Transcript PMN Slides - HBS People Space

Platform-Mediated Networks
Module Overview
November 8, 2007
Notes for Instructors
• These slides are available for download as a file named “PMN
Slides.ppt” at http://www.people.hbs.edu/teisenmann/
• I’ve provided comments on many of the slides, visible as “Notes”
(from the “View” menu, select “Notes Page”).
• Feel free to adapt the slides in any way you see fit. In the spirit of open
source, if you make changes or additions, please forward a copy to me
at [email protected] so I can post them for others. I’m also happy
to answer questions about the slides by email.
• The slides present concepts covered in an introductory module on
platform-mediated networks, designed for use in existing courses on
strategy, technology management, marketing, entrepreneurship, or
ecommerce. The module is described in “Platform-Mediated
Networks: Module Note for Instructors,” HBS #807-067.
• For instructors who wish to delve deeper, the module’s materials are
drawn from a case-based MBA elective course, described in
“Managing Networked Businesses: Course Overview for Educators”
HBS #807-104.
2
Topics
1.
2.
3.
4.
Overview, Definitions, and Core Concepts
Network Mobilization
Platform Control
Platform Envelopment
3
Our vision for the last 20 years can be summarized
in a succinct way. We saw that exponential
improvements in computer capabilities would make
great software quite valuable… In the next 20 years
the improvement in computer power will be
outpaced by the exponential improvements in
communications networks. The combination of
these elements will have a fundamental impact on
work, learning and play.
Bill Gates
The Internet Tidal Wave, May 1995
4
1995
•
•
•
•
•
•
Netscape IPO
Rob Glaser launches RealNetworks
VocalTec introduces VoIP
First cable modems
FCC auctions digital mobile spectrum
Palm launches Pilot
5
1999
• IBM embraces Linux
• XML is created, paving the way for “web
services”
• 802.11b (Wi-Fi) takes off
• Napster launched
• TiVO launched
6
2004: Explosive Growth in…
•
•
•
•
•
•
•
Google’s valuation
Skype
RSS, podcasting
Blogs
Open source software
Wikipedia
BitTorrent
7
Platform-Mediated Networks
• Network users access a common platform that
facilitates their interactions
• Platforms = subset of components and rules
employed by users in most of their transactions
– Components = hardware, software, services
– Rules = technical standards, protocols for information
exchange, policies, and contracts that govern
transactions
• Users rely on a platform when doing so is more
efficient than unmediated bilateral dealings
8
Network
User B
User
User A
A
Platform
Components
- Hardware
- Software
- Services
Rules
- Standards
- Protocols
- Policies
- Contracts
Architecture
9
eBay’s Platform
• Components
–
–
–
–
–
–
Browser and Internet access (from 3rd parties)
Website design
Bid tracking software
Shipping services (from 3rd parties)
Links to PayPal (an eBay-owned platform)
Etc.
• Rules
–
–
–
–
–
Registration requirements
Dispute resolution processes
Feedback system
Policies for bidding
Etc.
10
Network Effects
• Definition: Network’s value to a user depends on the
number of other network users
– “Value” = willingness-to-pay for network participation =
WTP for platform affiliation = cap on platform fees
• Properties
– Can be negative, e.g., due to congestion
– WTP tends to increase as “S”-shaped (logistic) function of
network growth
– Network effects are demand-side economies of scale, i.e.,
they impact revenues
• Network effects are not supply-side scale economies, which improve unit margins
through fixed-cost leverage
• However, many networked businesses do enjoy strong supply-side economies
11
Platform-mediated networks do not
necessarily encompass:
• Physical networks (e.g., gas utilities)
• Social networks (e.g., your golf buddies)
• Supply networks, aka “ecosystems,”
comprised of large firms and their most
committed suppliers and customers
(e.g., Wal-Mart, Toyota)
12
Why Study
Platform-Mediated Networks?
