Transcript Chapter 4 Rights Management

Economics of Information
Technology
資訊經濟
Spring 2010
Instructor: Dr. Yung-Ming Li
李永銘 博士
© 2006 Institute of Information Management
National Chiao Tung University
Course Information
• Instructor: Dr. Yung-Ming Li
• Meeting time:
– T Section 0130-0430
TH Section 0630-0930
• Meeting room: T Sec MB 312/ Th Sec MB 311
• Office hours : Tuesday 1000-1200 or by
appointment
• Email: [email protected]
• Web: www.nctu.edu.tw/~yml
© 2006 Institute of Information Management
National Chiao Tung University
Instructor’s Information
• Name: Yung-Ming Li
• Education
– Ph.D., University of Washington (Information Systems)
– M.S., University of Southern California (Computer Science)
– B.S., National Chiao Tung University (Computer & Information
Science)
• Experiences
–
–
–
–
A TA/RA (UW Business School)
A start up cofounder (KEYNet/KEYCITI)
A lecturer (KYU)
An engineer (Institute for Information Industry)
© 2006 Institute of Information Management
National Chiao Tung University
Research Interests
Electronic
Commerce
Online
Community
Digital
Media
Internet
Communications Networks
Topics
© 2006 Institute of Information Management
Economics
Operations
Technologies
Problems/Modeling
National Chiao Tung University
IS Methodologies
Economics
Computer
Science
Operations
Research
Algorithm
(Heuristic, discrete methodologies)
© 2006 Institute of Information Management
Game theory
(Equilibrium of distributed
Individual decisions)
Optimization
(centralized optimal
solution for resource
allocation)
National Chiao Tung University
• 智慧科技(Intelligence Technology)
– peer to peer, intelligent agent, data/web
mining, information security
• 資訊經濟(Information Economics)
– digital content, electronic commerce, web
social networks, Internet/telecommunication
service
© 2006 Institute of Information Management
National Chiao Tung University
CS v.s. Econ - Examples
• 1. Online Auction (eBay)
– Technology issues: networks security, database, AI,
etc.
– Economics issues: auction rule design (who will win ?
Intermediary, bidders, sellers, or society),
reputation/trust, etc.
• 2. P2P Networks (Kazaa)
– Technology issues: content search and download
protocol and network topology design, etc.
– Economics issues: Incentive to sharing (free riding),
pricing P2P networks services, etc.
© 2006 Institute of Information Management
National Chiao Tung University
CS v.s. Econ – Examples (Cont’)
• 3. Knowledge Management
– Technology issues: workflow design, data mining,
document presentation, etc.
– Economics issues: incentive mechanism to induce
cooperative sharing behavior, stability and efficiency,
etc.
• 4. Digital Media (content)
– Technology issues: multimedia, compression
technology, DRM technologies, etc.
– Economics problem: versioning content, bundling
content, etc.
© 2006 Institute of Information Management
National Chiao Tung University
Course Objectives
• IT economics becomes one of the IS main
stream areas in US (research papers in
top journals and courses offered in top
business schools)
• IT changes traditional economic behavior
(like Auction, P2P, Intelligent property, etc)
• Apply economics method to study the
emerging Internet/digital economy
© 2006 Institute of Information Management
National Chiao Tung University
Course Objectives (Cont’)
Modeling
IT
Information & Networks
services
© 2006 Institute of Information Management
Economic (game) modeling
Managerial insight
Business
Profit maximization
Business Strategies
National Chiao Tung University
Course Outline
•
•
•
•
•
•
•
•
•
•
Introduction (IT Economics)
Game theory
Information asymmetry
Networks externality
Incentive mechanism
Competition and cooperation
Trust and reputation Mechanism
Networks Pricing
Digital Content Pricing
Emerging Internet applications (P2P, DRM, electronic
commerce, online community,.. etc)
© 2006 Institute of Information Management
National Chiao Tung University
Reference books
• Textbooks
– Shapiro,C. and Varian, 1999, Information Rules. Harvard Business School
Press.
– Vulkan. N. 2003. Economics of E-commerce. Princeton
– Gibbons, R, 1993. Game Theory for Applied Economists. Princeton
University Press.
– Shy,Oz, 2001, The Economics of Network Industries. Cambridge
© 2006 Institute of Information Management
National Chiao Tung University
Reference Materials
• Magazines
– Business Week, Economist, Business 2.0
(start up)
© 2006 Institute of Information Management
National Chiao Tung University
Course Activities
• Lectures (from the instructor)
• Homework practices
• General IT-Business articles and research
papers reading, presentation, and
discussion
• Term project
© 2006 Institute of Information Management
National Chiao Tung University
Lecture and Homework
• The instructor will provide the class notes
for each lecture (Powerpoint)
• Homework will be assigned to help
students practice and familiarize the
methodologies
• All students are expected to try the
problems by himself. However, you are
highly encouraged to discuss the problems
© 2006 Institute of Information Management
National Chiao Tung University
Reading, Presentation, and
Discussion
• Identify and position the research question
• Evaluate the proposed approach to the
question
• Theoretical modeling issues
• Suggest a research question that would
extend the work
© 2006 Institute of Information Management
National Chiao Tung University
Term Project
• Select a interesting, timely, and promising
topic
• Emphasize the importance of chosen topic
(technology and business opportunities)
• Utilize discussed methodologies to model
the economic behaviors
• Derive managerial implications based your
model
© 2006 Institute of Information Management
National Chiao Tung University
Grading
•
•
•
•
Homework (20%)
Exam (20%)
Presentation (30%)
Term Project (30%)
© 2006 Institute of Information Management
National Chiao Tung University
Lecture Part I-1
The Information Economy
•
•
•
•
•
•
Information goods
Cost structure of production
Characteristics of consumption
Networks effect
Lock-in
Compatibility and System competition
© 2006 Institute of Information Management
National Chiao Tung University
Information goods
• Anything that can be digitalized
– Baseball scores, books, database, magazines,
movies, music, stock quotes, Web pages
• Focus on the value of information to
different consumers
– People have widely different values for a
particular piece of information
© 2006 Institute of Information Management
National Chiao Tung University
Cost characteristics
•
•
•
•
High fixed costs (sunk cost)
low marginal costs of production
No significant capacity constraints
Particular market structures
– Monopoly
– Cost leadership
© 2006 Institute of Information Management
National Chiao Tung University
Right Management
• Low reproduction cost is two-edged sword
– Cheap for owners
– But also cheap for copiers
• Maximize value of IP (intellectual property),
not protection
• Examples
– Video industry
– Hollywood now makes more from video sales
and rental market, them theater presentation
© 2006 Institute of Information Management
National Chiao Tung University
Consumption Characteristics
• Experience good
– Browsing, always new, reputation and brand
• A wealth of information creates a poverty of attention
– Emergence of search engine, data mining, personalization
technologies
• Internet is a hybrid medium between a broadcast and
point-to-point
– Allow information vendors to move from the conventional
broadcast advertising to one-to-one marketing
– Know your customer and provide customized information
© 2006 Institute of Information Management
National Chiao Tung University
Information Technology
• Information technology
