Notes on Information Rules, Shapiro and Varian part one

1
Notes on Information Rules,Shapiro and
Varianpart one

• Darral G. Clarke
• Professor of Management
• Marriott School of Management
• Brigham Young University

2
Information Rules

• Positive feedback and network externalities
• The value of a product to one user depends on how
  many other users there are
• As a result growth is a strategic imperative
• Standards
• Critical in a market with network externalities
• Customer expectations on what will become the
  standard
• Strong strategic partners
• Customers, complementors, competitors
• Key tradeoff between openness and control

3
7 Networks and Positive Feedback Positive
feedback 1

• The old industrial economy is driven by economies
  of scalethe new information economy is driven by
  the economics of networks
• The value of a network depends on the number of
  people connected to it
• Compare with postal service, railroads, airlines,
  and telephones

4
7 Networks and Positive Feedback Positive
Feedback 2

• Negative feedback systemstrong get weaker and
  the weak get stronger
• Decreasing returns to scale
• Difficulty in sustaining competitive advantage
• Optimal scale (beyond is negative)
• All these lead to equilibrium, shared monopolies
• Positive feedback systemstrong get stronger and
  the weak get weaker
• Not the same as growth or size
• Driven by desire of users to select the
  technology that will ultimately prevail
• Tippy marketstwo or more firms compete in a
  positive feedback market one strong others weak.
  Winner-take-all in the extreme
• Positive feedback systems follow a predictable
  S-shaped curve over time. E.G. Nintendo.

5
7 Networks and Positive Feedback Demand-side
economies of scale 3

• Virtually all industries go through a positive
  feedback phase early in evolution, but it is not
  winner take all because positive demand-side
  economies of scale are counteracted by negative
  supply-side economies of scale (Gen. Motors)
• Information economy more virulent positive
  demand-side economies of scale (network effects)
  but not faced with negative supply-side economies
  of scale
• Growth on the demand side both increases demand
  for the product and reduces costs (if development
  costs are fixed cost)
• Lions share of the rewards go to the largest
  firm, number two is much smaller

6
7 Networks and Positive Feedback Network
externalities 4

• Virtual networks share many properties with real
  networks like railroads and telephones
• Externalities arise when one participant affects
  others without compensation being paid
• Positive externalities give rise to positive
  feedbacks
• Ethernet inventor Metcalfs law If there are n
  people in the network, the value of the network
  is n(n-1)!

7
7 Networks and Positive Feedback Collective
switching costs Is an industry subject to
positive feedback? 5

• Collective switching coststhe combined switching
  costs of all users
• Qwerty Keyboard
• Biggest single force working in favor of
  incumbents
• Convincing 10 people in a network to switch is
  more than 10 times as hard as convincing one that
  is not in a network
• When is an industry subject to positive feedback?
• PC industry has positive feedbackIBM pcs did
  not
• ISP Servers dont have positive feedback due to
  standardized protocols for menus/browsers, etc

8
7 Networks and Positive Feedback Is an industry
subject to positive feedback? 6

• Likelihood of a market tipping to a single
  technology
• Must consider both demand-side and supply-side
  scale economies
• Must consider demand for variety
• Must consider switching costs
• Information goods and information infrastructure
  exhibit both economies of scale!

9
7 Networks and Positive Feedback Igniting
positive feedback 7

• Approaches for dealing with consumer inertia
• Evolution (help existing users upgrade unlike
  CBS)
• High compatibility but little increase in
  performance
• Revolution (eg. Introduction of fax)
• High performance, but difficult compatibility

10
7 Networks and Positive Feedback Evolution
Offer a migration path 7

• Evolution
• Can be employed on a modest scale, even by a
  relatively small player (Borland vs. Lotus 1-2-3
  Word vs. Wordperfect)
• Requires compatibility with existing technology
• Interfaces to old technology are critical
• Technical obstacles
• Consider converters and bridge technologies
• But, this strategy is vulnerable to the
  revolution strategy, especially by a powerful
  competitor

11
7 Networks and Positive Feedback Revolution
Offer compelling performance 7

• Offer such compelling performance that leaders
  will be willing to pay the price of adoption
• Performance increment 10 x
• Leaders fuel bandwagon effect
• Works best in a growing market
• Get some new users, that are not switchers
• Customer lock-in is not severe

12
7 Networks and Positive Feedback Openness versus
control 7

• Openness versus control is additional issue to
  performance/compatibility trade-off (Adobe)
• Proprietary control is more valuable if the
  market takes off (Intel chips not widely
  licensed)
• Openness will bolster chances of success by
  attracting allies and assuring customers that
  they will be able to turn to multiple suppliers
• Choice depends on
• whether you are strong enough to ignite positive
  feedback alone
• The danger of someone else, more open, scooping
  you
• Reward Total value added to industry x share of
  industry value

13
7 Networks and Positive Feedback Openness versus
control 8

• Openness
• Critical when no firm is strong enough to gain
  critical mass alone
• When multiple products must work together (pdf
  components)
• Involves timing as well as technical
  specifications
• Alliances span the distance from openness to
  control
• Task forces, special interest groups,
  cross-licensing
• Upstart wants openness to fight installed base
• Control (Microsoft APIs favor internal
  developers)
• Only those in the strongest positions can exert
  strong control
• Webs woven around a central sponsor or actor who
  collects royalties and preserves proprietary
  rights

14
7 Networks and Positive Feedback Generic
strategies in network markets 9

• Trade-off between openness/control and
  performance/compatibility

15
7 Networks and Positive Feedback Lessons 10

• Adoption dynamics follow a predictable pattern
• Customers value information technologies that are
  widely used
• Positive feedback works to the advantage of large
  players in a network and against small players
• Consumer expectations are vital to attaining
  critical mass
• Fundamental trade-off between performance and
  compatibility
• Fundamental trade-off between openness and
  control
• Four generic strategies performance,
  discontinuity, controlled and open migration
• Tactics have been used in the past
• Railroad Gauges
• AC versus DC electric
• Telephones
• Color tv HDTV