• Large and growing share of global
economy
• Distinctive management challenges
13
Large and Growing Share of
Global Economy
• Not just digital industries, also:
– Financial services, e.g., ATMs, credit cards, stock exchanges
– Transportation, e.g., package delivery, airlines, travel agents,
reservation systems, fuel cell-powered cars
– Retail, e.g., shopping centers, bar codes/RFID
– Energy, e.g., grid + appliances, energy trading
– Real estate, e.g., home buying
– Health care, e.g., HMOs
– Enterprise administration, e.g., recruiting, B2B procurement
• 60 of the world’s 100 largest companies earn most of
their revenue from platform-mediated networks
14
Distinctive Challenges
• Concepts are new: first academic papers on “twosided” networks published in 2003
• Platform-mediated networks are very complex, but
oversimplification is common
– Over- or underestimate strength of network effects
– Price to network’s sides as if they were separate markets
• Errors can be fatal
–
–
–
–
–
Yahoo, Amazon failed in U.S. auctions
eBay exited Japan and China; failed to dislodge PayPal
NASDAQ collusion = $1 billion fine; ECN entry
IBM spent $1+ billion on OS/2
Apple forfeited Microsoft’s position
15
Distinctive Challenges
• Business Model Design
• Winner-Take-All Dynamics
16
Business Model Design
“This is like the Cambrian explosion 550 million years
ago, when multicelled life first appeared on the scene. It
was the greatest speciation ever seen, but it was also —
which people forget — the greatest rate of extinction ever
seen. We’re going to see all kinds of ideas tried, and the
majority of them are probably going to fail.”
Jeff Bezos, CEO Amazon.com
(Business Week, 9/13/99)
17
18
Designing Business Models
is Difficult Due To:
• “Two-sidedness” of most networks
• Bifurcation of platform roles
• Rapid growth, precluding trial-and-error
19
One- and Two-Sided Networks
• “One-sided” networks: Transaction partners
alternate roles, e.g., e-mailers send & receive,
traders buy & sell
• “Two-sided” networks: Users are permanent
members of one distinct group — a “side” —
which transacts with a second group, e.g.,
– Job seekers + recruiters
– Card holders + merchants
20
A two-sided network has
four network effects
Side 1
Side 2
Platform
• A same-side effect for
each side, i.e.,
preference regarding
number of other users
on own side
• A cross-side effect in
each direction, i.e.,
preference regarding
number of users on
other side
• Each effect can be
positive or negative
21
Platform Roles: Sponsors and Providers
• Providers are users’ primary point of contact
with platform
• Sponsors do not deal directly with users; rather,
sponsors hold property rights that determine:
– Who may change platform technology
– Who may participate in network as a platform
provider or network user
22
VISA =
JOINTLY SPONSORED
SHARED PLATFORM
CARD
HOLDERS
MERCHANTS
ISSUING
BANKS
ACQUIRING
BANKS
VISA INTERNATIONAL
XBOX =
SOLE SPONSORED
PROPRIETARY PLATFORM
GAMER
DEVELOPER
CONSOLE
SDK
MICROSOFT
XBOX
23
Distinctive Challenges
• Business Model Design
• Winner-Take-All Dynamics
24
Schumpeterian Competition: Serial WTA Battles
•
•
•
•
•
•
•
•
•
•
VCR  DVD + PVR + VOD
LP  CD  download and/or subscription
Human market makers  ECNs
1G  2G  3G
Analog POTS  VoIP
Broadcast  cable  IP TV
Atari  Nintendo  Playstation  Xbox?
Wi-Fi  WiMax?
Gasoline-powered cars  Fuel cell-powered cars?
Barcodes  RFID?
25
Blu-Ray vs. HD-DVD
26
Winner-Take-All
• Network effects  increasing returns 
winner-take-all, i.e., one platform prevails
• Examples: Windows, eBay, PDF, DVD, fax,
real estate MLS
• Winner-take-all implies loser takes nothing!
• So, should you share platform with rivals?
• If not, should you race to acquire network
users?
27
WTA Implications
• Sharing and racing are “bet-the-company”
decisions, so organizational design is crucial
• Growth opportunities  capital market
bubbles
• WTA monopoly power  government
intervention
28
Platform Structure
• Winner-take-all: one platform serves the
mature networked market
• Mono-homing: most users on a given side
affiliate with a single platform
• Multi-homing: most users on a given side
affiliate with multiple platforms
29
Platform Structure Examples
Network
Fax
DVDs
Mobile FeliCa
Real estate MLS
Windows desktop O/S
Online auctions
PDF
Instant messaging
Credit cards
Yellow Pages
Recruitment sites
Video games
Shopping mall
Subscription music
Multichannel TV (DBS
vs. cable)
Side 1
Users
Sender/receivers
Consumers
Cell phone users
Home buyers
PC users
Buyers
Readers
Sender/receivers
Consumers
Consumers
Job seekers
Consumers
Consumers
Consumers
Consumers
Side 1
Structure
Side 2
Structure
WTA
WTA
WTA
WTA
WTA
WTA
WTA
Mixed-mode
Mixed-mode
Mixed-mode
Mixed-mode
Mixed-mode
Mixed-mode
Mixed-mode
MonoMixed-mode
MonoMultiMonoMultiMonoMulti-
Side 2
Users
(Homogeneous network)
Movie studios
Retail stores, etc.