– The infrastructure that make it possible to
store, search, retrieve, copy, filter, manipulate,
view, transmit, and receive information
• Adds value to information
– Static HTML in Web =1.5 million books
– If 10% is useful= 1 Borders Bookstore
– Value of Web is in ease of access
• Front end to database et
• Currency
© 2006 Institute of Information Management
National Chiao Tung University
Network Effects
• Value depends on number of users
– Networks effects lead to demand side economies of scale
• Positive feedback
– E.g. Fax (1843, 1987), Internet/ Email(1969,1989-1995)
• Indirect network effects
– DVD players, Software
• Expectations management (battle for the standard)
– Competitive pre-announcements to be standard
– Quattro Pro (Borland),1980s, MS pre -announce Excel
• Assemble a powerful group of strategic partners
– Customers, Complementors, competitors
– Ex. Java coalition (from Sun)
© 2006 Institute of Information Management
National Chiao Tung University
Lock-In and Switching Cost
• Example
– Stereos and LP (long-playing phonograph
records)
– Costly switch to CDs
• System lock-in: durable complements
– Hardware, software
– Individual, organizational, and societal
© 2006 Institute of Information Management
National Chiao Tung University
Compatibility
• Complements
– Different manufacturers
– Strategy for complementors as well as
competitors
– Compatibility as strategic choice
– Standards and interconnection
© 2006 Institute of Information Management
National Chiao Tung University
Systems Competition
• Microsoft-Intel: Wintel
– Intel
• Commoditize complementary chips
– Microsoft
• Commoditize PCs
• Apple
– Integrated solution
– Worked better, but lack of competition and
scale to current problem
© 2006 Institute of Information Management
National Chiao Tung University
Information Policy
• Antirust law
– Mergers and acquisitions
– Cooperative standard setting
– Monopolization
• Cases
– Microsoft’s Internet Explorer
– Peer to peer networks
© 2006 Institute of Information Management
National Chiao Tung University
Agenda (Meeting II)
• I: Pricing Information goods
• II: Versioning Information goods
• III: Right Management
© 2006 Institute of Information Management
National Chiao Tung University
Lecture notes I- 2
Pricing Information
• Pricing strategies
• Personalized pricing
• Group pricing
© 2006 Institute of Information Management
National Chiao Tung University
Example: Britannica v. Encarta
• Britannica: 200 years, $1,600 for a hardback set
• Microsoft purchased Funk & Wagnalls to make
Encarta (1992)
• Britannica response
– Sales dropped 50% between 1990 and 1996
– Online subscription at $2,000 per year
– Online subscription at $120
– CD for $200
– CD $70-$125 since 1996
• Problem: Whether it can sell to a large enough
market to recover its costs.
© 2006 Institute of Information Management
National Chiao Tung University
Production Costs
• First-copy costs dominate
– Sunk costs (not recoverable)
• Variable costs small; no capacity
constraints
– Microsoft has 92% profit margins
• Significant economies of scale
– Marginal cost less than average cost
– Declining average cost
© 2006 Institute of Information Management
National Chiao Tung University
Implications for Market
Structure
• Cannot be "perfectly competitive"
• 2 sustainable structures
– Dominant firm/monopoly
– Differentiated product
• Combinations of above
© 2006 Institute of Information Management
National Chiao Tung University
Strategy
• What to do
– Differentiate your product
• Add value to the raw information to distinguish
yourself from the competition
– Achieve cost leadership through economies of
scale and scope
© 2006 Institute of Information Management
National Chiao Tung University
Commoditized Information
• CD ROM phonebooks
• 1986: Nynex charged $10,000 per disk for
NY directory
• ProCD and Digital Directory Assistance
• Chinese workers at $3.50 daily wage
• Bertrand competition
– Start at $200 each
– Price forced to marginal cost
© 2006 Institute of Information Management
National Chiao Tung University
If You are in
Commodity Business
• Cost leadership
• Sell the same thing over again
– Baywatch (TV show), Reuters
– Reduces average cost
© 2006 Institute of Information Management
National Chiao Tung University
Differentiated Product
• Bigbook (maps+ database of phone
numbers and address)
• West Publishing (copyright key number
systems)
– Copyright and content
© 2006 Institute of Information Management
National Chiao Tung University
Personalize Your Product
• Personalize product, personalize price
– PointCast
– Personalized ads
• Hot words (in cents/view)
– Deja News:
– Excite:
– Infoseek:
– Yahoo:
2.0
2.4
1.3
2.0
© 2006 Institute of Information Management
4.0
4.0
5.0
3.0
National Chiao Tung University
Know Your Customer
• Registration
– Required: NY Times
– Billing: Wall Street Journal (ZIP code)
• Know your consumer
– Observe Queries
– Observe Clickstream
© 2006 Institute of Information Management
National Chiao Tung University
Clickstream
• Interest and how long you look
• Problem: Connectionless nature of HTTP
• Java: a promising solution
– Virtual Vineyards
– Optimized browsers
© 2006 Institute of Information Management
National Chiao Tung University
Logic of Pricing
• Quicken example
– 1 million wtp $60, 2 million wtp $20?
– Demand curve (next slide)
– Assumes only one price
• $60 or $20 has same revenue $60 million
– Price discrimination
• Price discrimination gives $100 million
– Problems
• How do you know wtp?
• How do you prevent arbitrage?
© 2006 Institute of Information Management
National Chiao Tung University
Demand Curve
Price
(Dollars)
$60
$40
$20
1
© 2006 Institute of Information Management
2
3
Quantity (Millions)
National Chiao Tung University
Forms of Differential Pricing
• A.C. Pigou (1920)
• Personalized pricing (first degree pricing)
– Sell to each user at a different price
• Versioning (second degree pricing)
– Offer a product line and let users choose
• Group pricing (third degree pricing)
– Based on group membership/identity
© 2006 Institute of Information Management
National Chiao Tung University
Personalized Pricing
• Vendor charges different prices to
different consumer
– Market research
– Selling via catalog
• Easy on the Internet
– Eg. Online travel agency
• Deep-sea fishing (high-price package)
• Snorkeling (budget package)
© 2006 Institute of Information Management
National Chiao Tung University
Personalized Pricing - Internet
• Example
– Virtual Vineyards (trace clickstream)
– Amazon.com (recommendation systems)
– Auctions
– Closeouts, promotions
© 2006 Institute of Information Management
National Chiao Tung University
Personalized Pricing (summary)
• Personalize your product and
personalizing you pricing
• Know the customer
• Differentiate your prices when possible
• Use promotions to measure demands
© 2006 Institute of Information Management
National Chiao Tung University
Group Pricing
• The prices weren’t really perfectly
individualized. Instead, people who had
certain purchase histories, zip codes, or
behavior patterns were offered different
prices (based on a group identity)
– Price sensitivity
– Network effects, standardization
– Lock-In
– Sharing
© 2006 Institute of Information Management
National Chiao Tung University
Price Sensitivity
• International pricing
–
–
US edition textbook: $70
Indian edition textbook: $5
• Problems raised by Internet
–
Localization as solution
© 2006 Institute of Information Management
National Chiao Tung University
Network Effects
• Sellers of software can exploit this
desire for standardization and offer the
organization quality discount
• Compatibility
– Site licenses
– Variety of schemes: per client, per user,
per server, etc.
