and de Jure Standards (2)

De jure: created by the lawful exercise of power

In the past, most broadcasting and telecom standards

De facto: determined by a combination of better

performance, network effects, openness, backward

compatibility, and/or biz model. Examples include:

PCs (Wintel)

Music (CDs)

Movie (VHS, DVD)

Phone (iOS, Android)

Instant messaging (What’s App, WeChat)

De facto and de Jure Standards (3)

Importance of de Jure standards is declining

Power of national committees have declined

Importance of market has increased

Although need for agreements on standards have increased,

thus making committees more important (>1000 for mobile

phones)

Many standards are created in a committee but market determines

winner (e.g., many mobile phone standards)

Many standards/platforms are created by single firms (Apple,

What’s App)

Outline


What are standards?





Open vs. closed


Various examples

Standard Wars

Battle between rival technologies to become

recognized “standard”

Winner-take all standards sometimes leads to winner

take all firms

Large benefits to having your technology become a

standard

one key method of strategic control

control how different products interact with each other

Thus firms invest a lot of money and time to make (or

try to make) their technology a standard

First key issue is performance vs. compatibility

Compatibility

Performance

(relative to Price)

Evolution

Revolution

Improved design

and adaptation

Performance (relative to Price) Versus Compatibility

(as compared to existing technology)

Types of Standards Wars: Degree of

Compatibility with Existing Technology

Compatible

Incompatible

Compatible Incompatible

Revolution

Versus

Evolution

Rival

Revolutions

Evolution

Versus

Revolution

Rival

Evolutions

Rival Technology

Yo

ur

Tec

hn

olo

gy

Source: Shapiro

and Varian

Types of Standards Wars

Compatible

Incompatible

Compatible Incompatible

New versions of

mobile communica-

tion standards (e.g.,

5G), wearable health?,

messaging apps?

Rival Technology

You

r T

ech

no

log

y

New versions of

Windows or

Medical Devices

Smart Watch vs.

updated versions

of iPhone or

Android

Microsoft Office vs.

free versions of word

processing, power point,

spreadsheet, Prezi

Outline


What are standards?





Open vs. closed


Various examples

Closed versus Open Strategy

Closed Strategy

Do not release specifications about interface standards

Control everything about interface standards

Open Strategy

Release specifications about interface standards

Work with other firms

Tradeoff between degree of openness & control

must be open to obtain users and obtain cooperation from

producers of complementary products due to importance of

network effects

as degree of openness increases, unit profits may decline

Openness (Two Definitions) Increases as One

Moves Down this slide

In Specifications

Do not release any specifications and make all hardware and software (most closed)

Only make software or hardware Release some information about key

interfaces

Release all information but control updates

Fully open standard and standard setting process

Number of Firms

One firm controls

standard (most

closed)

Members of alliance

control standard

All firms have access

to standard

Merchant

Merchant

(98%)

Consumer

Visa,

MasterCard

Acquirer

(0.4%)

(e.g., First

Data)

Consumer

Issuer

(e.g., Banks)

American

Express,

Discover

1 (Shop)

2 3

3

2

2

3

Bill/Pay

1 (Shop)

3 2Bill/Pay

Closed-Loop System

Open-Loop System

2: Authorization

3: Settlement (interchange fee in this case is 1.4% and merchant discount is 1.8%)

Together

Share 1.4%

Credit Cards

(example of greater openness with more firms): Visa and Master Card enabled

acquirers and issuers to sign up merchants and consumers, i.e., more open

Outline


What are standards?





Open vs. closed


Various examples

Key Tactics in Standards Wars

Preemption Announcing a product or service before it is ready in order to

reduce interests in a competitor’s products or services

Expectations management Assemble allies

Convince large companies or governments to support your service and then everyone expects you to win Governments (e.g., European governments in case of GSM)

Large corporations in case of video and software formats

Discounting the service for a specific set of users or providers of complementary services (previously discussed) Document readers (Adobe)

Video and music players

Key Assets in Standards Wars

For benefitting from network effects Control over an installed base of users – Microsoft in operating

systems

First-mover advantages – Apple, Google

For convincing other firms to align their technology with your technology or users to adopt your technology Strength in complements – Apple with media companies

Brand name and reputation – Apple, Google, IBM

For benefiting from technology being part of standard Intellectual property rights –Qualcomm in phones

For reducing need to have your technology in standard Ability to innovate – Apple

Manufacturing capabilities – Japanese firms previously had advantages

Outline


What are standards?





