Competing in Competing in Standards Driven MarketsStandards Driven Markets

When can you maintain control over the When can you maintain control over the use of an innovation/idea?use of an innovation/idea? zz Strong intellectual property rightsStrong intellectual property rights

zz FirstFirst--mover advantagesmover advantages –– Customer lockCustomer lock--inin –– Network effectsNetwork effects –– StandardsStandards

Market Power

Diffusion often looks quite differentDiffusion often looks quite differentin a market shaped by standardsin a market shaped by standards zz Network externalitiesNetwork externalities of all kinds may create lock in, so of all kinds may create lock in, so

that once established, a standard can be very difficult that once established, a standard can be very difficult to replaceto replace

zz LockLock--inin may occur when the technology is still in its may occur when the technology is still in its infancyinfancy –– e.g. VHS vs. Beta, MS Windows vs. OS/2e.g. VHS vs. Beta, MS Windows vs. OS/2

zz In markets in which standards are important, it may be In markets in which standards are important, it may be impossible to survive as a small playerimpossible to survive as a small player

OutlineOutline

zz DefinitionsDefinitions –– Standards & Network effectsStandards & Network effects

zz Switching costs, “lock in” and “tipping”Switching costs, “lock in” and “tipping” –– Do all markets tip?Do all markets tip?

zz Competing in standards driven markets:Competing in standards driven markets: –– Establishing a standardEstablishing a standard –– Making moneyMaking money –– Overturning an established standardOverturning an established standard

DefinitionsDefinitions

What is a standard?What is a standard?

zz A standard is a specification that allows for A standard is a specification that allows for interoperabilityinteroperability

zz E.g.:E.g.: –– Cups and lidsCups and lids –– Pistons and enginesPistons and engines –– Telephones and socketsTelephones and sockets –– Speakers and amplifiersSpeakers and amplifiers –– Hardware and softwareHardware and software

Standards and Dominant DesignsStandards and Dominant Designs

zz Dominant design Dominant design –– “the way we do things,”“the way we do things,” overall look & feeloverall look & feel

zz Standard Standard –– particular interface, format or systemparticular interface, format or system zz Standards or architectures allow for interoperabilityStandards or architectures allow for interoperability zz Not all dominant designs are standardsNot all dominant designs are standards

–– e.g., Henry Ford and the Model Te.g., Henry Ford and the Model T zz Not all standards are dominant designs…Not all standards are dominant designs…

–– e.g., WebTVe.g., WebTV zz …But many successful standards embody…But many successful standards embody

dominant designsdominant designs –– e.g., Apple’s operating systeme.g., Apple’s operating system

An industry without a standard:An industry without a standard:

An industry with a standard:An industry with a standard:

What are the pros and cons of What are the pros and cons of standards?standards?

zz ProsPros

zz ConsCons

zz ProsPros

zz ConsCons

Standards can be “public” or “private”Standards can be “public” or “private”

zz Public standardsPublic standards –– IP in the standard is publicly ownedIP in the standard is publicly owned –– Often administered by an industry consortium, or by Often administered by an industry consortium, or by

regulationregulation zz Private standardsPrivate standards

–– IP in the standard is controlled and owned by a firm (or IP in the standard is controlled and owned by a firm (or group of firms)group of firms)

Standards can be “open” or “closed”Standards can be “open” or “closed”

zz Open standardsOpen standards –– Details are released to third parties (“complementors”) Details are released to third parties (“complementors”)

so that they can develop complementary products, so that they can develop complementary products, services and technologiesservices and technologies

zz Closed standardsClosed standards –– Used within the firm, but details are not releasedUsed within the firm, but details are not released

Private standards may be open or Private standards may be open or closedclosed

Ownership is:

Public

Private

The technology is: Open Closed

Details of standard are made available to all: but owner has control over how the standard evolves and may charge for use

E.g. Nintendo, Palm OS

Details of standards are available to all: no single firm has control over how they evolve: no charge for