© 2006 Institute of Information Management
National Chiao Tung University
Lock-In
• If you are selling a good that has big
switching costs, then it pays you to offer
deep discounts to get customers
• Example
– Wall Street Journal’s Newspapers-ineducation
• Microsoft Office
– Per seat, concurrent
© 2006 Institute of Information Management
National Chiao Tung University
Sharing
• Inconvenient for the individual user to
manage information
• Information Intermediaries such as
library or system administrators can
perform the coordination task
• Transactions cost of sharing
– Videos
– Desire for repeat play
© 2006 Institute of Information Management
National Chiao Tung University
Summary
• Understand cost structure
• Commodity market: be aggressive, not
greedy
• Differentiate product and price
• Understand consumer
• Personalize products and prices
• Consider selling to groups
© 2006 Institute of Information Management
National Chiao Tung University
Lecture notes I- 3
Versioning Information
•
•
•
•
•
Product line (menu) pricing
Market segmentation
Self-selection
Quality (Vertical) Differentiation
Bundling
© 2006 Institute of Information Management
National Chiao Tung University
Value-Based Pricing
• Don’t need to price by identity
• Offer product line, and watch choices
• Design menu of different versions
– Target different market segments
– Price accordingly (self selection)
© 2006 Institute of Information Management
National Chiao Tung University
Example
• Quicken example
– Quicken for Windows at $20
– Quicken Deluxe at $60
• Traditional Information Goods
– Hardback/paperback
– Movie/video
© 2006 Institute of Information Management
National Chiao Tung University
Dimensions to Use (quality differentiation)
•
•
•
•
•
•
•
•
Delay (Fed Ex, PAWWS)
User Interface (DialogWeb, DataStar)
Image Resolution (PhotoDisk)
Speed of operation (Mathematica)
Format (Lexis/Nexis)
Capability (Kurzweil)
Features (Quicken, tech support)
Comprehensiveness (DialogWeb,
DataStar)
© 2006 Institute of Information Management
National Chiao Tung University
Example
• 40 type As (High type): $100 for speed, $40 for
slow
• 60 type Bs (Low type): $50 for speed, $30 for
slow
• Identity-based pricing: $7000 revenues
– 100x40+50x60 (both speed)
• Offer only speedy: $50 is best price,
revenues=$5,000
– 50x(60+40)>100x40
• Offer only slow: not as profitable ($3000)
– 30x(60+40)>40x40
© 2006 Institute of Information Management
National Chiao Tung University
Versioning Solution
• Try speedy for $100, slow for $30
– Will this work? Compare benefits and costs
– 100-100=0, but 40-30=10 > 0
– Discount the fast version: 100-p=40-30
– So, p=90
– Revenues = $5,400 = 90x40 + 30x60
© 2006 Institute of Information Management
National Chiao Tung University
Making Self-Selection Work
• May need to cut price of high end
• May need to cut quality at low end
• Value-subtracted versions
– May cost more to produce the low-quality
version.
• In design, make sure you can turn features
off!
© 2006 Institute of Information Management
National Chiao Tung University
Pitfalls
• Make sure users cannot easily turn the
low-end version into high-end versions
• Arbitrage
– Windows NT workstation/server
© 2006 Institute of Information Management
National Chiao Tung University
Online and Offline Versions
• Book: “The Whole Internet”
– Online free, $24.95 sold in bookstores
• Software: Netscape Navigator
– Download for free, purchased on disk
• National Academy of Science Press
– Both online (browsing format) and offline version
(reading)
• Separate distribution channels
– Substitute or complement ?
• Substitute : fee, advertising, or versioning
• Complement : promote online as aggressively as
possible
© 2006 Institute of Information Management
National Chiao Tung University
How Many Versions?
• One is too few
• Ten is (probably) too many
• Two things to do
– Analyze market
– Analyze product
© 2006 Institute of Information Management
National Chiao Tung University
Analyze Your Market
• Does it naturally subdivide into different
categories? AND
• Are their behaviors sufficiently different?
• Example: Airlines
– Tourists v. Business travelers
© 2006 Institute of Information Management
National Chiao Tung University
Analyze Your Product
• Dimensions to version
• High and low end for each dimension
• Design for high end, reduce quality for low
end
• Low end advertises for high end
© 2006 Institute of Information Management
National Chiao Tung University
Goldilocks Pricing
• Goldilocks: Just right
• Mass market software (word, spreadsheets)
– One or two version (professional, standard)
– Network effects
– User confusion in identifying appropriate product
• Default choice: 3 versions
• Extremeness aversion
• Small/large v. small/large/jumbo
© 2006 Institute of Information Management
National Chiao Tung University
Microwave Oven Example
• Bargain basement at $109, midrange at
$179
– Midrange chosen 45% of time
• High-end at $199 added
– Mid-range chosen 60% of time
• Wines
– Second-lowest price
© 2006 Institute of Information Management
National Chiao Tung University
Customizing the Browser
• Java as a versioning technology
• Collect behavior information (Java)
• Optimize viewing
–
B&W page images
• Can turn it on and off
© 2006 Institute of Information Management
National Chiao Tung University
Bundling
• Offer a package
• Example: Microsoft Office
– 90% market share
• Work together
• Discount one of the products
© 2006 Institute of Information Management
National Chiao Tung University
Reduce Dispersion
•
•
•
•
Example: price separate or together
Mark: $120 for WP, $100 for spreadsheet
Noah: $100 for WP, $120 for spreadsheet
Profits
– Without bundling: $400 (100 for WP,100 for
spreadsheet)
– With bundling: $440 (220 for WP+
spreadsheet)
© 2006 Institute of Information Management
National Chiao Tung University
Reduce Dispersion:
Price separate or together?
Word Processor
Spreadsheet
Mark Ketting
$120
$100
Noah Count
$100
$120
Profits: With Bundling: $440
© 2006 Institute of Information Management
Without: $400
National Chiao Tung University
Information Bundles
•
•
•
•
Magazines and newspapers
Law of large numbers
Customized bundles
Nonlinear pricing
– Value decreasing
– In previous example sell first item for $120
– Sell second item for $100
– Example: MusicMaker
© 2006 Institute of Information Management
National Chiao Tung University
Promotional Pricing
•
•
•
•
Sales, coupons, rebates
Only worthwhile if segment market
Credible signal of price sensitivity
Chanallege: software agents
–
Example: Bargain Finder,Price Scan
© 2006 Institute of Information Management
National Chiao Tung University
Summary
• Version your product
• Version dimensions: Delay, interface,
resolution, speed, etc.
• Add value to online information
• Use natural segments, otherwise use 3
versions (Goldilocks pricing)
• Control the browser
• Bundling may reduce dispersion
© 2006 Institute of Information Management
National Chiao Tung University
Lecture Note I-4
Rights Management
• Implications of digitalization technology
• Demand of information good
• Analytics of right management
© 2006 Institute of Information Management
National Chiao Tung University
Intellectual Property Law
• “Intellectual property law cannot be patched,
retrofitted, or expanded to contain digitized
expression… Information wants to be free.”
John Perry Barlow
• Is he right?
• The opportunities offered by digital reproduction
far outweigh this problem
– Like other reproduction technologies in the past, such
as printing press, VCR
© 2006 Institute of Information Management
National Chiao Tung University
Production and Distribution
• Digital tech lowers production costs
• Digital tech lowers distribution costs
• Examples
– Tape recorder lowers production, but not distribution
costs
• Distribution cost is the same as original
– AM radio broadcast lowers distribution costs, not
reproduction costs
• Quality is reduced
– Black and white photocopy of an art book ?