Open vs. closed


Various examples

Standards Battle in the US Railroad Gauges

Although some governments chose the width of the railroad gauge (e.g., Japan, Europe), the U.S. government did not

By accident different size gauges (width of rail line) were used in different parts of the U.S.

In 1860 (beginning of U.S. North-South Civil War)

50% of rail gauge was 4 feet 8 inches (the northern states)

50% was 5 feet (the southern states)

No real issues of openness (all were open) or compatibility/performance comparison with previous technology

Key issue was network effects and winner take all

North built railroad to west during and after Civil War

Network effects caused 4 feet 8 inch gauge to win and South changed all of its railroad lines to 4 feet 8 inches

Color Television

U.S. Government

chose RCA’s (owned NBC) technology

as black-and white standard in 1940

Initially chose CBS’s technology as color standard in 1951

But CBS technology was not backward compatibility with

B&W TVs

And manufacturers refused to make color TVs

RCA proposed color TV standard that was compatible

with B&W TV in mid-1950s

U.S. government changed to RCA technology in mid-1950s

But took many years (until 1968) for color TVs sales to

pass those of B&W TVs – issue of cost and critical mass

Color Television (continued)

Openness versus control

Both CBS and RCA licensed their technology (similar

openness)

Choice of RCA’s technology provided it with important

licensing fees and temporary manufacturing advantages

Compatibility and Performance

Performance advantages of first color TVs did not make up

for lack of compatibility with B&W TVs

Video Cassette Recorders (VCRs)

Ampex introduced first VCR in mid-1950s for broadcasters

Many firms (including Japanese ones) introduced simpler and cheaper VCRs (Helical design) for training etc. in mid-1960s

Reductions in price created consumer market in early 1970s Consumers used them to record television programs

Pre-recorded movies did not have strong sales until early 1980s

Sony and Matsushita/JVC introduced incompatible systems in mid-1970s Sony’s (Betamax) system appeared first and achieved early lead in sales

But Matsushita/JVC’s system (VHS) had longer recording times and more manufacturers

Sales of VHS units passed Beta in 1977, Beta discontinued in mid-1980s

Video Cassette Recorders - continued

Network Effects

they emerged as pre-recorded movies became available; this

caused winner take all for VHS

However, since recording television programs drove diffusion of

VCR, network effects did not initially apply to VCRs

Compatibility and Performance

Backward compatibility with Ampex Quadruplex was irrelevant

as only broadcasters used Quadruplex

But many argue performance advantage of VHS (longer

recording time) led to its greater diffusion than Betamax


Others argue that VHS’s greater openness (JVC/Matsushita

licensed more producers of hardware) was key to success

Personal Computers

Initial competition

First PC released in 1975

Apple, Commodore, Tandy released PCs in 1977

Apple and CP/M compatible (OS) machines were leaders by 1978

Apples machine used proprietary technology such as OS

IBM PC

IBM introduced open-modular product in 1981 that used external technology (e.g., Microsoft and Intel) that is summarized on the next slide

IBM’s PC included:

Operating System from Microsoft

Hybrid 8- and 16-bit microprocessor from Intel 8-bit capability provided compatibility with software written

for CP/M OS

16-bit capability enabled software superior to that used in Apple computer: Word Perfect replaced Word Star in word processing software, Lotus 1-2-3 replaced VisiCalc in spreadsheets

But other manufacturers introduced clones

Microsoft (and Intel) became big winners through control of key interfaces. Subsequently, they have introduced products that are backward compatible

Personal Computers - continued

Network Effects

Increased in importance following release of IBM PC


Openness of IBM machine contributed to its success

But openness enabled Microsoft, Intel to become big winners

Lessons:

IBM should have pursued more closed policy

Apple should have pursued more open policy

Compatibility and performance

IBM PC was not compatible with previous generations of

computers (but compatible with some previous PCs)

But for many users IBM PC was superior in terms of

performance-price ratio to mainframe and mini-computers

Outline (and Learning Objectives)

What are standards and complex systems?



What is a critical mass of users?