E.g. TCP/IP, HTML

Standards are owned and controlled by the public sector but are not freely available

E.g. Cryptography

Technology may be standard, but details are not made available beyond the firm

E.g. IBM 360 Architecture

their use

All options have both advantages and All options have both advantages and disadvantagesdisadvantages

Ownership is:

Public

Private

The technology is: Open Closed

With Strong Network Effects Market With Strong Network Effects Market Share Share ItselfItself Creates ValueCreates Value

Value to consumer

Actual (or anticipated) size of the installed base

Value of standards Driven product

Conventional product

“Great products” vs. “Architectures”“Great products” vs. “Architectures”

Great ProductsGreat Products zz Consumers base their Consumers base their

purchase decision on the purchase decision on the intrinsic value of the product intrinsic value of the product to themto them

zz What would this be worth to What would this be worth to me if I were the only buyer in me if I were the only buyer in the world?the world?

zz Competition on the basis of Competition on the basis of features, price etcfeatures, price etc

ArchitecturesArchitectures zz Consumers base purchase Consumers base purchase

decisions on the size of the decisions on the size of the (actual or projected) installed (actual or projected) installedbase and/or the (actual or base and/or the (actual orprojected) future availability projected) future availabilityof complementary products of complementary productsand servicesand services

zz How many other people are How many other people arelikely to buy this product?likely to buy this product?

zz Competition on the basis of Competition on the basis of the size of the installed base, the size of the installed base, availability of complementary availability of complementaryproducts etcproducts etc

Standards create value because they Standards create value because they create create network effectsnetwork effects zz Direct network effects: Direct network effects:

–– Network sizeNetwork size •• Value increases with the number of other individuals who own Value increases with the number of other individuals who own

the same productthe same product E.g.: Telephones, fax machinesE.g.: Telephones, fax machines

zz Indirect network effects:Indirect network effects: –– Complementary products/servicesComplementary products/services

•• Value increases with the number of complementary products that Value increases with the number of complementary products thatare available: E.g: CDs, Software, VHS/Betaare available: E.g: CDs, Software, VHS/Beta

–– Modular innovation (plug and play)Modular innovation (plug and play) •• Value increases with innovation across the system (E.g: stereo Value increases with innovation across the system (E.g: stereo

systems)systems) –– Learning by using Learning by using

•• Standards mean customers only invest once in learning to use Standards mean customers only invest once in learning to usethe technology: E.g.: Qwerty Keyboard, Autocadthe technology: E.g.: Qwerty Keyboard, Autocad

TippingTipping oror

Will all markets eventually Will all markets eventually converge converge

to a single standard?to a single standard?

TippingTipping

zz Markets “tip” when one standard becomes the Markets “tip” when one standard becomes the preferred choice of nearly every consumerpreferred choice of nearly every consumer –– VHSVHS –– Windows on the PCWindows on the PC

zz Not all markets tip: in some markets multiple Not all markets tip: in some markets multiple standards costandards co--existexist –– UNIX vs. Windows on serversUNIX vs. Windows on servers –– Nintendo vs. Sony in video gamesNintendo vs. Sony in video games –– Palm vs. Windows CE in PDAsPalm vs. Windows CE in PDAs

28

With no network effects, equilibriumWith no network effects, equilibrium market share tracks consumer market share tracks consumer preferencespreferences

0

1

0

Probability the next consumer chooses to buy A

A’s share of installed base

30% of the population Likes cornflakes

Cornflakes gets a 30% share

1

28

If network effects are important, If network effects are important, markets may “tip”markets may “tip”

0

1

0

Probability the next consumer chooses to buy A

A’s share of installed base 1

Strong network effects & high switching Strong network effects & high switching costs may create “lock in”costs may create “lock in” zz All consumers might prefer to adopt a different All consumers might prefer to adopt a different

standardstandard zz If it is expensive to switch between standards, (high If it is expensive to switch between standards, (high

switching costs) and network effects are important and switching costs) and network effects are important and costly to create, then markets may become “locked in” costly to create, then markets may become “locked in” to particular standardsto particular standards

zz “Lock in” has dramatic competitive implications“Lock in” has dramatic competitive implications

Will all markets “tip”?Will all markets “tip”?