• Quality is reduced
© 2006 Institute of Information Management
National Chiao Tung University
Make Lower Distribution Costs
Work for You
• Information is an experience good
• Must give away some of your content in
order to sell rest
• Can use product line/versioning
– Easy to read, hard to print
– National Academy of Sciences Press
• Online content can increase the sales of the
physical version of information good
© 2006 Institute of Information Management
National Chiao Tung University
Demand for Repeat Views
• Give away all your content, but only once
• Music, books, video have different use
patterns
– Radio broadcast of a song is an ad for itself
(versioning)
• Example: Children
– Barney: free videos
– Disney: sued day care centers
© 2006 Institute of Information Management
National Chiao Tung University
Demand for Similar Views
• Free samples direct customers back to you
• McAfee Associates
– John MacAfee posted a virus fix on a BBS and asked
those who downloaded it and send him whatever
they thought it was worth
– $5 million in first year
– $3.2 billion market value by 1997
– Half of virus protection market
• Similar, but not identical products
– Variation on the same basic theme
– E.g. Playboy
© 2006 Institute of Information Management
National Chiao Tung University
Demand for
Complementary Products
• Give away index and sell content
– Wall Street Journal, New York Times, Economist
give away index
• Free content, organization/index is what
matters
– Farcast sells “current awareness” to help you
search and organize a variety of information
sources
– Two week subscription free trial, 13$ a month
© 2006 Institute of Information Management
National Chiao Tung University
Illicit Copying
• Digital piracy can’t be eliminated but it can
be kept under control
• Compensating factors
– Timely information
• Sports scores, financial information, and gossip
– Negative feedback for bitlegger
• The bigger you are, the easier to detect
© 2006 Institute of Information Management
National Chiao Tung University
Historical Examples
• Cheap photocopying has probably increased the
demand for printed content
– E.g. academic journals
• Circulating libraries
–
–
–
–
–
Books were expensive (a book cost a week’s wage)
1800: only 80,000 frequent readers in all of England
1840:1000 libraries
1850: 5 million readers
The publishers served new mass market instead of
the elite
© 2006 Institute of Information Management
National Chiao Tung University
Historical Examples (cont’)
• Video stores
– 1980: US$1000 for VCR, Video $90 retail,
and 60 to video store
– Video rental as prelude to purchase
• “Lady and the tram” sold 3.2 million copies at
$19.95 (Disney)
• video purchase price drop by more than 90%
© 2006 Institute of Information Management
National Chiao Tung University
Growing the digital content market
• Key issue: how to exploit economics of scale
– A:1000 consumers pays a dollar a piece to download
a piece of software that costs pennies to produce and
distribute
– B: 100 consumers paying $10 a piece for software
that costs $5 to produce and distribute
• Vastly cheaper distribution may feel like a threat,
but it offers great opportunity
• Maximize the value of intellectual property, not
protection
• Questions: DRM vs P2P
© 2006 Institute of Information Management
National Chiao Tung University
Choosing Terms and Conditions
• Revenue = price x quantity
• More liberal terms and conditions (Less
protected)
– Increases price
– Decreases quantity sold
© 2006 Institute of Information Management
National Chiao Tung University
The analytics of Rights
Management
Price
Price
Demand
Curve
Revenue
Quantity
© 2006 Institute of Information Management
Revenue
Demand
Curve
Quantity
Reduced sales
National Chiao Tung University
Simple Model
• Baseline case: max p(y)y
– y = amount sold
– p(y) = demand, assume zero cost
• Make Terms& Conditions more liberal
– Y =amount consumed, y=amount sold
– Original :Y=y
– New demand curve P(Y)= αp(Y) with α>1
– Y= βy with β >1
© 2006 Institute of Information Management
National Chiao Tung University
Analysis
• New profit maximization problem
– Max P(Y) y
– Max α/βp(Y)Y
• Conclusion:
– Y*=y* the same (amount consumed)
– profits depend on α/β
© 2006 Institute of Information Management
National Chiao Tung University
Transactions Costs
• Transaction cost
– E.g. cost of travel and delay
• Site license reduce the transaction costs of the
seller and the buyer
• Site license v individual licenses?
– Who can distribute more cheaply?
• Site licenses are often priced at a low multiple of the
software’s unit purchase price
– How effectively can group aggregate value?
• Redistribute articles within the organization with no liability
© 2006 Institute of Information Management
National Chiao Tung University
Summary
• Two challenges: cheap production, cheap
distribution
• Cheap distribution: helps advertise by giving
away samples
• Copy protection that imposes costs on users is
vulnerable to competitive forces
• Basic tradeoff in terms and conditions: more
liberal terms make product more valuable buy
may reduce sales
• Site licenses and other group pricing schemes
are a valuable tool
© 2006 Institute of Information Management
National Chiao Tung University
Summary (cont’)
• Copy protection that imposes costs on
users is vulnerable to competitive forces
• Basic tradeoff in terms and conditions:
more liberal terms make product more
valuable buy may reduce sales
• Site licenses and other group pricing
schemes are a valuable tool
© 2006 Institute of Information Management
National Chiao Tung University
Lecture Note I-5
Recognizing Lock-In
• Measure switching cost
• Classification of Lock-In
• Lock-in cycle
© 2006 Institute of Information Management
National Chiao Tung University
Recognizing Lock-In
• Is Internet economy is friction-free economy ?
• Cost of switching
– Your choices for the future will be hammed in by the
selections you made in the pass
– Buyers typically must bear costs when they switch
from one information systems to another
• Compare
– Ford v. GM (low switching cost)
– Mac v. PC (high switching cost)
© 2006 Institute of Information Management
National Chiao Tung University
What’s the Difference?
