MD240 -Management Information Systems

Oct. 25, 2005Network Externalities:

The Kingmaker of Tech Industry Competition

Topics Covered

• Network Externalities– Defined, Strategic Importance, Examples

• Operating Systems & Hardware Markets– Competition Among Operating Systems and

Computing Platforms– The Linux Challenge– Dell vs. the World– The Video Game Industry: Xbox Reloaded &

strategies for competing with new platforms

Network Externalities(a.k.a. Network Effects, Metcalfe’s Law)

• A product or service becomes more valuable as its installed base expands• Why do consumers care about installed base?

– Exchange opportunities– Stability– Extrinsic, complementary benefits

More Exchange Opportunities

More Members

Why are Markets for Network Goods Different?

• Market competition occurs very early and is particularly fierce

• Markets are ‘tippy’ and subject to bandwagons

• Markets exhibit monopolistic tendencies

• The ‘best’ technology or highest quality product doesn’t always win

SoftwareOperating Systems

control hardware and provide an environment in which applications execute

Application Programsend-user program that performs a specific function

Individual examples: word processor, spreadsheet. Collections of apps: Office (suite), SAP R/3 (ERP)

Appletssmall application programs which execute within a

larger environment (e.g. Java applets within browser)

operating system

applications

Competition in the OS Space

PersonalComputersWindows XP

Apple

Mutli-UserSystemsWindows 2000Windows Server2003

Unix (Sun, IBM, HP / Compaq)Linux

ConsumerDevicesWindows MobileUltimate TVXboxTablet PCWindows XP Media Center Edition

Palm (handheld)Liberate (set top)SonyLinux

Microsoft

Competition

A Growth Stock No More?

The Microsoft Stimulus Package

• In ’04 Microsoft returned $9 billion to individual investors that hold the stock (excluding all the institutions & funds).

• The Bush child tax credit returned $14 billion.

• Bill Gates has pledged all $3.4 billion to his charitable foundation.

Comments from Windows Source Code

private\genx\shell\inc\prsht.w:// we are such morons. Wiz97 underwent a redesign between IE4 and IE5

private\shell\ext\ftp\ftpdrop.cpp:// We have to do this only because Exchange is a moron.

private\shell\shdoc401\unicpp\desktop.cpp: // We are morons. We changed the IDeskTray interface between IE4

private\shell\browseui\itbar.cpp:// should be fixed in the apps themselves. Morons! .

Fear the Penguin?

Server MarketDesktop Market

16 Bit Game ConsolesSource: Schilling 2003

32/64 Bit Game Consoles (failed)Source: Schilling 2003

32/64 Bit Game ConsolesSource: Schilling 2003

128 Bit Game ConsolesSource: Schilling 2003

Components of Consumer Value for Network Goods

TechnologicalFunctionality

Installed base(exchange)

ComplementaryGoods Availability(extrinsic benefits)

Panel AIncumbent product

Switching Costs(stability)

Panel BNew entrant, compatiblewith existing installed baseand complementary goods

Switching Costs (stability)

TechnologicalFunctionality

Installed base(exchange)

ComplementaryGoods Availability(extrinsic benefits)

Compatible technologiescan tap into the same installed base and complementary products as the incumbent.This dramatically lowers (or eliminates) switching costs, leaving the products to compete on technical functionality.

Components of Consumer Value for Network Goods

TechnologicalFunctionality

Installed base(exchange)

ComplementaryGoods Availability(extrinsic benefits)

Switching Costs(stability)

Panel AIncumbent product

Panel CNew, incompatible entrant

TechnologicalFunctionality

Radical innovation may be necessary if an incompatible technology is to overthrow an established standard.

The technical benefits of the new innovation must exceed the exchange, extrinsic, and stability benefits of the incumbent.

Competing in a Standards BattleTactics for New Entrants• Complementary Products

– Develop own complementary goods

– Develop through third-parties (subsidize, exclusives)

• Attract Consumers– lower price, subsidize adopters,

money back guarantee, free trial

• Distributors– Subsidies / guarantees

(consoles on consignment)– Alliances (Sun & Netscape to

distribute Java)

Tactics for Incumbents• Continuous innovation within the

standard– Create a moving target

• Backward compatibility– Problem with Intel Itanium

• Create Switching Costs– Exclusive products– iTunes– AIM

Signaling can be used by both: Pre-announcements, credible commitments (Xbox=$500 million marketing budget, 3DO = $37 million)