Value to consumer

Size of the installed base

Will all markets will tip?Will all markets will tip?

0

1

0 1

Probability the next consumer chooses to buy A

A’s share of installed base

Competing in Competing in Standards Driven MarketsStandards Driven Markets

Competing in standards driven marketsCompeting in standards driven markets

zz Establishing a standardEstablishing a standard zz Making money: exploiting a standardMaking money: exploiting a standard zz Overturning a standardOverturning a standard

A Caveat: Standards can destroy valueA Caveat: Standards can destroy value

zz Standards may reduce choice: Standards may reduce choice: –– “Any color so long as its black”“Any color so long as its black”

zz Standards may reduce the rate of innovation:Standards may reduce the rate of innovation: –– Innovation is confined to subsystems:Innovation is confined to subsystems:

no “systemic” change is possibleno “systemic” change is possible

zz Standards may sustain monopoly rent extraction:Standards may sustain monopoly rent extraction: –– “Microsoft is making minor changes in its business model...”“Microsoft is making minor changes in its business model...”

(Of a plan to discontinue the practice of charging for the(Of a plan to discontinue the practice of charging for the estimated number of employees using a program andestimated number of employees using a program and replace it with a contract that charges for every employee)replace it with a contract that charges for every employee)

Thus:Thus: The adoption of a standard standard The adoption of a standard standard is not inevitable and once established, is not inevitable and once established, any particular standard is always any particular standard is always under threatunder threat

So standards are established by driving So standards are established by driving the adoption of critical mass...the adoption of critical mass...

Adoption Rate

0

A leads

B leads

Both adopter types choose A

Both adopter types choose B Lock in To B

Standards in action: SunStandards in action: Sun

zz Sun founded in 1982 to focus on the workstation Sun founded in 1982 to focus on the workstation marketmarket

zz “Open” standard: “Open” standard: –– Standard components, Standard components, –– UNIX operating systemUNIX operating system

Sun: Establishing the standard Sun: Establishing the standard

zz 1980: Apollo founded1980: Apollo founded zz 1983: Apollo has $18m in sales, dominates the 1983: Apollo has $18m in sales, dominates the

workstation market workstation market ---- uses a proprietary operating uses a proprietary operating systemsystem

zz 1983: Sun has $1m in sales, mostly to universities1983: Sun has $1m in sales, mostly to universities zz Lead customer, Computervision “likes the technology Lead customer, Computervision “likes the technology

but doesn’t find the company credible” but doesn’t find the company credible” ---- “we love your “we love your technology but there is no way you can supply it. technology but there is no way you can supply it. Apollo is the standard in the industry, well financed Apollo is the standard in the industry, well financed and well managed.”and well managed.”

zz What should Sun do?What should Sun do?

How are standards established?How are standards established?

zz Standards “win” when a critical mass of consumers Standards “win” when a critical mass of consumers have adopted them. have adopted them. OROR

zz When a critical mass of key players believe that the When a critical mass of key players believe that the standard will be adopted.standard will be adopted.

Or by:Or by:

zz The sheer power of the concept, design or delivery of The sheer power of the concept, design or delivery of the productthe product

zz Coming to market ahead of competitionComing to market ahead of competition zz Building expectationsBuilding expectations zz Very aggressive pricing: “giving the product away”Very aggressive pricing: “giving the product away” zz Developing, or encouraging the development of, Developing, or encouraging the development of,

Complementary products and servicesComplementary products and services

Two main routes to capture valueTwo main routes to capture value

ControlControl--Point Point competitioncompetition

zz Benefit directly from ownership Benefit directly from ownership from a fee or thru a markfrom a fee or thru a mark--up on up on products using the standard (e.g., products using the standard (e.g., Wintel)Wintel)

only possible when the only possible when the standard is privately held.standard is privately held.