• Durable investments in complementary
assets that are specific to that brand of
machine (e.g. hardware, Software)
• Dynamics:
– Supplier wants to lock-in customer
– Customer wants to avoid lock-in
• Basic principle: Look ahead and reason
back
© 2006 Institute of Information Management
National Chiao Tung University
Examples
• Bell Atlantic’s digital switch equipment
– Competitors: AT&T, Northern Telecom and Siemens
– Final Decision : Bell Atlantic invested $3 billion in AT&T’s 5ESS
digital switch which used proprietary operating system
– Large switching costs to change switches
• Recognize 888 Toll–free $8million
• Offer voice dialing $10 million
• 30~40% switch related revenue
• Computer Associates
– Leading supplier of software that work with IBM’s MVS and
VSE/ESA
– The third largest software company (behind MS and Oracle)
– Rival :Legent corporation
© 2006 Institute of Information Management
National Chiao Tung University
Small Switching Costs Matter
• Example
– Phone number portability
– Email addresses
• Emergence of new business model: Hotmail
– advertising, portability
• New service: ACM, CalTech
– offer e-mail forwarding as a way to avoid address
lock-in
– Keep in with members and alumni
• Evaluation: Compare switching costs to revenue
on a per customer basis
© 2006 Institute of Information Management
National Chiao Tung University
Valuing an Installed Base
• Total cost of switching =costs the customer bears
+costs the new supplier bears (from the perspective of
the new supplier)
– Customer C switches from A to "same position" with
B
– Total switching costs = customer costs + B's costs
•
Example
– Switching ISPs costs customer $50 new ISP $25
– New ISP make $100 on customer: induce switch
– New ISP makes $70 on customer: don’t induce
switch
© 2006 Institute of Information Management
National Chiao Tung University
Analytics of Switching Cost
• Market structure
– Perfectly competitive market with many identical firms
• parameter:
–
–
–
–
–
p: price
c: ISPs’ marginal cost
s: customer’s switching cost (cost to change ISP)
d: discount for switching
r: interest rate (monthly)
© 2006 Institute of Information Management
National Chiao Tung University
Competitive market equilibrium
• Customer’s decision
No difference
choice
( p  d)  p / r  s  p  p / r
switched
Not switched
d s
• ISP ‘s decision
Zero profit
pc
0
r
pc
d  s  ( p  c) 
r
r
p c
s
1 r
( p  c)  s 
© 2006 Institute of Information Management
National Chiao Tung University
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
© 2006 Institute of Information Management
National Chiao Tung University
Classification of Lock-In
• Contractual commitments: Compensatory or
liquidated damages
• Durable purchases: 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
© 2006 Institute of Information Management
National Chiao Tung University
Contractual Commitments
• “Requirements contract”:
– Purchase supplies from one supplier
– Minimum order size commitment
– Guarantee (price , quality)
• Beware of “evergreen contracts”
– Automatically renew sixty or ninety days
before initial ending date
© 2006 Institute of Information Management
National Chiao Tung University
Durable Purchases
•
•
•
•
Aftermarket sales (supplies, maintenance)
Depends on (true) depreciation
Usually fall with time
Watch out for multiple pieces of hardware
– Supplier will want to stagger vintages
– Contract renewal
•
Technology lock-in v. vendor lock-in
© 2006 Institute of Information Management
National Chiao Tung University
Brand-specific Training
• How much is transferable?
• Example: Software
• Competitors want to lower switching costs
– Eg. Help systems
• Borland Quattro Pro aimed at Lotus 1-2-3
• Word aimed WordPerfect
• Customers desire to standardize all of
their equipment by using a single vendor
– E.g. Fleet commonality
© 2006 Institute of Information Management
National Chiao Tung University
Information & Databases
• Information and database grow over time
• Lock-in to grow stronger with time
• Vendors’ strategies : raise or lower
consumers’ switch cost and capitalize on the
crucial distinction between proprietary and
standardized formats
• Consumers’ strategy: keep control of
information and databases by using
standardized formats and interfaces
© 2006 Institute of Information Management
National Chiao Tung University
Specialized Suppliers
• With specialized equipment, the switch costs
depends on the ability of new suppliers to offer
comparable equipment when needed in the
future
• Examples
– NASA’s suppliers, advertising, legal, accounting
firms
• Purchasers’ strategy: Dual sourcing
– IBM (Intel and AMD)
© 2006 Institute of Information Management
National Chiao Tung University
Search Costs
• Especially, Mass market
• Transactions cost in finding new suppliers
– Psychological costs, time and effort to find a
new supplier, risk cost
• Also costs borne by the new supplier
– Promotion, closing deal, setting up account, credit risks
• Example: Credit Cards
– Costly to attract new accounts
– Danger of adverse selection
– $100 million in receivables would be worth
about $120 million
– Market valuation of “loyalty”
© 2006 Institute of Information Management
National Chiao Tung University
Loyalty Programs
• Constructed by firm
–
–
Frequent flyer programs
Frequent coffee programs
• Personalized Pricing
–
Gold status in airline
• Affiliation
– Amazon Associates Program
• Referral fee: 5+1/8 %
– B&N's Affiliates program
• Referral fee: 7 %
– Add nonlinearity?
• Cumulative referrals
• Give playoff only after some milestone
© 2006 Institute of Information Management
National Chiao Tung University
Lock-in cycle
Brand Selection
(Free) Sampling
Lock-In
Entrenchment
© 2006 Institute of Information Management
National Chiao Tung University
Summary
•
•
•
•
•
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
© 2006 Institute of Information Management
National Chiao Tung University
Lecture Note I-6
Managing Lock-In
• Buyers’ strategies to avoid lock-in
• Sellers’ strategies to exploit lock-in
© 2006 Institute of Information Management
National Chiao Tung University
Basic Strategy for Buyers
• Bargain for compensation at beginning
– Convey the impression that your benefits from
switching are small and costs large
– Express your ability to influence other purchasers
• Limit your vulnerability
– Dual sourcing (partial switching)
– Demand compensation for each step
• Watch out for creeping lock-in
– Insist having the rights to relationship information with
the seller
– E.g. doctor switching
© 2006 Institute of Information Management
National Chiao Tung University
Buyers : Watch Out For
• Vague commitments
• Revealing too much about
vulnerabilities
• Entrenchment phase strategy
– May want to switch in part, just to gain
leverage
© 2006 Institute of Information Management
National Chiao Tung University
Basic Strategy for Sellers
• Invest
– Employ tactics to build your installed base at least possible
cost
– Figure different valuable customers and tailor your offering
to match
• Entrench
– Design products and promotions so that customers
continue to invest in your product or systems
– Lengthen and strengthen cycle
• Leverage
– Maximize the value of installed base
– Sell complementary products to these consumers
© 2006 Institute of Information Management
National Chiao Tung University
Basic Tensions (sellers vs buyers)
• For sellers: claim openness, but don’t
deliver
– Example: simple open interface (RTF),
powerful closed interface (DOC)
• For buyers: say you have large switching
costs to get large compensation
– But want to minimize lock-in as much as possible
© 2006 Institute of Information Management
National Chiao Tung University
Investing in an Installed Base
• Looking ahead at the whole look-in cycle
– Recognize lock-in customers are valuable assets
• Fighting for new customers
– Revenue from lock-in customers is the return on the investment
• Structure the life-cycle deal
– Be explicit about commitments to openness you make to attract
customers
• High market shares don’t imply high switching costs
– Rival often design their products to minimize switching cost (Netscape
Navigator v MS Explorer)
• Attracting buyers with high switching costs
– Offer discounts to influential buyers
• Multiplayer strategies
– Look for opportunities to exploit divergent interests
– Selling to influence buyers and the others will follow
© 2006 Institute of Information Management
National Chiao Tung University
Encouraging Customer Entrenchment
• Entrenchment by design
– Offer value-added information services to
deepen your relationship with your customer
• Loyalty program and cumulative discount
– The reward to past loyalty must be available
only to customers who remain loyal
© 2006 Institute of Information Management
National Chiao Tung University
Leveraging Your Installed Base
• Selling complementary products
• Selling access to your installed base
• Setting differential prices to achieve lock-in
– Prices aimed at locked-in customers may not appeal to new buyers.
