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Positive analysis of OS and the network
externalities
Faculty of Economics, Keio University
Tatsuo TANAKA
Email:[email protected]
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Network externality works in terms of
the interface among modules or users.
• PC’s OS
– Modules are
application software
and OS.
– Interface is API.
• Word Processor and spreadsheet
– Modules are users
– Interface is file format (+ friends-areteacher effects)
• Routers
– Modules are users (or routers)
– Interface is TCP/IP protocol and its
implementation
Application
software
Users
Users
Router
Router
API
Operating
system
OS
File Format
Word processor
and spreadsheet
2
Routers
Market structure : two contrary views
View I
• When interface is not open, there exists a tendency towards
monopoly even if firms obey the fair trade rules.
– Once the monopoly is established, no firm can challenge the monopoly
firm unless there is a “huge” innovation that overcomes the benefit of
the network externality. (so-called “lock-in”)
– Competition becomes weak. The price remains high and incentive for
innovation becomes low. (Losses of monopoly)
– The monopoly firm will try to extend the monopoly by bundling
complimentary products to its monopoly module (“leverage”)
View II
• Such “huge” innovations are common in the information
technology related industries.
– History shows successive changes of the dominant firms in the IT
industries. Windows faces potential challengers such as Linux.
– Decrease of price, enough incentive for innovations.
– Bundling the compliments into the products is beneficial to the users
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Solutions : two contrary views
View I
• [First best] Make the interface open so that other firms can
reap benefits from the network externality.
– In other word, the interface (e.g., API) should be unbundled from the
specific products.
• [Second best] Disintegrate the product or company into the
monopoly module and other modules.
– In other words, the monopoly module (e.g., OS) should be unbundled
from other modules (e.g., applications).
View II
• The first solution discourages the incentive for innovations.
• The second solution is harmful to users because bundling the
products is beneficial to the users.
4
Our approach to this issue
• Start: High and stable share or profit. Strategic(predatory) pricing.
• Step 1: Estimate network Is network
No
externality
externality
– Compare the effect of
network externality with
functional changes by
innovations.
• Step 2: Evaluate losses
from monopoly
– Price: Does price decrease
continuously?
– Innovations: Does the speed
of innovation get slower?
• Step3: Consider solutions’ cost
and benefits
– Make interface open
– Disintegrate the product
strong?
Ordinary
competition
policy
Yes
Losses from
monopoly?
No
Yes
Solutions’
effects and
side effects
Watch
anti-competitive
action
Not
effective
Watch
effective anti-competitive
action
Solutions
1) make the interface open
2)disintegrate the product
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Today’s subject: OS
• User survey (n=3319)
– History of OS usage during 1993-2004
– Reason of choice of OS
– Subjective evaluation of the OS
– Number of application software he/she regularly uses.
– Price of OS
• Presumption of this study
– Users remember his usage history of OS well.
93 94
OS
MacOS
Reason
1
NofAppli 5
Price
NA
95
96
97 98
W98
2
7
25k
6
99
00 01 02 03 04
W2000
WXP
3
3
8
7
NA
NA
Question:Why did you choose the OS?
