Creating New Industries:

Different Industries,

Different Challenges of Formation

Jeffrey Funk

Associate Professor

Division of Engineering & Technology Management

National University of Singapore

Mail: etmfjl@nus.edu.sg

These slides summarize ideas that are described in a paper (Complexity, Critical Mass, and Industry Formation:

A Comparison of Selected Industries, Industry and Innovation, 2010) and a chapter in a forthcoming book from

Stanford University Press (Technology Change and the Rise of New Industries)

New Industries

• Can be thought of as a set of products or services

– based on new concepts and/or architectures

– supplied by new collection of firms

– and of a significant amount of sales e.g., >$5 billion)

• According to Joseph Schumpeter,

– waves of new technologies have created new industries

– along with opportunities and wealth for new firms as the new

technologies destroyed existing technologies and their

incumbent suppliers

– this process is often called “creative destruction”

Timing of Industry Formation

• For all industries, industry formation requires

– products that are economically feasible and thus offer a

superior value proposition to an increasing number of users*

– firms to recognize the potential for this superior value

proposition and introduce the products

• But for other industries, there are additional challenges

of industry formation

– industries that involve complex products and/services

– industries that require a critical mass of users or

complementary products for growth to continue

Other chapters in “Technology Change and the Rise of New Industries” (and other slides)

address this issue

Outline

• Typology of Industry Formation

– degree of complexity

– whether a critical mass of users or complementary products is

needed for growth to continue

• Simple Products

• Simple Networked Products

• Complex Systems

• Complex Network Systems

• Conclusions

Relative Complexity at Time of Creation

Typology of Industry Formation

Critical Mass

of users or

Complementary

Products

was Required

Yes

No

Low High

Complex Network Systems

Radio (AM, FM) Broadcasting Systems

Television (Black & White, Color,

Digital) Broadcasting Systems

Fixed-Line Telephone Systems

Mobile Phone (Analog, Digital) Systems

PC Internet, Mobile Internet

Complex Systems

Electric Power Automated

Automobile Algorithmic Trading

Mainframe Online Universities

Computers Biotechnology

Nuclear Power Semiconductors

Airline/Aircraft

Simple Network Products

Digital Video Disc (DVD)

Music Players (Phonograph,

Cassette Tape, Compact Disc)

Facsimile

Personal Computer (PC)

Simple Products

Refrigerator Washing Machine

Dryer Air Conditioner

Vacuum Cleaner Sewing Machine

Video Cassette Digital Watch

Recorder (VCR)

Pocket calculator Digital Camera

Complexity (1)

• The complexity of an industry can be measured in terms

of the number of

– subsystems

– processes, and/or

– lines of software code in the products or services offered in the

industry

• Complex systems usually require more

– technical, regulatory, and administrative decisions to be made

– organizations (including government agencies) and often

larger ones to be involved with these decisions

– resources for their development and operation (e.g., R&D,

land, frequency spectrum) than do less complex systems

Complexity (2)

• Therefore, the following are more important for

industries based on complex than simple systems

– government support for R&D

– government purchases

– government regulations and licenses with respect to limited

resources (e.g., frequency spectrum or land including regulated

monopolies)

– new forms of organizations (including vertical disintegrated

ones) and

– agreements among firms on standards and methods of value

capture

Critical Mass (1)

• Whether a critical mass of users or complementary

products are needed for growth depends on whether

– a product by itself has value to users and/or

– there are immediate and large benefits to users from an

expansion in number of them or complementary products

• Some products require a critical mass of users for

growth to occur

– users only obtain value if there are multiple users and if those

multiple users jointly use the products

– Examples include telephones, facsimiles, video conferencing,

short message services (SMS), Internet mail, dating sites, and

social networking sites

Critical Mass (2)

• Other products require critical mass of complementary

products

– immediate and large benefits to users from expansion in

complementary products

• Examples include music/video players, video games,

computers, radio/TV broadcasting, PC/mobile Internet

• One reason for large benefits - users demand wide

variety of music, video, programs, computer software

• Need for critical mass increases

– importance of firms finding agreements on standards and on

methods of value capture and creating alliances that support

these agreements

Outline

• Typology of Industry Formation

– degree of complexity

– whether a critical mass of users or complementary products is

needed for growth to continue

• Simple Products

• Simple Networked Products

• Complex Systems

• Complex Network Systems

• Conclusions

Simple Products

• Simple products

– had low complexity

– didn’t require a critical mass of users/complementary products

• Timing of formation depended on when

– products offered a superior value proposition to users

– firms recognized the potential for this superior value

proposition and introduced the products

• Because such new products are often expensive,

– first users were ones with high incomes

– and thus, products representing new industries have diffused

faster in U.S., Europe, and Japan than in other countries

Outline

• Typology of Industry Formation

– degree of complexity

– whether a critical mass of users or complementary products is

needed for growth to continue

• Simple Products

• Simple Networked Products

• Complex Systems

• Complex Network Systems

• Conclusions

Simple Networked Products (1)