Differential pricing is the solution
• Attempts to raise search costs
– Make yourself easy to find and your rivals hard to find
• Exploiting first-mover advantage
– Staggers termination dates on different customer contracts to
keep rivals from achieving scale economies
• Controlling cycle length
– Get your customers to extend their contracts before those
contracts expire
© 2006 Institute of Information Management
National Chiao Tung University
Summary
• Buyers
– Bargain hard
– Use second-sourcing and open systems
– Improve bargaining position at choice stage
• Sellers
– Invest in your installed base
– Cultivate influential buyers
– Design product and pricing to get customers to invest
in your technology
– Sell your customers complementary products
– Sell access to your installed base
© 2006 Institute of Information Management
National Chiao Tung University
Lecture Note I-7
Networks and Positive Feedback
•
•
•
•
Positive feedback
Network Externality
Evolution VS Revolution
Openness VS Control
© 2006 Institute of Information Management
National Chiao Tung University
Positive Feedback
• Positive feedback
– The stronger get stronger, the weaker get weaker
– market dominated by a single firm or technology
• Negative feedback
– The stronger get weaker, the weaker get stronger
– Market in oligopoly
– Stabilizing (competitive and balanced equilibrium)
• Positive feedback market
– Makes a market “tippy”: “Winner take all markets”
– Examples: VHS v. Beta (1980), Wintel v. Apple (1990)
– A more potent force in the network economy or
market for information infrastructure
© 2006 Institute of Information Management
National Chiao Tung University
Positive Feedback
100%
Market
Share
Winner
50%
Battle zone
Loser
0%
Time
© 2006 Institute of Information Management
National Chiao Tung University
Number of Users
Adoption Dynamics
Saturation
100%
50%
Takeoff
Launch
0%
Time
Adoption of new technologies: S-shape curve
(CD, color TV, video game machine, email, Internet, etc.)
© 2006 Institute of Information Management
National Chiao Tung University
Sources of Positive Feedback
• Supply side economies of scale
– Declining average cost
– Marginal cost less than average cost
– Example: information goods
• Demand side economies of scale
– Network effects
– In general: fax, email, Web
– In particular: Sony v. Beta, Wintel v. Apple
© 2006 Institute of Information Management
National Chiao Tung University
Demand Side Economies of Scale
Virtuous cycle
Value to User
100%
e.g. Lotus 1-2-3
50%
Vicious cycle
0%
e.g. VisiCalc
Number of Compatible Users
Implication: success and failure are driven by the consumer expectation
and the underlying value of product
© 2006 Institute of Information Management
National Chiao Tung University
Demand Side Economies of Scale
Willingness to pay
Demand
Stable equilibrium (2)
Critical mass
Network size
Stable equilibrium (1)
© 2006 Institute of Information Management
National Chiao Tung University
Critical Mass
© 2006 Institute of Information Management
National Chiao Tung University
Example: Fax
© 2006 Institute of Information Management
National Chiao Tung University
Network Externalities
• Networks
– Real networks
• Communications, transportation
– Virtual networks
• Like “Mac network”
• Externality
– Externality arise when one market participant affects
others without compensation being paid
• Value of Network
– Metcalfe’s Law:
Value of network of size n proportional to n2
© 2006 Institute of Information Management
National Chiao Tung University
Laws of growth
• Sarnoff’s Law - content
– Radio and television networks
– The value pf broadcast networks is proportionate to the number of views
• Morre’s Law (microprocessor investor)-innovation
– Hyper-evolution of electronics, computers, and networks
– The number of elements that could be packed into the same amount of
space on microchip double very year
• Metcalfe’s Law (Ethernet inventor)- communication
– Growth of value in networks
– The total value of a network where each node can reach every other
node grows with the square of the number of the nodes
• Reed’s Law - community
– Links between computer networks and social networks
– Email, BBS
– The value of online social networks grows proportionately to users
exponentially
© 2006 Institute of Information Management
National Chiao Tung University
Lock-In and Switching Costs
• Network effects lead to substantial
collective switching costs
– The combined costs of all users
– Nonlinear
– Even worse than individual lock-in
– Due to coordination costs
• Example:
– QWERTY (1870) vs AOEUIDHTNS (1932)
© 2006 Institute of Information Management
National Chiao Tung University
Igniting Positive Feedback
• Evolution (compatibility)
– Give up some performance to ensure
compatibility, thus easing consumer adoption
• Revolution (performance)
– Wipe the slate clean and come up with the
best product possible
© 2006 Institute of Information Management
National Chiao Tung University
Tradeoff of Compatibility and
Performance
Compatibility
Evolution
Improved design or adapters
Revolution
Performance
© 2006 Institute of Information Management
National Chiao Tung University
Evolution
• Offer migration paths to new
technologies
• Examples
– Microsoft, Intel
• Build new network by links to old one
– One way compatibility
• Problems: technical and legal
© 2006 Institute of Information Management
National Chiao Tung University
Strategies of Evolution
• Technical obstacles
– Use creative design
– Think in terms of system
– Converters and bridge technologies
• Legal obstacles
– Need IP licensing
– Example: Sony and Philips CDs (pay patent
license fee)
© 2006 Institute of Information Management
National Chiao Tung University
Revolution
• Performance: Groves’s law: “10X rule”
• Success
– depend on switching costs, critical mass
– Market is growing rapidly, lock-in is mild,
performance loom larger than backward
compatibility
• Example: Game video
– Lower switch cost for ten-year-boys
– Sega vs Nintendo
© 2006 Institute of Information Management
National Chiao Tung University
Openness v. Control
• Your reward = [Total value added to
industry] x [Your share]
– Total value added to industry
• Depends on product and
• Size of network
– Your share
• Depends on how open
© 2006 Institute of Information Management
National Chiao Tung University
Your Share of Industry Value
Tradeoff of Openness and Control
Propriety
Optimum
Open
Total Value Added to Industry
© 2006 Institute of Information Management
National Chiao Tung University
Openness vs. Control
• Openness
– Full openness
• Anybody can make the product
– Alliance
• Only members of alliance can use
• Control
– Control standard and go it alone
• If several try this strategy, may lead to standards
wars
© 2006 Institute of Information Management
National Chiao Tung University
Generic Strategies
Company’s market share Total industry’s value
Compatibility
Compatible
Control
Open
Controlled
Migration
Open
Migration
2
Performance
3
Incompatible Performance Discontinuity
Play
1
© 2006 Institute of Information Management
4
National Chiao Tung University
Generic Strategies (cont’)
• (1)Performance Play
– Introduce new, incompatible technology
– Examples: Palm Pilot, Iomega Zip
• (2)Controlled Migration
– Compatible, but proprietary
– Examples: Windows 98, Pentium
• (3)Open Migration
– Many vendors, compatible technology
– Examples: Fax machines, some modems
• (4)Discontinuity
– Many vendors, new technology
– Examples: CD audio, 3 1/2” disks
© 2006 Institute of Information Management
National Chiao Tung University
Historical Examples of
Positive Feedback
• Railroad Gauges….
• Battle of the Systems: AC v. DC….
• Telephone networks and
Interconnection….
• Color Television….
• High-Definition Television (HDTV)….