• Reason of Choice
– 1)Excellent functions
Functions(Innovation)
– 2)Many application on this OS
Network Externalities
– 3)Many users to ask for advise
– 4)Already bought applications on this OS
Switching Cost
– 5)I get used to the operation of this OS
– 6)Same OS as in my company
NE + SC
– 7)Low price
Price
– 8)No other choice in the PC shop
– 9)I just choose PC hard
Others
– 10)Other
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Reason of OS choice:Windows
Functions
new
NE
SC
Price
WinXP
Win2000
WinME
Win98
Same OS as in my
company (SC + NE)
Low price
Win95
No other choice in the PC
shop
I just choose 10%25%
PC hard
:Increased
Win3.1
old
Excelent functions
(Innovations)
Many application on this
OS (NE)
There are many users of
this OS (NE)
Already bought appli on
this OS (SC)
I get used to this OS (SC)
MSDOS
0%
20%
40%
60%
Functions
Network E. :Decrease 40%20%
80%
100% Other
Switching C. :Increased 5%15%
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Reason of OS choice:Mac OS
Functions
new
NE
SC
M acO S X
M acO S 9
M acO S 8
Excelent functions
(Innovations)
M any application on this
O S (N E)
There are m any users of
this O S (N E)
A lready bought applion
this O S (SC )
I get used to this O S
(SC )
Sam e O S as in m y
com pany (SC + N E)
Low price
M acO S 7
old
N o other choice in the
P C shop
I just choose P C hard
:30%~45%
S ystem 7
0%
20%
40%
60%
Functions
Network
E. :Decrease
20%10%
O ther
80%
100%
Switching C. :Increased 5%20%
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Variables: how to measure
• Functions
– Users’ subjective evaluation of the OS
– Q:”Please evaluate the OS by score 0 ~ 100”
• Network Externalities
– Share of the OS
– Dummy for the largest share OS
• Switching Cost
– Number of application software in use.
• Price
– Average of users’ reports
Vij:utility when OS i’s user chooses OS j as a new OS.
Vij=a + b*Pricej + c*Functionj
+ d*Switching Costij + e*Network Effectj
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Functions:Subjective Evaluation of OS’s functions
Q:” Evaluate the functions of the OS by score 0 – 100.”
Evaluation on Functions by OS versions
Windows
MacOS
Innovations continue.
Average score of of all users
11
MacOSX
MacOS9
MacOS8
MacOS7
System7
WinXP
Win2000
WinME
Win98
Win95
Win3.1
Windows’ score is
slightly higher than
MacOS
MSDOS
90
80
70
60
50
40
30
20
10
0
Functional evaluation
has increased.
Functional difference
can explain
Windows’
larger share to some
extent.
Number of Users
by OS
versions
(total=3319)
Number
of users
by OS versions
1＝MS-DOS
2500
2＝Windows3.1
3＝Windows95
2000
4＝Windows98
WinXP
5＝WindowsMe
Win98
6＝Windows2000
1500
7＝WindowsXP
Win95
8＝system7
9＝MacOS7
1000
10＝MacOS8
Win3.1
WinMe
11＝MacOS9
MSDOS
12＝MacOSX
500
Win2000
13＝Linux
14＝その他Ｕｎｉｘ
15＝その他ＯＳ
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2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
MacOs
1993
0
Network Externalities:
Share of Windows and MacOS
Win vs Mac share, source=PC white book、Web source
100.0
Windows share has
increased steadily
from 70-80% to
90%
Network Externalities
has increased.
The difference of the
share is over 80%
90.0
80.0
Windows
70.0
60.0
50.0
40.0
30.0
MacOS
20.0
10.0
Win
Mac
13
20
04
20
03
20
02
20
01
20
00
19
99
19
98
19
97
19
96
19
95
19
94
19
93
0.0
Switching Cost: Number of software
Q:” How many application software do you use regularly? “
num ber of application soft that are used a few tim es a
m onth,by O S
Number of software
has increased to
around 7.
Switching cost has
increased
9.0
8.0
Windows
7.0
MacOS
6.0
5.0
No difference
between Windows’
users and MacOS
users.
4.0
3.0
2.0
Average number of software of the OS users
14
MacOSX
MacOS9
MacOS8
MacOS7
System7
WinXP
Win2000
WinME
Win98
Win95
MSDOS
0.0
Win3.1
1.0
Variance among users
are very large.
Price of OS
Q:” Write your OS’s price if you purchased it”
Prices of OS (unit=yen)
Price of Windows
increased, whereas price of
MacOS decreased.