• The difference between simple network-products and

simple products is in whether

– a critical mass of either users or complementary products is

needed for growth to occur

– and this depends on whether product by itself has value to users

and/or whether there are immediate and large benefits to users

from expansion in number of users/complementary products

• Local area networks (LANs) and fax machines required

critical mass of users

– because multiple users were needed for users to obtain value

– critical masses of users emerged inside firms and later

emergence of standards facilitated communication between

firms and in the case of fax machines, between consumers

Simple Networked Products (2)

• The other products shown in upper left hand quadrant

– required critical mass of complementary products to emerge for

growth to occur

– users have demanded variety of music, movie (e.g., DVDs),

and computing software before they adopted new hardware

– positive feedback between number of users and variety of

software

• Some firms have supplied both hardware and software

(i.e., vertical integration)

• Other firms have created alliances in order to set

standards and offer compatible hardware and software

Has it Become More Difficult to Create

Critical Mass? (1)

• Several new music formats - digital audio tape (DAT),

digital compact cassettes (DCC), mini-discs – failed and

legal on-line music services have grown slowly

• For first three

– their performance advantages over CDs were small

– music companies did not strongly support them

– DAT was not backward compatible with cassette tapes albeit

DCC was

– “switching costs” for CDs perhaps too large for DCC to diffuse

• For on-line music, sales lagged until Apple put together a

new scope of activities and revenue sharing model

Has it Become …..Critical Mass? (2)

• PC industry was also temporarily immune to “creative

destruction”

• Large switching costs and Microsoft’s control of

“standard” interfaces slowed introduction of new

computers/OS/microprocessors

• It has only been increasing compatibility between Wintel

and Apple computers and new discontinuities that have

reduced power of Microsoft and Intel

– Many orders of magnitude improvements in ICs are making

compatibility and new discontinuities such as PDAs, tablet

computers, and cloud computing possible

These Examples Highlight Differences

Between Simple and Simple Network Products

• With simple products (e.g., hand-held tape players, digital

cameras)

– it is primarily recognizing when a new product representing a

new industry might become economically feasible

– and having technical capabilities to introduce product

• With simple network products such as PDAs (Palm),

tablet computers, and MP3 players (Apple)

– capabilities associated with creating standards and alliances are

also important

Outline

• Typology of Industry Formation

– Degree of complexity

– Whether a critical mass of users or complementary products is

needed for growth to continue

• Simple Products

• Simple Networked Products

• Complex Systems

• Complex Network Systems

• Conclusions

Complex Systems (1)

• Complex systems have a large number of

– subsystems, processes, or lines of software code in products or

services offered in the industry

• This complexity leads to need for – large amounts of R&D

– new regulations with respect to limited resources (e.g., land and frequency

spectrum)

– price-insensitive customers

• Some governments (e.g., U.S. one) have funded R&D,

implemented regulations (or deregulation) and been the

necessary price-insensitive customers more than have

other governments

Government Agencies in U.S.

• Were major funders of R&D for

– aircraft, computers, nuclear power, semiconductors, and bio-

technology

• Were major (price insensitive) customers for

– aircraft, airlines (postal services), computers, nuclear power,

semiconductors, and bio-technology

• Also implemented favorable regulations for

– many of these industries

– one example is for limited resources (e.g., land for electric

power distribution and regulated monopolies)

• These are major reasons for early formation of these

industries in the U.S.

More Specific Examples

• Biotechnology (late 1970s)

– first emerged in U.S. due to strong universities, a venture

capital market, and favorable regulatory system that

protected intellectual property and that enabled universities

to benefit from federally-funded research

• Automated algorithmic trading (in 1990s)

– first emerged in U.S. due to strong universities (i.e., finance

departments), venture capital market, and favorable

regulatory system (or lack of regulations)

• Online universities (in 2000s)

– first emerged in U.S. partly due to existence of government

subsidized loans for private universities (i.e., policy)

But none of these Industries Required Critical Mass

of Users/Complementary Products

• Some complex systems used in combination with

existing products/services

– automobiles used existing roads, fuel sources, repair shops

– mainframe computers initially used punch cards

– nuclear power stations used existing steam turbines and

transmission lines

– semiconductors used in existing electrical systems

• Some initially introduced as stand-alone systems

– mainframe computers, electric power (for street lighting)

– in stand-alone systems, integrated supplier provides all

hardware and software and thus there are only supply-based

economies of scale

But such Network Effects or Switching Costs

May Emerge……

• Network effects did later emerge for mainframe

computers as vertical disintegration occurred, which

enabled different firms to provide computer,

peripherals, and application software

• Network effects also emerged for automobiles in the

form of gasoline and service stations

– will these network effects make it difficult for electric or

hydrogen vehicles to diffuse?