© 2006 Institute of Information Management
National Chiao Tung University
Summary
• Positive feedback means strong get stronger and weak
get weaker
• Consumers value size of network
• Adoption dynamics follows an S-shape growth path
• Positive feedback works for large networks, against
small ones
• Consumer expectations are critical
• Fundamental tradeoffs: (performance and compatibility),
(openness and control)
• Generic strategies
– Performance play, Controlled Migration, Open Migration,
Discontinuity
© 2006 Institute of Information Management
National Chiao Tung University
Agenda
• Cooperation & Compatibility
• Standard War
• Information Policy
© 2006 Institute of Information Management
National Chiao Tung University
Lecture Note I-8
Cooperation and Compatibility
• Standard and competition game
• Standard setting tactics
© 2006 Institute of Information Management
National Chiao Tung University
How Standards Change the
Game
• Expanded network externalities
– Make network larger, increase value
• Reduced uncertainty
– No need to wait
• Reduced consumer lock-in
– Netscape’s “Open Standards Guarantee”; MS ‘s XML
• Competition for the market v. competition within
the market
– Shift from an early battle for dominance to later for
market share
© 2006 Institute of Information Management
National Chiao Tung University
How Standards Change the
Game (cont’)
• Competition on price v features
– Reduce product differentiation, commoditized
products
• Competition to offer proprietary extensions
– Strong incentives for suppliers to differentiate
by developing proprietary extensions
(standard extension)
• Component v systems competition
– With interconnection, can compete on
components
© 2006 Institute of Information Management
National Chiao Tung University
Who Wins and Who Loses?
• Consumers
– Generally better off
– But variety may decrease
• Complementors
– Generally better off
– May sever brokering role
• Example: Impacts of DVD standard on
distributor Blockbuster
• Gain from sells a complement to DVD
• Threaten from new channel of distributions
© 2006 Institute of Information Management
National Chiao Tung University
Who Wins and Who Loses? (cont’)
• Incumbents
– May be a threat
– Strategies
• Deny backward compatibility
• Introduce its own standard
• Ally itself with new technology (e.g. Sony and Philips
on DVD)
• Innovators
– Technology innovators collectively welcome
standards
– If the group benefits, there should be some
way to make members benefit
– Small players may especially welcome a
standard
© 2006 Institute of Information Management
National Chiao Tung University
Formal Standard Setting
• Fundamental principle
– Essential patents must be licensed on “fair, reasonable and
non-discriminatory” terms
• ITU (International Telecommunications Union)
– 1865, now UN agency
– Notoriously slow
• Organization
– Independent professional body: IEEE (Institute of Electric and
Electronic Engineers
– Government body: NIST (National Institute of Standards and
Technology)
– Unofficial groups
• ACM- SIGART (artificial intelligence) , SIGCOMM (data
communication), SIGGRAPH (computer graphics), SIGIR
(information retrieval)
© 2006 Institute of Information Management
National Chiao Tung University
Tactics in
Formal Standard Setting
• What is your goal?
– National or international?
– Protecting your interests?
• What are others goals?
– Do they really want a standard?
© 2006 Institute of Information Management
National Chiao Tung University
Tactics in
Formal Standard Setting (cont’)
• Don’t automatically participate
– If you do, you have to license
• Keep up momentum
– Continue R&D while negotiating
• Look for logrolling
– Trading technologies and votes
• Be creative about deals
– Second sourcing, licensing, hybrids, etc.
© 2006 Institute of Information Management
National Chiao Tung University
Tactics in
Formal Standard Setting (cont’)
• Beware of vague promises
– “reasonable” royalty commitment from
holders of key patents
• Search carefully for blocking patents
– Patents held by non-participants
• Preemptively build installed base
– Achieve stronger negotiating position
© 2006 Institute of Information Management
National Chiao Tung University
Building Alliance
•
•
•
•
Assembling Allies
Interconnection among Allies
Negotiating a Truce
Alliances in Action
© 2006 Institute of Information Management
National Chiao Tung University
Assembling allies
• Partners of Allies
– Customers, suppliers, rivals, and complementor
• Assembling allies
– Pivotal customers should get special deals
• MS give IE users free access to Wall Street Journal
– But don’t give your first customers too big an advantage
• Offer temporary price break
• Who bears risk of failure?
– Usually ends up with large firms
– But bankruptcy favors small firms
– Government is even better!
• Smart cards in Europe (mandated for pay phone)
© 2006 Institute of Information Management
National Chiao Tung University
Interconnection among Allies
• Presence of strong network externality
• Become more strategic once networks began to
compete against each other over the same
routes :side by side networks rather than end to
end networks
• In you control a key interface or bottleneck, you
should open it up but on you own terms and
conditions
– Reduce the risk to lost control over the network over
time
– Eg. Sun’s Java (Microsoft “improve” Java working
only on windows)
© 2006 Institute of Information Management
National Chiao Tung University
The standards game
Player B
Player
A
Willing
to fight
Willing
to fight
Wants
standard
© 2006 Institute of Information Management
War
Wants
standard
Attempt to
block
Attempt to Voluntary
block
standard
National Chiao Tung University
Negotiating a truce
• Maximizing Return
– Do the benefit-cost calculation
– How to divide a larger pie?
– Your reward = Total value added x your share
• Cooperation between Netscape and
Microsoft
– Open Profiling Standard
– VRML
– SET
© 2006 Institute of Information Management
National Chiao Tung University
Alliances in Action
• Alliance Examples
– Xerox - Ethernet (Metcalfe). DIX Coalition
• Ethernet beat IBM token ring and becomes LAN
standard
– Adobe - PostScript (Warnock) and PDF
(portable document format)
– Microsoft - Active X
© 2006 Institute of Information Management
National Chiao Tung University
Managing Open Standards
• Standard is in danger if it lacks a sponsor
– Example: Unix
• AT&T invention by accident
• Gave away source code to EDU
• 1993 Coalition: Novell purchased rights for $320 million and
gave name to X/Open
• Open standards can be hijacked by companies
seeking to extend them in proprietary directions
– Example: SGML and XML
– Multiple dialects being promulgated
© 2006 Institute of Information Management
National Chiao Tung University
Summary
• Competition requires allies
• Standard affects competition in several
predictable ways
• Standards benefit consumers and suppliers, at
expense of incumbents and sellers
• Formal standard setting adds credibility
• Find natural allies
• Before a battle, try to negotiate a truce
• Try to retain control over technology, even when
establishing an open standard
© 2006 Institute of Information Management
National Chiao Tung University
Lecture Note I- 9
Standards Wars
• Classification of standards wars
• Tactics for standards wars
© 2006 Institute of Information Management
National Chiao Tung University
Standard Wars
• Two new incompatible technologies struggle to become
a de facto standard
• Examples
–
–
–
–
–
North v. South (in railroad gauges)
Edison v. Westinghouse (in electricity)
NBC v. CBS (in color TV )
3Com v. Rockwell/Lucent (in modem)
United States v. Japan (in HDTV)
• Wars can end
– A truce (as with modems)
– A duopoly ( as in video games) : Nintendo v Sony
– A fight to the death (as with VCRs)
© 2006 Institute of Information Management
National Chiao Tung University
Recent Standards Wars
• AM stereo
– mutually destructive
– Auto industry invested, radio didn’t
• Digital wireless phones
– two incompatible technologies
• Europe: GSM Global system for Mobile Communication), 108
countries adopt
• US: GSM, TDMA (cousin of GSM), CDMA compete
– TDMA: 5 million
– CDMA: 2.5 million
– GSM: 1 million
• 56 k Modems
– resolved through a standard agreement
• US Robotics x2 attempted preemption
• Rockwell/Lucent K56 Flex
• Compromise standard ITU V.90
© 2006 Institute of Information Management
National Chiao Tung University
Classification of Wars
Compatible Incompatible
Compatible
Rival
Evolution
Incompatible Revolution
v.
Evolution
Evolution v.
