Transcript Recognizing Lock-In

Information Rules:
A Strategic Guide to the Network Economy
Lock-In effect
&
Networks externality
Seungkyoon Shin
Recognizing Lock-In
• Cost of switching
• Compare
– Ford v. GM
– Mac v. PC
Information Rules
2
Spring 2000
What’s the Difference?
• Durable investments in complementary assets
–
–
–
Hardware
Software
Netware
• Switching cost and lock-in are ubiquitous in
information systems
• Supplier wants to lock-in customer
• Customer wants to avoid lock-in
• Basic principle: Look ahead and reason back
Information Rules
3
Spring 2000
Examples of lock-in
• Bell Atlantic and AT&T
– 5ESS digital switch used proprietary operating
system
– Large switching costs to change switches
• Computer Associates
– Vender Level Locking
– System Level Locking
Information Rules
4
Spring 2000
Small Switching Costs Matter
•
•
•
•
Look at lock-in costs on a per customer basis
Phone number portability
Email addresses (Mail Forwarding issue)
Hotmail (advertising, portability)
– $400 mil for 9.5 mil subscribers
• ACM, CalTech
– Provide forwarding service to approach possible donors
Information Rules
5
Spring 2000
Valuing an Installed Base
• Customer C switches from A to "same position" w/ B
– Total switching costs = customer costs + B's costs
• Example
– Switching ISPs costs customer $50 new ISP $25
– New ISP make $100 on customer, switch
– New ISP makes $70 on customer, no switch
• In a competitive market, Profit=switching costs
Information Rules
6
Spring 2000
Profits & Switching Costs
In General:
• Profits from a customer =
total switching costs + quality/cost advantages
• In commodity market like telephony, profit per
customer = total switching costs per customer
• Use of this rule of thumb
– How much to invest to get locked-in base
– Evaluate a target acquisition (e.g., Hotmail)
– Product and design decisions that affect switching
costs
Information Rules
7
Spring 2000
Classification of Lock-In
• Durable purchases and replacement: declines
with time
• Brand-specific training: rises with time
• Information and data: rises with time
• Specialized suppliers: may rise
• Search costs: learn about alternatives
• Loyalty programs: rebuild cumulative usage
• Contractual commitments: damages
Information Rules
8
Spring 2000
Durable Purchases
•
•
•
•
•
Telephone switches, Mainframe, OS
After-market sales (supplies, maintenance)
Depends on (true) depreciation
Usually fall with time due to depreciation
Watch out for multiple pieces of hardware
– Supplier will want to stagger vintages
– Contract renewal
• Technology lock-in vs. vendor lock-in
Information Rules
9
Spring 2000
Brand-specific Training
•
•
•
•
•
When personnel are trained
General training/brand specific training
How much is transferable?
Software, an obvious example
Competitors want to lower switching costs
– Borland’s Quattro Pro help for Lotus 123 users
– MS Word and WordPerfect help
Information Rules
10
Spring 2000
Information & Databases
• Data files
– Insist on standard formats
– S/W and database
– Whether information can be easily ported over
to another system
• Zip - CD - DVD Transition
Information Rules
11
Spring 2000
Specialized Suppliers
• If durable equipment or S/W is highly
specialized, it will be hard to find alternatives
• Pentagon: Joint strike fighter project
– Structuring competition among suppliers
– Boeing, Lockheed Martin, McDonald
• IBM
– Dual sourcing
– Intel and AMD
Information Rules
12
Spring 2000
Search Costs
• Consumers’ Search Cost
– Psychological costs of change
– Time and efforts
– Risk to customers
• Suppliers’ Search Cost
– Promotional cost
– Cost of actually closing the deal
– Cost of setting up a new account
– Risk to suppliers
• Example of Risk: Credit Cards
– $100 million in receivables is worth about $120 million
– Market valuation of “loyalty”
Information Rules
13
Spring 2000
Loyalty Programs
• Constructed by firm (artificial lock-in)
– Frequent flyer programs
– Getting more popular in E-Commerce
– Keep track of history sales: consumer information
• Personalized Pricing
– Gold status
• Example: Amazon and Barnes and Noble
– Amazon Associates Program v. B&N's Affiliates
program
• Add nonlinearity?