– many automobile users may expect battery recharging

stations or hydrogen refueling stations to be available

Outline

• Typology of Industry Formation

– Degree of complexity

– Whether a critical mass of users or complementary products is

needed for growth to continue

• Simple Products

• Simple Networked Products

• Complex Systems

• Complex Network Systems

• Conclusions

Complex Network Systems (1)

• Combines the challenges of

– complex systems

– creating a critical mass of users or complementary products

• Complex systems often require

– large amounts of R&D, new regulations with respect to land

and frequency spectrum, or price insensitive customers

• Creating a critical mass of users often requires

– firms to agree on standards and methods of value capture and

create alliances to support these agreements

Complex Network Systems (2)

• Governments have needed to

– facilitate agreements on standards

– manage limited resources of land or frequency spectrum

– but encourage competition

• Examples include

– Radio (AM, FM) and Television (Black & White, Color,

digital) Broadcasting Systems

– Fixed-Line and Mobile Phone (Analog, Digital) Systems

– PC Internet and Mobile Internet

Complex Network Systems (3)

• Recently

– Agreements on standards have become easier

– While choices of standards have increased dramatically

– This seeming contradiction comes from greater firm formation,

more standard setting agencies, and other institutional changes

• But this was not always the case

• And agreements on standards do not always come

easy……

Example of PC Internet in U.S. (1)

• Federal government funded development in universities

• Universities developed and implemented open standards

• Early deregulation of telecom industry and firms’ early

implementation of PCs and LANs

– contributed to interlinking between government-funded, commercial, and

corporate networks

• Easy dissemination of browsers over inter-linked networks in

early 1990s and lifting of restrictions on commercial activities in

mid-1990s

– triggered an explosion in Internet activity, or in this presentation’s words,

the formation of the Internet industry

For more details, see: Mowery, D. & Simcoe, T 2002, Is the Internet a US invention? – an economic and technological

history of computer networking, Research Policy, vol. 31, pp. 1369-1387

Example of PC Internet (2)

• Europe (outside of Scandinavia and UK) and Japan were slower

to fund implementation of Internet infrastructure and when they

did

– they focused on proprietary technologies that were supported by their

“national champions”

• Their universities were also slower to implement information

technologies

– their governments funded less university research and were slow to

liberalize their telecommunications industries

• This allowed other countries

– like Korea, Singapore, and Hong Kong to experience faster diffusion of

Internet services than did Japan and many European countries

Example of Mobile Phones

• Scandinavia (followed by U.S. and UK) experienced

earlier growth than did other countries

– government-sponsored entities created open standards,

licensed service providers, allowed competitive sale of phones

• Their service providers also

– set lower prices than did other countries

• On other hand, most Western European countries had

earlier growth in digital phones than did U.S.

– they chose single standard and began licensing new entrants in

the late 1980s long before U.S.

For more details, see: Funk J and Methe D. 2001. Market and Committee Based Mechanisms in the Creation and

Diffusion of Global Industry Standards: the case of mobile communications, Research Policy 30 (4): 535-708

Example of Mobile Internet (1)

• Mobile Internet has seen completely different process of

formation than did the PC Internet

– firms and not universities initially created the mobile Internet

• Japanese service providers created a critical mass of users in

1999 and 2000 with

– phones that displayed content in a consistent manner (i.e., using standards)

– entertainment content that was supported by a micro-payment system

– inexpensive Internet mail

– site access via the input of a URL

• The Japanese service providers were able to do these things

partly because they still dictated phone specifications to

manufacturers

For more details, see: Funk, J. 2012. Multiple Standards and Critical Masses, and the Formation of New Industries:

The case of the Japanese mobile Internet, European Journal of Innovation Management 15(1): 4-26

Example of Mobile Internet (2)

• Western firms had trouble creating critical mass of users

due to

– lack of agreement on standards

– lack of inexpensive Internet mail

– little revenue sharing with content providers by service

providers

• Phone manufacturers failed to agree on standards in

WAP (Wireless Automation Protocol) Forum primarily

because

– large ones such as Nokia did not want open standards to

emerge

– and lead to market for phones that is similar to PCs

Example of Mobile Internet (3)

• Service providers did not want Internet mail to

cannibalize SMS revenues and make them a “pipe” as in

PC Internet

• These problems were finally solved by

– improvements in ICs and displays

– that made it possible for new entrants such as Apple and

Google to introduce phones that can access PC content on a

phone

– this eliminated the necessity of creating a critical mass of

mobile Internet content, users and phones

Conclusions

• For all industries, industry formation requires

– products that are economically feasible and thus offer a

superior value proposition to users

– firms to recognize the potential for this superior value

proposition and introduce the products

• But for other industries, there are additional challenges

for industry formation

– industries that involve complex products and/services

– industries that require a critical mass of users or

complementary products for growth to continue

These Additional Challenges Include

• Simple Network Products

– agreements on standards and methods of value capture and

alliances to support these agreements

• Complex Systems

– Governments fund R&D, be a price insensitive customer, and

implement appropriate regulations (or deregulation) for scarce

resources such as land or frequency spectrum

• Complex Network Systems

– Combines challenges of network and complex systems

– Governments must often: 1) facilitate agreements on

standards; 2) manage limited resources of land or frequency

spectrum; and 3) encourage competition