Home sellers
Application providers
Sellers
Document creators
(Homogeneous networks)
Merchants
Marketers
Recruiters
Game developers
Stores
Artists/labels
Programming networks
30
Networked Market is More Likely to be
Served by a Single Platform When:
• The platform is a natural monopoly
OR…
• Multi-homing costs are high AND
• Network effects are positive and strong AND
• Demand for differentiated features is weak
– OR dominant platform can offer such features
selectively to users willing to pay premium
31
Natural monopoly: minimum efficient
scale of production > mature market size
ure 2: Unit Cost Curves Showing Constant vs. Increasing Returns To Scale
Constant Returns
Long-Run ReturnRReturns
Unit Cost RReturns
Quantity
Increasing Returns
Long-Run
Unit Cost
Quantity
32
Natural monopolies are rare, but evident in
some networked businesses
• Past: local utilities (phone, power,
cable TV), railways, postal delivery
• Present
– Internet content delivery networks (e.g.,
Akamai, which has 85% market share based on
huge investment in servers)
– Failed LEO satellite communications (e.g.,
Iridium, Teledesic)
33
Strength of Network Effects
• Network effects are stronger when:
– Users demand novelty from repeated transactions (e.g., DVDs)
– Mobile users require geographic coverage (e.g., ATMs, Wi-Fi,
refueling)
– Participants in a matching network have idiosyncratic needs and
offers (e.g., home buying, executive recruiting)
• Access to network users is not valued equally
– Some are extremely valuable (e.g., friends, family)
– Others are worth little/nothing (e.g., strangers in another country)
– Some have negative value (e.g., telemarketers, stalkers)
• Strong preference for variety yields“long tail”
34
Measuring Network Effects: Conjoint Analysis
• Interviews elicit reactions to product attributes—
including network size—usually through paired
comparisons
– Hence, CONsidered JOINTly
• Requires consumers to understand attributes, so
may not be reliable for breakthrough products
• Studies should be designed by market research
professionals and cost between $50k-$250k
35
Homing costs: costs/investments incurred by
user due to platform affiliation
Upfront
•Search and negotiation
•Account setup, e.g., software configuration
•Initial hardware & software investment; system integration
•Training
Ongoing
•Membership and transaction fees
•Maintenance costs; customer service hassles
•Tenure- or volume-based benefits
Exit
•Account termination hassles and costs, e.g., changing email
address, moving funds between brokerage accounts
•Contract severance penalties
•Salvage value of hardware, software
36
Switching Costs
• Out-of-pocket expenses and inconveniences incurred by
network users (or by platform providers on their behalf)
when users switch from one platform to another
• Network effects may deter or encourage switching,
depending on the relative sizes of rival platforms.
• However, network effects and switching costs are
conceptually distinct and should not be confused
37
Homing vs. Switching Costs
1 SETUP + 1ONGOING
Mono-homing
2 SETUPS + 1 TERMINATION + 1 ONGOING
Switching
2 SETUPS + 2 ONGOING
Multi-homing
38
Homing vs. Switching Costs
• Usually they move together, e.g., satellite radio (both high),
package delivery (both low)
• Sometimes, switching cost is high but multi-homing cost is
low
– eBook readers: costly to switch because you must replace entire
library, but not very costly to multi-home
– Email account: costly to switch because you must notify all your
contacts, but not very costly to multi-home
39
Homing vs. Switching Costs
• When predicting whether a new networked market
will be served by a single platform, focus on multihoming costs
• When predicting whether to race to acquire network
users, focus on switching costs
• When predicting whether an established platform is
vulnerable to displacement by a new platform, focus
on both multi-homing costs and switching costs
40
Users’ Preferences for Differentiated
Platform Functionality
• User segments have different needs
– DBS picture is sharper than cable’s
• Appealing for sports and movie lovers?
– DBS requires a set-top box for every TV
• A liability for large families?
• Can functionality be offered selectively to
users willing to pay a premium?