Information Rules
14
Spring 2000
Suppliers and partners
• Bilateral, or two-sided lock-in
• Railroad spur lines
• Customized software
– Game for the Nintendo 64 platform
– S/W for Apple computer
Information Rules
15
Spring 2000
Follow the Lock-in cycle
Brand Selection
Sampling
Lock-In
Entrenchment
Information Rules
16
Spring 2000
Information Rules:
A Strategic Guide to the Network Economy
Networks and Positive Feedback
Old and New
• Industrial Economy
– Populated with oligopolies
– Economies of Scale
• Information Economy
– Temporary monopolies
– Economies of Networks
Information Rules
18
Spring 2000
Important Ideas
• Positive feedback
• Network effects
• Returns to scale
– Demand side
– Supply side
Information Rules
19
Spring 2000
Positive Feedback
•
•
•
•
•
Strong get stronger, weak get weaker
Negative feedback: stabilizing
Makes a market “tippy”
Examples: VHS v. Beta, Wintel v. Apple
“Winner take all markets”
Information Rules
20
Spring 2000
Sources of Positive Feedback
• Supply side economies of scale
– Declining average cost
– Marginal cost less than average cost
– Example: information goods, Automobile industry
• Demand side economies of scale
– Network effects
– In general: fax, email, Web
– In particular: Sony v. Beta, Wintel v. Apple
Information Rules
21
Spring 2000
Network Effects
• Real networks:
– Fax machines, compatible modems, email
• Virtual networks
– Mac users, CD-ROM driver, Nintendo 64
– Computer (both S/W and H/W) buyers are picking a
network, not simply a product. E.g. user group
• Number of users
– Metcalfe’s Law: Value of network of size n proportional
to n2
• Importance of expectations
Information Rules
22
Spring 2000
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
Information Rules
23
Spring 2000
Don’t Get Carried Away
• Network externalities don’t always apply
– ISPs (but watch out for QoS)
– PC production
• Likelihood of tipping
– See next slide
Information Rules
24
Spring 2000
Likelihood of Tipping
Low Scale High Scale
Economies Economies
Low Demand
For Variety
Unlikely
High
High Demand
For Variety
Low
Depends
Information Rules
25
Spring 2000
Chicken & Eggs
• Fax and fax machines
• VCRs and tapes
• Internet browsers and Java
Information Rules
26
Spring 2000
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
Information Rules
27
Spring 2000
Evolution
• Offer a migration path
– Failure of CBS
• Examples
– Microsoft
– Borland v Lotus
• Build new network by links to old one
• Problems: technical and legal
Information Rules
28
Spring 2000
Technical Obstacles
•
•
•
•
Compatibility/Performance Trade-off
Use Creative design
Think in terms of system (NBC/CBS)
Converters and bridge technologies
– One-way compatibility
– Office 97/95
– Boland Q-pro/Lotus 1-2-3
Information Rules
29
Spring 2000
Legal Obstacles
• Need IP licensing
• Example:
– Sony and Philips CDs
– Amazon.com’ banner ad
Information Rules
30
Spring 2000
Revolution
• Users will bear the switching cost when
production is so much better than what
people are currently using
• Groves’ law: “10X rule”
• But depends on switching costs
• Example: Nintendo vs. Sega
Information Rules
31
Spring 2000
Openness v. Control
• “Open” approach: offering to make the
necessary interfaces and specifications
available to others
• “Control” approach: keeping your system
proprietary
• The goal is to maximize the value of your
technology, not control
Information Rules
32
Spring 2000
To maximize the value…
• Your reward = Total value added to industry
x your share of industry value
• Value added to industry
– Depends on product and
– Size of network
• Your share
– Depends on how open
Information Rules
33
Spring 2000
Openness
• More cautious strategy than control
• Full openness
– Anybody can make the product
– Problem: no champion
• Alliance
– Only members of alliance can use
– Problem: holding alliance together
Information Rules
34
Spring 2000
Control
• Control standard and go it alone
• A strategy for Market leaders: AT&T, MS,
and Intel
• If several try this strategy, it may lead to
standards wars
Information Rules
35
Spring 2000
Generic Strategies
Compatible
Control
Open
Controlled
Migration
Open
Migration
Incompatible Performance Discontinuity
Play
Information Rules
36
Spring 2000
Performance Play
• Introduce new, incompatible technology
• Examples
– Palm Pilot
– Iomega Zip
• Attractive if
– Great technology
– Outsider with no installed base
Information Rules
37
Spring 2000
Controlled Migration
• Compatible, but proprietary
• Examples
– Windows 98
– Pentium chips
– Upgrades and update of S/W programs
Information Rules
38
Spring 2000
Open Migration
• Many vendors, compatible technology
• Little switching cost for customers
• Examples
– Fax machines
– Modems
Information Rules
39
Spring 2000
Discontinuity
• New technology, but incompatible with
existing technology
• Supplied by many vendors
• Examples
– CD audio
– 3 1/2” disks
Information Rules
40
Spring 2000
Lessons on Lock-in
•
•
•
•
•
Switching costs are ubiquitous
Customers may be vulnerable
Value your installed base
Watch for durable purchases
Be able to identify 7-types of lock-in
Information Rules
41
Spring 2000
Lessons on
Network and Positive feedback
• Positive feedback means strong get stronger
and weak get weaker
• Consumers value size of network
• Works for large networks, against small
ones
• Consumer expectations are critical
• Fundamental tradeoff: performance and
compatibility
Information Rules
42
Spring 2000
Lessons, continued
• Fundamental tradeoff: openness and control
• Generic strategies
–
–
–
–
Performance play
Controlled Migration
Open Migration
Discontinuity
• Lessons of history
Information Rules
43
Spring 2000