Transcript Network and Positive Feedback

Information Rules:
A STRATEGIC GUIDE TO THE NETWORK ECONOMY
Networks and Positive Feedback
Carl Shapiro
Hal R. Varian
Modified by Ekaterina Shurkova and Gaurav Gupta
Important Ideas
Positive feedback
Network effects
Economies of scale
Demand side
Supply side
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Network Effects
Real networks
Virtual networks
Number of users
Adds value
Metcalfe’s Law:
Value of network of size n proportional to n2
Example: fax machine, Playstation Users
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Positive Feedback
Strong get stronger, weak get weaker
Negative feedback
Makes a market “tippy”
Example: VHS v. Beta
“Winner take all markets”
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“Winner take all markets”Positive Feedback
100
Market Share (percent)
Winner
50
Battle Zone
Loser
0
Time
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Positive Feedback (Example)
Atari ↔ Nintendo
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Adoption Dynamics
Number of users
Saturation
Takeoff
Launch
Time
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Adoption Dynamics (Examples)
Biological world;
Fax machine;
E-mail;
The Internet;
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Sources of Positive Feedback
Supply side economies of scale
Declining average cost
Marginal cost less than average cost
Example: information goods
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Sources of Positive Feedback
Demand side economies of scale
Based on number of users
Does Not dissipate when the market grows
Adds more value
Example : MS Word
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Popularity adds value in a Network industry
Value to user
Virtuous cycle
Vicious
cycle
Number of compatible users
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Lock-In and Switching Costs
Network effects lead to substantial
collective switching costs
Even worse than individual lock-in
Due to coordination costs
Example: QWERTY
Example: Metric System in the US
Cell Phone Providers (free calls)
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Don’t Get Carried Away
Network externalities don’t always apply
ISPs (but watch out for QoS)
PC production
DVD Players
Likelihood of tipping
See next slide
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Likelihood of Tipping
Low Scale High Scale
Economies Economies
Low Demand
For Variety
Unlikely
High
(e.g. staples)
(e.g. Operating System)
High Demand
For Variety
Low
Depends
(e.g. Shampoo)
(e.g. Fast Food)
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Igniting Positive Feedback
Evolution
Give up some performance to ensure
compatibility, thus easing consumer adoption
Revolution
Wipe the slate clean and come up with the best
product possible
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Evolution
Offer a migration path
Examples
Microsoft (WordPerfect)
Borland copies from Lotus
Apple (new Intel chip)
Build new network by links to old one
Problems: technical and legal
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Technical Obstacles
Use Creative design
Think in terms of system
Converters and bridge technologies
One-way compatibility
Office 97 as an upgrade of Office 95
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Legal Obstacles
Need IP licensing
Example: Sony and Philips CDs
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Revolution
Groves’s law: “10X rule”
But depends on switching costs
Example: Records -> CDs

DVD -> new format(?)
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 Your reward = Total
added to industry x
your share
 Value added to
industry
Depends on kind of
Product and
Size of network
 Your share
Royalty payments
Your share of industry value
What To Choose
Proprietary
Optimum
Your Reward
Open
Total value added to Industry
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Openness v. Control
Openness
Make interfaces and specifications available to
others
Example Jabber
Control
Keeping the technology or system proprietary
Example Skype
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Openness
Full openness
Anybody can make the product
Problem: no champion
Alliance
Only members of alliance can use
Example SAE (Society Of Automotive
Engineers) Technology - ESP
Problem – holding the alliance together
Example AIM (Apple/IBM/Motorola)
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Control
Control standard and go it alone
Usually market leaders
If several try this strategy, may lead to
standards wars
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Generic Strategies
Compatible
(Evolution)
Control
Open
Controlled
Migration
Open
Migration
Incompatible Performance
Discontinuity
(Revolution)
Play
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Performance Play
 Introduce new,
incompatible technology
 Examples
Palm Pilot
Iomega Zip
 Attractive if
Great technology
Outsider with no installed
base
Compatible
(Evolution)
Control
Open
Controlled
Migration
Open
Migration
Incompatible Performance
Discontinuity
(Revolution)
Play
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Controlled Migration
 Compatible, but proprietary
 Examples
Windows
Upgrades
Compatible
(Evolution)
Control
Open
Controlled
Migration
Open
Migration
Incompatible Performance
Discontinuity
(Revolution)
Play
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Open Migration
 Many vendors, compatible technology
 Examples
Fax machines
Compatible
(Evolution)
Control
Open
Controlled
Migration
Open
Migration
Incompatible Performance
Discontinuity
(Revolution)
Play
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Discontinuity
 Many vendors, new technology
 Examples
Satellite radio
Compatible
(Evolution)
Control
Open
Controlled
Migration
Open
Migration
Incompatible Performance
Discontinuity
(Revolution)
Play
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Historical Example of Positive Feedback
RR gauges
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