– To match DBS picture quality, cable would
have to convert to all-digital architecture, so
selectivity is not an option
41
Homing Logic: Affiliate With Platform
When ∑VP + I ≥ H
• VP = expected value from ability to interact
with a potential transaction partner
• I = value from platform, independent of
platform size
• H = homing cost
42
Multi-Homing Logic
• For platforms A and B, calculate ∑VP + I ≥ H
• Consider incremental value from access to potential transaction
partners from multi-homing on A and B, compared to monohoming with the best single platform, A
– B may offer access to some partners not affiliated with A
– Due to differentiation, B may offer more value for certain transactions
than A
• Compare incremental value to incremental homing cost
43
WTA Potential?
DVD:
WTA
Credit Cards:
Multi-Homing
Strength of
Network Effect
High for most users on
both sides, i.e., consumers
and studios
High for most users on
both sides, i.e., card
holders and merchants
Multi-Homing
Cost
High for both sides
Low for both sides
Demand for
Inimitable
Features
Low due to technical
standardization of TV
High: “revolve” vs.
charge (i.e., pay-in-full
with no preset limit)
44
Mono-Homing + Multi-homing
Example: Online Subscription Music
Side 1 Mono-Homing:
Consumers
Side 2 Multi-Homing:
Music Companies
Strength of
Network Effect
•High: want access to
all music
•High: revenue increases
in direct proportion with
user base
Multi-Homing
Cost
•High: monthly fees,
playlist management
•Low: duplicated legal
work, but zero inventory
and modest incremental
production costs due to
digital distribution
Demand for
Inimitable
Features
•Moderate: differences
include quality of
editorial content, IM
integration
•Low: music companies
have similar needs for
DRM, promotional
support, etc.
45
Topics
1.
2.
3.
4.
Overview, Definitions, and Core Concepts
Network Mobilization
Platform Control
Platform Envelopment
46
Barriers to Network User Adoption
• Business stealing risk: too many rivals on your side
– Unlike other risks, does not involve provider/user trust
• Holdup risk: dominant platform extracts too much value (e.g.,
Microsoft OS for cable set-top box or mobile phones)
• Stranding risk: 1) user backs wrong side in WTA battle; 2)
platform fails to invest; 3) no backward compatibility
• Integration risk: platform provider integrates into network
user role (e.g., Microsoft with Office & Halo)
• Favoritism risk: to attract users, extract rent, or serve selfinterest, platform provider skews terms in one side’s favor (e.g.,
Covisint)
• Relationship risk: In 2-sided net, who controls access to users
on other side? (e.g., Xbox vs. EA; Autobytel loans)
47
Willingness-To-Pay and Network Size
•
WTP
•
D2
– Bigger network is more useful
– Existing customers will consume more
– New prospects will join network
D3
•
P2
P3
D1
N2
Outward shifts become smaller as expected
network size nears saturation point, Ns, due to
– Later adopters not as valuable as early adopters
– Congestion
P1
N1
D1 is traditional demand curve if
customers/prospects expect a network size
equal to N1
If customers/prospects expected a bigger
network, N2, then demand curve would shift
outward to D2
N3
Ns
Network Size
48
Beware Metcalfe’s Law
• According to Metcalfe’s Law, the value of a network grows
with the square of growth in its user base
– In a mesh network with each of N nodes connected to every other node,
there are N x (N-1) links, i.e., ~ N2
• But, ∆ Value = ∆ N2 only if:
– Per capita transaction volumes also increase by ∆ N2
– Each user’s WTP per transaction remains constant as her transaction
volume grows
• In the real world: diminishing returns set in and constraints on
attention/budget prevail
49
Upward Sloping Demand
in Network Industries
WTP
D3
Fulfilled Expectations
Demand Curve
D2
P2
P3
• “Fulfilled expectations” curve
traces price that would exactly
fulfill demand, for a given
expected network size
• Curve is upward sloping in
domain where network effects
dominate price elasticity
effects
P1
D1
N1
N2
N3
Network Size
50
Multiple Equilibria in Network Industries
• Assume competitive market with
Price = Marginal Cost
• Market has three equilibrium points:
N0, N1, and N2
• N1 is not a stable equilibrium
WTP
Fulfilled Expectations
Demand Curve
P
Marginal
Cost
N0
N1
N2
Network Size
– If expected network size < N1,
firms cannot make money, so N0
prevails
– If expected network size is > N1,
supply will surge to N2
• Implication: network markets are
tippy —they can stall, and they can
grow explosively— and
expectations matter!