Revolution
Rival
Revolution
E
© 2006 Institute of Information Management
National Chiao Tung University
Examples
• Rival evolution
– DVD v. Divx, 56k modem, various flavors of
Unix
• Rival revolutions
– Nintendo 64 v. Sony PlayStation
• Evolution v. Revolution
– Spreadsheet (Lotus 1-2-3 v Excel), database
(dBase IV v Paradox)
© 2006 Institute of Information Management
National Chiao Tung University
Key Assets in Network Markets
•
•
•
•
•
•
•
Control over an installed base
Intellectual property rights
Ability to innovate
First-mover advantages
Manufacturing
Strength in complements
Reputation and brand name
© 2006 Institute of Information Management
National Chiao Tung University
Two Basic Tactics
• Preemption
– Build installed base early for positive feedback
– But watch out for
• rapid technological progress
• Imperfect Quality
• Expectations management
– Manage expectations
– But watch out for vaporware
• Announce an upcoming product so as to freeze your rival’s
sales
© 2006 Institute of Information Management
National Chiao Tung University
Once You’ve Won
• Staying on your guard
– Offer a migration path fend off challenges from upstarts
– French’s Minitel system (1980, online transaction system)
• Commoditize complementary products
– Retain franchise as the market leader but encourage a
competitive market for complements
• Competing against your own installed base
– Durable goods monopoly (Intel again)
© 2006 Institute of Information Management
National Chiao Tung University
Once You’ve Won (cont’)
• Protect your position
– Attract important complementors
• Leverage installed base
– Expand network geographically
• Stay a leader
– Develop proprietary extensions
© 2006 Institute of Information Management
National Chiao Tung University
What if You Fall Behind?
• Adapters and interconnection
– Target a market niche or interconnect with
the larger networks
• Survival pricing
– Hard to pull off
– Different from penetration pricing
• Legal approaches
– Renege the openness promise
© 2006 Institute of Information Management
National Chiao Tung University
Battle of the Browsers: Microsoft
v. Netscape
• Characteristics
– Rival evolutions
– Low switching costs
– Small network externality
• Strategies
– Preemption in distribution
– Penetration pricing
– Expectations management
– Alliances
© 2006 Institute of Information Management
National Chiao Tung University
Summary
• Understand the type of war
– Rival evolution
– Rival revolution
– Revolution v Evolution
•
•
•
•
•
Strength depends on 7 critical assets
Preemption is a critical tactic
Expectations management is critical
When you’ve won the war, don’t rest easy
If you fall behind, avoid survival pricing
© 2006 Institute of Information Management
National Chiao Tung University
Lecture Note I-10
Information Policy
• Competition policy
• Government’s role
© 2006 Institute of Information Management
National Chiao Tung University
Public policy
• “Cooperate centric view” v. “policy centric
view”
– profitability v. net social benefits
• Adam Smith: competitive pressures between
producers will often induce them to make
choice that maximize the general welfare
• Jim Barksdale (CEO of Netscape) :
“…working with the government is far more
productive than trying to ignore it.”
© 2006 Institute of Information Management
National Chiao Tung University
Themes of Information Policy
• Differentiation of products and prices
– High first-copy costs of information and information technology
– Problem: charge different users different prices for essentially
the same product
• Lock-in
– Information products works together in systems, switching any
single product can be very costly to users
– Problem: Aftermarket monopolist
• Positive feedback
– Network externality is ubiquitous in the information industry
– Problem: Standard (Cartels and Collusion)
© 2006 Institute of Information Management
National Chiao Tung University
Competition Policy
• Principles of Competition Policy
– Ensure a fair fight, not to punish winners or
protect losers
• Sherman Act (1890)
– Monopoly isn’t illegal, but attempt to
monopolize is
• Clayton Act (1914)
– Protects competition as a process
© 2006 Institute of Information Management
National Chiao Tung University
Price Differentiation
• Price and product differentiation
– Mass customization, differential pricing, personalized content,
versioning
• Robinson-Patman Act (1936)
– Price discrimination is illegal if it “effectively lessens
competition”
• Legal arguments that work
– Can set lower prices resulting from lower costs
– Set differential prices to meet competition
– Pricing only questionable if it “lessens competition”
© 2006 Institute of Information Management
National Chiao Tung University
Example 1: Differential Pricing
Can Hurt Consumers
• 100 people wtp $20, 1000 people wtp $6 (No
delay)
• Optimal flat price = $6
– Revenue=$6600 ( 6X(100+1000) )
• 100 people wtp $20 for early edition, $5 for later,
1000 people wtp $5 for later
• Versioning: Optimal to sell at (early, $20) and
(later, $5)
– Revenue=$7000 (20X100+5X1000)
• Consumers now are worse off
– Inefficient: social loss $1*1000 (due to delay)
© 2006 Institute of Information Management
National Chiao Tung University
Example 2 : Differential Pricing
Can Benefit Consumers
• 1000 consumers wtp $20, 100 people wtp $6 for
early, $5 for later
• Optimal flat price = $20
– Revenue=$20000 (20x1000)
• Versioning: sell for (early, $20) and (later, $5)
– Revenue=$20500 (20x1000+5x100)
• Key: will versioning increase size of market?
social gain $5*100 (due to new customers)
© 2006 Institute of Information Management
National Chiao Tung University
Government Choices
• Do nothing
• Act on basis that monopoly was illegally
obtained
– Break up
– Prohibit suspect practices
• Regulate the monopolist
– Control genuine monopoly power where it
exists
© 2006 Institute of Information Management
National Chiao Tung University
Implications for Strategy
• Monopoly may be inhibited from using strategies
that are legal for other firms
– Even small firms may be accused of antitrust
violations
• E.g. Iomega Zip drive (product design, distribution, IP
enforcement)
• Mergers and acquisitions, cooperation with rivals
to set standards, and market dominance can
antitrust scrutiny
• Cooperative standard setting can be
investigated if there are pricing, collusion, cartels
© 2006 Institute of Information Management
National Chiao Tung University
Cooperative Standards Setting
• Cooperation or collusion ?
• Standards setting or cartel?
• Watch out for prices and terms
agreements
• Performance standards as barrier to entry
• Patent cross licenses
• Interconnection agreements
© 2006 Institute of Information Management
National Chiao Tung University
Single Firm Conduct
• Exclusive dealing provision
– Insists its customers not deal with its
competitors
• Tying (bundling)
– Insists its customers take another product if
they want the monopolized item
– Internet Explorer is separate product or
merely part of an integrated operating system ?
© 2006 Institute of Information Management
National Chiao Tung University
Government Role’s in
Achieving Critical Mass
• Private sector can be creative about
network externalities
• Important basic technology needs to be
proven or demonstrated
– E.g. Internet
– The government can provide critical mass to
ignite positive feedback, but it should be
cautious about picking winner
© 2006 Institute of Information Management
National Chiao Tung University
Summary
•
•
•
•
•
•
•
•
Don’t expect government’s role to diminish
Every company needs to know the rules
You can usually use differential pricing
Policy should ensure fair fight, not punish winners or
protect losers
Mergers are subject to review by Justice Department
and Federal Trade Commission
Cooperate to set standards and develop new
technologies, so long as efforts benefit consumers
If you gain a leading share of market, conduct audit of
your practices
Don’t expect government regulation of telecom to
diminish any time soon
© 2006 Institute of Information Management
National Chiao Tung University