What are “standards wars” and what impact do they have on competition? Key issues: Performance vs. compatibility

Open vs. closed


Various examples (mobile phones)

Mobile Phones (1)

Single transmitter systems introduced in 1920s for police, taxi, fire, military, etc.; public systems introduced in 1950s But single transmitter/receiver restricted number of users

Dividing system in cells and reusing frequency spectrum in each cell increased system capacity and reduced the cost

First cellular systems introduced in late 1970s in Scandinavia and later in U.S. interface standards determined interaction between base

stations and phones

U.S. standard (AMPS) became global standard

Mobile Phones (2)

Digital services first introduced in 1991 (GSM standard)

First successful mobile Internet service in 1999 in Japan required many different standard standards

Compatibility between different standards and thus integral design

As processing power and memory capacity increased, it became possible to

design phone systems and phones in a modular way

use interface standards from PC Internet

and now we have the iPhone and the Google phone

Let’s look at the history of the mobile phone industry

in more detail

Batteries

Key Interface Standard in Mobile Phone Industry

Phone

Manufacturers

Displays

Interface defined by air-interface

standards such as GSM and CDMA

Chips

Software

Operators

Base Stations

Switching Equipment

Network Software

Retail Customer

Source: Adapted from (Steinbock, 2003; Peppard and Rylander, 2006)

Type of

Mobile

Dates Generation of

Technology

Global

Standard(s)

Single

transmitter

/receiver

Early 1900s Wireless Telegraph Not applicable

From 1920s Wireless Voice

(police, military)

Not applicable

Cellular 1970s,

1980s

1G

Analog

AMPS (U.S.)

1980s, early

1990s

2G Digital GSM (Europe)

Late 1990s 3G W-CDMA

2000s Mobile Internet PC Internet-based

standards

Evolution of Technology and Standards in Mobile Phones

Competition Between 2G Digital Phone Systems

Europe Countries agreed to develop single standard in 1987

Began awarding new licenses in 1989

Non-European countries began adopting GSM in early 1990s

Services started in 1992

U.S. Finalized specs for standard (D-AMPS) in 1989

But no new licenses! And incumbents didn’t invest in digital

Alternative from Qualcomm (CDMA) later emerged and U.S. government allowed service providers to use any technology

Japan NTT DoCoMo created the Japanese standard in cooperation only

with Japanese manufacturers (i.e., no openness!)

Compatibility

Performance

Evolution

Revolution

Improved design

and adaptation

Qualcomm’s Technology (CDMA) vs. GSM in late 1990s

Qualcomm

GSM updates

Qualcomm’s CDMA Technology

Successful IP strategy

Charges the same licensing fee for use of its patents in both its

3G CDMA (e.g., cdma2000) technology and the most widely

used version of CDMA technology (W-CDMA)

Qualcomm makes lots of money

Unsuccessful standards strategy

W-CDMA is much more widely used than Qualcomm’s 3G

technology

Qualcomm’s partners (Motorola, Lucent, Nortel) have lost

significant share of the infrastructure market because of the lack

of success in Qualcomm’s 3G technology

New Standards Continue to Emerge

Network standards (between base station and phone)

4G

Cognitive Radio

WiFi

WLAN

Content and Application related standards

2D Bar Codes

Payments and tickets (Wallet Phones)

3D content

Operating System (which connects applications with content)

We will talk about operating systems next week

Conclusions (1)

Network effects have a large impact on value proposition for some products Some very large, some not so large

But when effect is large, large impact on competition and profits

Network effects impact on many products that involve interface standards

Interface standards technically define interfaces between different modules or building blocks in complex systems

Relatively open standards facilitate vertical disintegration and thus new types of scope of activities (next week)

But small amounts of control can lead to high profits for some firms

Thus monitoring, participating and succeeding in standards are critical issues in defining business models

Conclusions (2)

The choice of standards is not just due to technical

performance (intrinsic value) but also due to network

effects (favors early installed base)

Levels of openness and backward compatibility, and

other tactics that lead to an early installed base (i.e.,

network effects) are also important

degree of network effects can differ dramatically among products

and systems

strong network effects can lead to early leader becoming

standard

very strong network effects can lead to high switching costs

Conclusions (3)

Although different types of standards require different

types of strategies, degree of openness and compatibility

play critical roles in all standard setting

Openness increases chance of adoption but may decrease profits

Backward compatibility also increases chances of adoption

Performance advantages can overcome backward

incompatibility (i.e., there is a tradeoff between performance

and compatibility)

Who pays and how much (methods of value capture) are critical

in building a critical mass of users for your system/product and

the standards included in the system/product