51
The Penguin Problem
52
The Penguin Problem
(Farrell & Saloner, 1986)
• In new markets, uncertainty is high; individuals have
different expectations about long-term demand
• If user base is fragmented, users cannot communicate
expectations or coordinate behavior. Network may
stall, even with strong network effects!
• No-one moves unless everyone moves, so no-one
moves, like penguins afraid to be first to dive for food
53
Two ways to categorize platforms:
• Structure: Proprietary, Shared, Joint
Venture, Licensor
• Function: Connectivity, Variety, Matching,
Price Setting
54
Categorization Based on Platform Function
• Connectivity: platform facilitates point-to-point exchange of information,
physical goods, or passengers (e.g., fax; Fedex)
– More points connected  more valuable network  more points  etc.
• Variety: platform elicits supply of a variety of complements from one
network side and promotes complement consumption by the other side
(e.g., console + games; credit card + merchant locations)
– More complements  more demand-side users  more complements  etc.
• Matching network: platform matches transaction partners with
heterogeneous needs and offers (e.g., real estate; online dating)
– More buyers  more sellers  improved odds of suitable transaction  more
buyers  etc.
• Price-setting network: platform facilitates exchange of well-defined
items valued differently by trading partners (e.g., stock exchange,
gambling book-maker)
– More buyers  more sellers  reduced price volatility  more buyers  etc.
55
Categorization Based on Platform Function
One-Sided
Multi-Sided
Partner’s Identity
Generally Known in Advance
Partner’s Identity Generally Discovered
Through Transaction
Connectivity
Price-Setting
Phone, fax, IM, SMS, email, Ethernet, etc.
Package/freight delivery
Passenger air and rail lines
Secure document delivery (e.g., Tumbleweed)
Online invitations (e.g., eVite)
Securities and commodity exchanges
Online /offline auctions
Wholesale electric power markets
Gambling bookmakers
Variety
Matching
DVDs, VCRs, HDTV, CD audio, video game
consoles, satellite radio, etc.
World Wide Web
Internet content delivery (e.g., Akamai)
Internet-based media players (e.g., PDF)
PC, smart phone, PDA operating systems
Media aggregators (e.g., YouTube)
Ad-supported media (e.g., TV networks)
Wi-Fi: sides = end users & access points
Barcodes or RFID for product ID
Credit cards, email payments (e.g., PayPal)
Fuel cell-powered cars & refueling stations
ATMs
Shopping malls
HMOs
Electric grid: sides = outlets & appliances
Real estate brokerage
Online and offline travel agencies
Online car buying
Online and offline insurance brokerage
Mutual fund “supermarkets” (e.g., Schwab)
Business-to-business online exchanges
Executive search, online recruitment
Yellow Pages, paid search (e.g., Google)
Nightclubs, online personal ads and dating
services, marriage brokers, brothels
Markets for expertise (e.g., Yahoo Answers)
56
Key Challenges in Network Mobilization
Connectivity
•Ensure reliability
•Optimize reach (infrastructure investment
to extend network vs. incremental
revenue)
Variety
•Optimize price structure, exclusivity
•Elicit complement supply despite:
–Risky platform-specific investments
–Conflict with large users over rent
division, end user relationship control
–Concerns about platform provider
integration into user role
•Help end users find complements
Price Setting
•Balance users’ different needs for:
–Anonymity
–Transparency with respect to most recent
price and best current offer
–Transaction speed
–Flexibility to trade with preferred partners
Matching
•Optimize price structure, exclusivity
•Build user trust
•Address worries about business stealing
•Manage concerns about conflicts of
interest, ownership of data, etc.
•Avoid disintermediation, off-exchange
trading
57
Internalizing Externalities
• Externality = benefit or harm experienced by B due to A’s
actions, with no compensating payment
– Positive externality: I admire your flowers
– Negative externality: your pig pen is upwind
• Network effects are externalities
• Three approaches for internalizing externalities
– #1: Side payments between users, e.g., I buy grandma’s videophone
– #2: In two-sided network, permanent subsidization of one side
– #3: Inter-temporal internalization: sponsor “primes the pump” with
discounts to early adopters; this leads others to revise expectations/WTP
• For #2 and #3, proprietary platform is typically required;
otherwise, free riders exploit subsidy
– Exception: sponsors can dictate pricing terms that underwrite subsidies, as
with credit cards and real estate
58
Strategies for Network Mobilization
• Pricing
– Permanent: should one side be subsidized?
