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Network Effects, Platforms, Standards, and Complex Systems

These slides discuss Network Effects, Platforms, Standards, and Complex Systems. All of these concepts continue to become more important as the digital economy progresses. From Uber to Instacart, and from smart phones to driverless vehicles, these concepts are playing an increasingly important role in the global economy. Their impact is most obvious when one thinks of the winner take all markets that are becoming increasingly common.

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Network Effects, Platforms, Standards, and Complex Systems

  1. 1. 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
  2. 2. 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
  3. 3. 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
  4. 4. What are Platforms and Standards? Windows Platform Android Platform Interface Standards
  5. 5. 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
  6. 6. 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
  7. 7. 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
  8. 8. 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
  9. 9. With Strong Network Effects, Market Share Itself Creates Value Value to consumer Actual (or anticipated) size of the installed base Value of Network Effects Driven product Conventional product (e.g., automobile)
  10. 10. While the competing products lose value Competi- tiveness of competing standard Installed base of products that work with your standard Network Effects- Driven product Conventional product
  11. 11. 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
  12. 12. 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
  13. 13. 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
  14. 14. 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
  15. 15. 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
  16. 16. 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
  17. 17. 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
  18. 18. 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?
  19. 19. 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
  20. 20. 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
  21. 21. 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?
  22. 22. 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
  23. 23. 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
  24. 24. 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
  25. 25. 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
  26. 26. 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,
  27. 27. 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?
  28. 28. 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  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)?
  29. 29. Standards in Wearable Health  Many stand-alone products exist (Apple iWatch and Apple Health, Google Nest AndroidWear, 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
  30. 30. 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)
  31. 31. Standards for Messaging Apps  MessagingApps 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 forWhat’sApp  Which messaging app will become the global standard?  The more users, the more valuable to  Other users  businesses
  32. 32. 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
  33. 33. 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
  34. 34. The Ultimate Standard  Have you seen the movie “InTime”  trailer-justin-timberlake (up to 1:00)  What does this have to do with standards and making money?
  35. 35. 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
  36. 36. 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)
  37. 37. 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
  38. 38. 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
  39. 39. 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)
  40. 40. 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)
  41. 41. 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
  42. 42. 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
  43. 43. Compatibility Performance (relative to Price) Evolution Revolution Improved design and adaptation Performance (relative to Price) Versus Compatibility (as compared to existing technology)
  44. 44. 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 YourTechnology Source: Shapiro and Varian
  45. 45. Types of Standards Wars Compatible Incompatible Compatible Incompatible New versions of mobile communica- tion standards (e.g., 5G), wearable health?, messaging apps? Rival Technology YourTechnology 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
  46. 46. 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
  47. 47. 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
  48. 48. 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
  49. 49. 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 2 Bill/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
  50. 50. 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
  51. 51. 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
  52. 52. 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
  53. 53. 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
  54. 54. 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
  55. 55. 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
  56. 56. 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
  57. 57. 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
  58. 58. 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  Openness versus control  Others argue that VHS’s greater openness (JVC/Matsushita licensed more producers of hardware) was key to success
  59. 59. 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
  60. 60. 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
  61. 61. Personal Computers - continued  Network Effects  Increased in importance following release of IBM PC  Openness versus control  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
  62. 62. Outline (and Learning Objectives)  What are standards and complex systems?  How are standards chosen?  What are network effects?  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  Key tactics and assets  Various examples (mobile phones)
  63. 63. 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
  64. 64. 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
  65. 65.  Let’s look at the history of the mobile phone industry in more detail
  66. 66. 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)
  67. 67. 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
  68. 68. 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!)
  69. 69. Compatibility Performance Evolution Revolution Improved design and adaptation Qualcomm’s Technology (CDMA) vs. GSM in late 1990s Qualcomm GSM updates
  70. 70. 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
  71. 71. 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
  72. 72. 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
  73. 73. 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
  74. 74. 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