LevelLevel--Ground Ground CompetitionCompetition

zz Make money by competing on Make money by competing on “level ground” through competing “level ground” through competing via manufacturing, service, via manufacturing, service, delivery or other capabilities (e.g., delivery or other capabilities (e.g., Ericsson & Bluetooth)Ericsson & Bluetooth)

standard may be public or standard may be public or private.private.

Positioning a standard requires Positioning a standard requires grappling with this fundamental tensiongrappling with this fundamental tension

Ownershipis:

The Technology Is: Open Closed

Priv

ate

Publ

ic

No opportunity formonopoly rentsBUT easier to getaccepted & may beable to extract rents thru other superiorinformation

Open interfacesallows for creation of complements; mayalso increase acceptance ofstandard BUT mayincrease competition

Complete monopolyrent extraction BUT all complementaryproducts must beproduced by thefirm – hard to getaccepted.

Displacing an Displacing an Established StandardEstablished Standard

Displacing an Established StandardDisplacing an Established Standard (Overcoming switching costs)(Overcoming switching costs) zz Raise the benefits:Raise the benefits:

–– Introduce an “insanely great” productIntroduce an “insanely great” product –– Build network effects:Build network effects:

•• Invest in complementary goods & servicesInvest in complementary goods & services •• Build market shareBuild market share

zz Reduce the costs:Reduce the costs: –– Make your standard “backwards compatible”Make your standard “backwards compatible” –– Lower the cost of your productLower the cost of your product

How are standards renewed in the face How are standards renewed in the face of incumbents?of incumbents?

zz Step One Step One -- Evolution vs. RevolutionEvolution vs. Revolution

–– EvolutionEvolution •• Give up some performance to ensure compatibility, thus Give up some performance to ensure compatibility, thus

easing consumer adoption (e.g., Microsoft, Intel)easing consumer adoption (e.g., Microsoft, Intel) •• Migrating existing usersMigrating existing users

–– RevolutionRevolution •• Wipe the slate clean and come up with the best product Wipe the slate clean and come up with the best product

possible (e.g. Nintendo)possible (e.g. Nintendo) •• Gathering new users or innovators who want to ownGathering new users or innovators who want to own

every gadgetevery gadget

How are standards renewed in the face How are standards renewed in the face of incumbents?of incumbents?

zz Step Two Step Two -- Openness vs. ControlOpenness vs. Control

–– Openness hastens adoption, signals commitmentOpenness hastens adoption, signals commitment

ButBut

–– Foregoes control of the standardForegoes control of the standard

Generic Renewal StrategiesGeneric Renewal Strategies Control Open

Inco

mpa

tible

C

ompa

tible

Controlled Migration

Open Migration

DiscontinuityPerformance Play

Take AwaysTake Aways

zz Successful Strategies in StandardsSuccessful Strategies in Standards--Oriented Markets Are often a Oriented Markets Are often a “Hard” Sell“Hard” Sell –– Giving away profits to customers and competitorsGiving away profits to customers and competitors –– Profits are in the future Profits are in the future —— losses are upfront!losses are upfront!

zz “Tipping” the Market“Tipping” the Market –– Key is to create customer value by first building the “right” Key is to create customer value by first building the “right”

type of installed base (lead users, encouraging complements, type of installed base (lead users, encouraging complements,etc…)etc…)

–– Ensure Complementary Technologies, Necessary “Software,” Ensure Complementary Technologies, Necessary “Software,”and the Potential for Future Competitionand the Potential for Future Competition

zz Debate the Product Development Tradeoffs Debate the Product Development Tradeoffs —— Earlier and Earlier and OftenerOftener