– Penetration: should platform providers race to
acquire network users?
• Participation
– Exclusivity: should platform providers seek
exclusive relationships with some users?
– Integration: should platform providers become
network users to avoid chicken & egg problem?
59
60
Pricing Puzzles
• What explains “Ladies Night”?
• Why do similar industries charge different
sides?
– Video games: end user subsidized; developer
pays
– PCs: end user pays; developer subsidized
61
Assume monopolist serves markets A and C
Marginal cost = 0
With no network effect between A and C, monopolist prices each product to
maximize P x Q
Case 1: No Network Effect
Market C
Market A
PA
PC
P*A
P*C
Q*A
QA
Q*C
QC
62
Case 2: Positive Cross-Side Network Effects
Compare ((P^A x Q^A) – (P*A x Q*A) – (P*B x Q*B)) to
((P^B x Q^B) – (P*B x Q*B) – (P*A x Q*A))
Demand on each side grows if QMAX is sold on the other side at a zero price.
Charge the side that most highly values growth in the other side.
Side A
P^A
Side B
P^B
P*B
P*A
Q*A Q^A
QMAXA
Q*B
Q^B QMAX
B
63
Strategies for Network Mobilization
•
•
•
•
Permanent Subsidies
Accelerated Growth Strategies
Exclusivity
Vertical Integration
64
65
66
Racing to Acquire Users
• Firms race to acquire customers when they face:
– Increasing returns to scale
– High switching costs
• Late mover advantages—e.g., reverse engineering,
free riding on pioneer’s missionary marketing—may
discourage preemptive investment
• Will investors fund racing strategies?
67
Racing to Exploit Increasing Returns
• Without increasing returns:
– Maximize: Profit = Revenue - Cost
– Implies: Marginal Revenue (MR) - Marginal Cost (MC) = 0
– MR = MC
• With increasing returns due to network effects:
–
–
–
–
Willingness-to-pay (WTP) = f(Number of other users)
So, adding a user boosts every other users’ WTP
MR + NPV of extra revenue from other users = MC
To maximize profit, you should price lower (reducing MR)
or invest more in marketing (increasing MC)
– In other words, you should race to acquire customers!
68
High switching costs also encourage firms
to race to acquire customers
• In an otherwise competitive market, a firm should earn profit
equal to the sum of switching costs confronting its customers
– $100 price just covers costs of producing/delivering one unit
– Assume consumers buy one unit of product in periods 1 and 2
– If switching costs are $50, then firm A can price at $149.99 to its
existing customers in period 2.
– To steal A’s customers, Firm B must fully compensate customers for
switching costs
– However, $150 is the best price B can offer and still recover its cost
• These economics will fuel a race to acquire unaffiliated
customers in period 1: each firm will price at $50.01
69
The Payoff from
Racing to Acquire Customers
• As investment rises, NPV of a
new customer eventually
declines due to:
Impa ct
on NPV
I*
Zero
Current P eriod Investment in
Customer Acquisition Efforts
– Broadening beyond natural
segments
– Prematurely soliciting prospects
– Retaliatory responses
– Scalability constraints
• I* corresponds to Lifetime Value
of Customer = 0 for the last
customer you acquired
– Average LVC should be positive
70
Lifetime Value of a Customer
• Rule: acquire customers until Lifetime Value of a Customer (LVC) = 0 for
last customer acquired, i.e., PV of variable contribution margin = customer
acquisition cost (including incremental capital expenditures)
– LVC does not allocate fixed costs. If LCV is positive, but you don’t have
enough customers to cover the present value of fixed costs, you’ll never earn a
profit!
– LVC provides a guideline for marketing spending; it is not a substitute for
detailed cash flow analysis
• Issues with LVC in networked industries
– Issue #1: LVC should include new customer’s impact on other customers’
willingness to pay
– Issue #2: Harder to calculate LVC in two-sided networks (e.g., Monster.com)
– Issue #3: With some connectivity networks (e.g., Federal Express), variable costs
depend on user density, so you must project customer base to calculate LVC
71
What might explain departures from longterm value maximizing investment levels?
• Investment < I*
Impa ct
on NPV
I*
– Resource allocation processes
– Funding constraints
– Antitrust constraints
• Investment > I*
– Inadvertent: Overconfidence
– Deliberate: Exploit overvaluation
Zero
Current P eriod Investment in
Customer Acquisition Efforts
72
Managing through a
speculative valuation cycle
• Can/should managers exploit overvaluation?