50000
45000
Windows
40000
MacOS
35000
Since MacOS9, Windows
are more expensive than
MacOSs
30000
25000
20000
15000
10000
5000
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MacOSX
MacOS9
MacOS8
MacOS7
System7
WinXP
Win2000
WinME
Win98
Win95
Win3.1
MSDOS
0
Model: OS i,j = Windows or MacOS
Vkij:utility when user k using OS i chooses OS j as a new OS.
Vkij=a + b*Functionkj + c*Network Externalitiesj
+ d*Switching Costkij + e*Pricej
• Functionkj:user k’s subjective evaluation of the OS j
• Network Externalitiesj
– (1) Market share of OS j
– (2) Dummy for the Windows
• Switching Costkij :
– If i=j, 0
– if i is not equal to j, number of software in use of user k
• Pricej: average price of OS j
Users choose OS j that Vkij> Vkij’ for other OS j’
Discrete choice model
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Estimated result and interpretation
Case1
Functions
Evaluation(0-100)
Share of previous year
Network
(unit=%)
Externalitie
Dummy for Windows
s
Switching Number of application
Cost
software
Price
（unit=1000yen）
quasai R2(no coefficient)
quasai R2(With constant)
Number of observations
p-value in the parenthesis
Case2
Significant, and sign is as
expected except for price
0.0522
(0.00)
0.0244
(0.00)
0.0528
(0.00)
(0.00)
0.0123
(0.00)
(0.00)
0.0270 Assume 7 application software.
(0.00)
Assume 80% difference in share.
How much functional advance is
1.8655 necessary to beat Network E?
(0.00) (0.0244*80)=1.949 utility
-0.1589 -0.1612
1.949/0.0522=37.3
How much functional advance is
0.670 necessary to beat switching cost?
0.248 (0.1589*7)=1.11 utility
1.11/0.0522=21.3
6895
0.670
0.249
6895
Need 37 points gain in function to beat network externalities.
Need 21 points gain in function to beat switching cost.
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Does innovation beat the network externalities and switching
cost?
• Need 37 points to beat NE, 21 points to beat SC. Total=58 points
• Increase of functional improvement of version-up has been about
10 points(See the graph again) Evaluation on Functions by O S versions
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Average score of of all users
M acO S X
M acO S 9
M acO S 7
S ystem 7
W inX P
W in2000
W in98
W in95
MacOS
W inM E
It is almost impossible.
Thus, there is entry barrier that
is not likely to be overcome by
innovations.
W in3.1
Windows
M acO S 8
90
80
70
60
50
40
30
20
10
0
M SDO S
58 point is correspond
to5.8 times version-ups.
In other words, if we
assume that version-up is
done in 2.5 years, new
OS maker needs to make
OS with over 15-years
advanced technologies.
How to introduce competition
• (1) Compatibility: Opening the interface completely.
– API of OS
– File format of MS Word and Excel
– Former Interface, Current Interface, Next Interface
• (2) Disintegration or Regulation of vertical integration
– Separating the noncompetitive part (OS or Office) from
the competitive part(other application software)
Critiques:
These policies harm the incentive for the innovation of new interface
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Optimum level of incentive
Opening the
interface
Discourage the innovation welfare loss
Competition is recovered  welfare gain
Which is large?
A special case of general question of incentive design for innovation
Benefit of users and
future innovators
Benefit of current
innovators
Patent scope: narrow --- wide
Patent period: short --- long
Interface:
How many years of monopoly is
weak  Patent  strong
optimal?
protection
#monopoly=single firm’s control.
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Case of Interface
User’s benefit + Future
innovator’s benefit
Social optimum
Current innovator’s
benefit
Question:
Let’s assume that we make
Microsoft to open the interface.
Does it discourage critically
potential innovators who want
to be next Bill Gates?
Opening : Next
Current Former not open
Version version version
Monopoly: 5years
period
10years
15years unlimited
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Does it encourage innovators
who want to challenge
Microsoft by providing
compatible goods?
If so, users also get the benefit.
Thank you for your attention!
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