– Currency for acquisitions (Google)
– Buffer (Akamai)
• How will different types of investors react to bust?
– Private vs. public equity (e.g., Fedex vs. UPS)
– VC vs. strategic investor
– Family (e.g., Cox)
73
Strategies for Network Mobilization
•
•
•
•
Permanent Subsidies
Accelerated Growth Strategies
Exclusivity
Vertical Integration
74
Topics
1.
2.
3.
4.
Definitions and Core Concepts
Network Mobilization
Platform Control
Platform Envelopment
75
Platform Roles: Sponsors and Providers
• Providers are users’ primary point of contact with
platform
• Sponsors do not deal directly with users; rather,
sponsors hold property rights that determine:
– Who may change platform technology
– Who may participate in network as a platform
provider or network user
• Each role may be filled by one firm or many;
sometimes, a single company fills both roles
76
Platform Types
One Provider
One
Sponsor
Proprietary
•Macintosh
•Monster.com
•Playstation
Many
Sponsors
Joint Venture
•CareerBuilder
•Orbitz
•Covisint
Many Providers
Licensor
•Windows
•American Express
•Scientific-Atlanta
Shared
•Linux
•Visa
•Real Estate MLS
77
Key Design Decision
• Preserve proprietary control of new platform, e.g., eBay,
Federal Express, Google?
Or…
• Share platform with rivals who offer compatible but
differentiated platform products and services, e.g.,
barcodes, Wi-Fi, DVD?
78
Outcomes Vary
• Proprietary platforms may prevail
– Akamai vs. Content Bridge
– eBay vs. FairMarket
• Shared platforms may prevail
– Citibank vs. Cirrus ATM networks
• Proprietary and shared platforms may coexist
– Macintosh and Linux
– American Express (until 2004) and Visa
79
Decision Rules
• Aspiring platform providers with a big edge (e.g., via
strong patents) should almost always pursue proprietary
approach
• When many evenly matched firms can simultaneously
launch a new platform:
– Winner-take-all propensity encourages shared approach
– Free-rider problems encourage proprietary approach
80
If a Proprietary Platform
Serves the Entire Market…
• Users will worry about hold-up by monopolist
• Prospective providers will worry about losing
100% of their investment if they are not the
winner
81
Free-Rider Problems with
Big Upfront Investments
User Subsidization
Centralized Infrastructure
82
WTA Potential?
Yes
Yes
Free
Rider
Issue?
No
No
Proprietary Favored
•Proprietary examples:
PayPal, Yellow Pages in
smaller cities
•Shared examples: WWW,
real estate MLS
Proprietary Favored
•Proprietary examples: video
games, paid search
•Coexistence examples:
NYSE/ECNs; credit cards
Shared Favored
•Shared examples: DVD,
fax, barcodes, Wi-Fi, SMS
Coexistence Common
•Coexistence examples:
Symbian + Blackberry; Linux
+ Mac
83
Competing on a Shared Platform
84
Competing on a Shared Platform
• Pulled together by positive impact on platform adoption and
each firm’s survival odds
–
–
–
–
Fear of “penguin effect”
Fear of WTA outcome (e.g., mobile FeliCa)
Fear of Balkanization (e.g., pre-standard 11n)
Fear of outside threats (e.g., mobile phone OEMs vs. Microsoft)
• Pulled apart by reduction in appropriability of platform rent
–
–
–
–
–
Concern about too many rivals
Desire to incorporate own technology in standard (802.11)
Desire to differentiate a standardized product (e.g., J2EE; 802.11)
Friction between IP owners and free riders (e.g., RAND-Z)
Propensity to form coalitions that exclude close rivals (e.g., KDDI +
JCB vs. DoCoMo + Sumitomo)
85
Value Capture Strategies for
Shared Platform Providers
• Restrict Membership
– Can backfire if excluded parties sponsor competing platform, e.g., Sun vs.
IBM/Microsoft in web services
• Profit from IP
– If too low, IP-rich firms may avoid platform
– If too high, IP-poor may avoid platform and stalemates may occur as firms
vie to contribute technology
• Profit from Implementation
– Freely contribute IP to secure time-to-market advantage or develop
proprietary extensions to industry standards
– But, proprietary extensions may splinter a platform, e.g., Unix
86
Key Skills
• Timing: Too soon = ignored; too late = blocked
• IP Management: Avoid “submarine” patents and patent “thickets” via:
– Standard-setting organization (SSO) disclosure rules
– Patent pools
– Patent hoarding to ensure “mutual assured destruction”
• Diplomacy: Tactics include appeasement, intelligence gathering, logrolling,
bluffing, burning bridges, irrational commitment to dogma, etc.
– SSO delegates require rare mix of technical prowess and diplomacy skills; their
loyalties are often divided between profession and firm
• Organizational Design: Ad hoc vs. established SSOs; “forum shopping”;
SIGs; etc.
87
Topics
1.
2.
3.
4.
Definitions and Core Concepts
Network Mobilization
Platform Control
Platform Envelopment
88
Platform Envelopment
• Platform Envelopment: Entry by one platform provider
into another’s market, combining its own functionality with
the target’s in a multi-platform bundle that leverages
common components and/or shared user relationships
• Envelopment is a powerful force shaping the evolution of
platform-mediated networks
– Path to platform leadership change that does not require
Schumpeterian creative destruction
– Driver of industry convergence
– Strategy for cross-layer competition
89
Platform Entrenchment
• Single platform often dominates due to demand- and supply-side
scale economies, e.g., Windows, eBay, PDF
• Dominant platforms often difficult to displace due to network
effects and switching costs To succeed, entrants generally must
offer revolutionary products, e.g., ECNs, fuel-cell cars, IPTV,
VoIP, WiMax
• Hence, platform leadership change often entails serial winnertake-all battles, with superior new platforms displacing old ones
• Platform envelopment is a second path to platform leadership
change that does not require Schumpeterian creative
destruction
90
Platform providers serving separate markets may
share users and components
Users
Platform
A
Platform
B
Users
Platform
A
Platform
B
91
Platform Envelopment
Platform
A
Platform
B
• B enters A’s market
with a multi-platform
bundle
• A is vulnerable if it
cannot match an
appealing bundle
92
Envelopment in Subscription Music
•
AT&T
Apple
•
•
Yahoo
Rhapsody
•
•
Labels
Consumers
•
Prior to 1999, RealPlayer dominates
streaming media
Microsoft’s WMP envelops RealPlayer,
bundling streaming server into NT at no
extra cost
Real launches subscription music service
Rhapsody
Yahoo discounts subscription music, crossselling via portal
Apple could bundle subscription service
into iTunes, leveraging iPod
AT&T Wireless bundles Yahoo
subscription music with cell phone service
Real
Microsoft
93
Convergence  Envelopment
94
Xbox 360 vs. PS3
95
Cable vs. Telco
96
Cross-Layer Competition  Envelopment
Applications
Applications
Middleware
Operating Systems
Operating Systems
PCs
PCs
Components
Components
97
Telephone and Telegraph
“One newspaper account
described AT&T, in its
slow but steady
envelopment of the
telegraph industry, as a
‘quiet octopus.’”
Hochfelder,
Business History Review,
2002
98
Mechanism: Bundling
• Efficiency Gains: Transaction and production cost savings; improved user
experience
• Price Discrimination: Reduces heterogeneity in consumers’ aggregate
valuations
• Strategic Advantages: Extend market power into complement market;
protect core market by foreclosing rivals’ access to key complement
99
Foreclosure
Conglomeration
(Cross Layer)
(Convergence)
Intermodal
Relationship
Complements
Functionally
unrelated
Weak substitutes
Examples
•Microsoft vs. Real
•eBay vs. PayPal
•Microsoft vs. Adobe
•Cable vs. Telco
•DoCoMo vs. JCB
•iPhone vs. Blackberry
•Monster vs. LinkedIn
•UPS vs. Federal Express
•Blockbuster vs. Netflix
Efficiency
Gains
•Economies in
marketing
•Avoid double
marginalization
•Only viable with
strong production
cost synergies
•Production cost
synergies
•Some economies in
marketing
Price
Discrimination
Benefits
Limited
Moderate to strong Limited
Strategic
Advantages
Extend market
Limited
power, defend core
Neutralize emerging
threat
100
Defending Against Envelopment
• Match bundle, but bundle vs. bundle competition can be fierce
• Find a “big brother” via merger (e.g., Scientific-Atlanta + Cisco;
Lotus + IBM) or alliance (e.g., RealNetworks + Comcast, Cingular)
• Cede and redeploy, e.g., RealNetworks shifts from streaming to
subscription media
• Sue, e.g., Novell, RealNetworks, Netscape, Sun vs. Microsoft
101