Competing in Standards Driven Markets

When can you maintain control over the use of an innovation/idea?

Strong intellectual property rights

First--mover advantages

–– Customer lock - in–– Network effects–– Standards

Market Power

Diffusion often looks quite differentin a market shaped by standards

Network externalities of all kinds may create lock in, so that once established, a standard can be very difficultto replaceto replace

Lock - in may occur when the technology is still in its infancy

e.g. VHS vs. Beta, MS Windows vs. OS/2

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

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Outline

Definitions

Standards & Network effects

Switching costs , “lock-in” and tipping

Do all markets tip ?

Competing in standards driven markets :

Establishing a standard

Making money

Overturning an established standard

Definitions

What is a standard?

A standard is a specification that allows for interoperability

E.g.:

Cup and lids

Pistons and engines

Telephones and sockets

Speakers and amplifiers

Hardware and software

Standards and Dominant Designs

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

Standard –– particular interface, format or system

Standards or architectures allow for interoperability

Not all dominant designs are standards

e.g., Henry Ford and the Model T

Not all standards are dominant designs…

e.g., WebTV

…But many successful standards embody dominant designs

e.g., Apple’s operating system

An industry without a standard:

An industry with a standard:

What are the pros and cons of standards?

Pros

Cons

Pros

Cons

Standards can be “public” or “private”

Public standards

IP in the standards is publicly owned

Often administered by an industry consortium, or byregulation

Private standards

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

Standards can be “open” or “closed”

Open standards

Details are released to third parties (“complementors”)So that they can develop complementary products, service and technologies

Closed standards

Used within the firm, but details are not released

Privates standards may be open or closed

The technology is :

open closedDetails of standards are available to all : no single firm has control over how they evolve: no charge for their use

E.g. TCP/IP, HTML

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

E.g. CryptographyPublic

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

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

E.g. IBM 360 Architecture

Private

Ownership is :

All options have both advantages and disadvantages

The technology is :

open closed

Public

Private

Ownership is :

With Strong Network Effects Market Share Itself Creates Value

Value to consumer

Value of standards Driven product

Conventional product

Actual (or anticipated) size of the installed base

“Great products” vs. “Architectures”

Great Products Architectures

Consumers base their purchase decision on theintrinsic value of the product to them

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

Competition on the basis of features, price etc

Consumers base purchase decisions on the size of the (actual or projected) installed base and/or the (actual or projected) future availability of complementary products and servicesHow many other people are likely to buy this product?Competition on the basis of the size of the installed base, availability of complementary products etc

Standards create value because they create network effects

Direct network effects:Network size

Value increases with the number of other individuals who own the same product E.g.: Telephones, fax

Indirect network effects:Complementary products/services

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

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

Learning by usingStandards mean customers only invest once in learning to use the technology: E.g.: Qwerty Keyboard, Autocad

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•

•

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Tippingor

Will all markets eventually converge

to a single standard?

Tipping

Markets “tip” when one standard becomes thePreferred choice of nearly every consumer

VHS

Windows on the PC

Not all markets tip: in some markets multipleStandards co-exist

UNIX vs. Windows on servers

Nintendo vs. Sony in video games

Palm vs. Windows CE in PDAs

With no netword effects, equilibriumMarket share tracks consumerperferences

0

0

1

1A’s share of installed base

Cornflakes gets a 30% share

30% of the population Likes cornflakes

Probability the next consumer chooses to buy A

If network effects are important,markets may “tip”

0

0

1

A’s share of installed base

Probability the next consumer chooses to buy A

1

Strong network effects & high switching costs may create “lock in”

All consumers might prefer to adopt a different standard

If it is expensive to switch between standards, (highSwitching costs) and network effects are important andCostly to create, then markets may become “locked in”To particular standards

“Lock in” has dramatic competitive implications

Will all markets “tip”?

Value to consumer

Size of the installed base

Will all markets will tip?

0

0

1

A’s share of installed base

Probability the next consumer chooses to buy A

Competing in Standards Driven Markets

Competing in standards driven markets

Establishing a standard

Making money: exploiting a standard

Overturning a standard

A Caveat: Standards can destroy value

Standards may reduce choice:

Any color so long as its black”

Standards may reduce the rate of innovation:

Innovation is confined to subsystems: no “systemic” change is possible

Standards may sustain monopoly rent extraction:

“Microsoft is making minor changes in its business model…” (Of a plan to discontinue the practice of charging for the estimated number of employees using a program and replace it with a contract tht charges for every employee)

Thus:

The adoption of a standard standardis not inevitable and once established, any particular standard is alwaysunder threat

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

Both adopter types choose A

Both adopter types choose B Lock in To B

Adoption Rate

A leads

B leads

0

Standards in action: Sun

Sun founded in 1982 to focus on the workstationmarket

“Open” standard:

Standard components,

UNIX operating system

Sun: Establishing the standard

1980: Apollo founded

1983: Sun has $1m in sales, mostly to universities

What should Sun do?

1983: Apollo has $18m in sales, dominates theWorkstation market – uses a proprietary operatingsystem

Lead customer, computervision “likes the technologyBut doesn’t find the company credible” – “we love yourtechnology but there is no way you can supply it.Apollo is the standard in the industry, well financedAnd well managed.”

How are standards established?

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

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

OR

Or by:

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

Coming to market ahead of competition

Building expectations

Very aggressive pricing: “giving the product away”

Developing, or encouraging the development of, Complementary products and services

Two main routes to capture value

Control – Pointcompetition

Level – Ground Competition

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

Only possible when the standard is privately held.

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

Standard may be public or private.

Positioning a standard requires grappling with this fundamental tension

The Technology Is:

Ownershipis:

Open

No opportunity for monopoly rents BUT easier to get accepted & may be able to extract rents thru other superior information

Open interfaces allows for creation of complements; may also increase acceptance of standard BUT may increase competition

Complete monopoly rent extraction BUT all complementary products must be produced by the firm – hard to get accepted.

ClosedP

ub

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ate

Displacing an Established Standard

Displacing an Established standard (Overcoming switching costs)

Raise the benefits:

Introduce an “insanely great” product

Build network effects:

Invest in complementary goods & services

Build market share

Reduce the costs:

Make your standard “backwards compatible”

Lower the cost of your product

How are standards renewed in the face of incumbents?

Step One - Evolution vs. Revolution

EvolutionGive up some performance to ensure compatibility, thus easing consumer adoption (e.g., Microsoft, Intel)

Migrating existing users

Revolution

Wipe the slate clean and come up with the best product possible (e.g. Nintendo)

Gathering new users or innovators who want to own every gadget

How are standards renewed in the face of incumbents?

Step Two - Openness vs. Control

Openness hastens adoption, signals commitment

but

Foregoes control of the standard

Generic Renewal Strategies

Control

Controlled Migration

Open

Co

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ble

Inco

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Performance Play

Open Migration

Discontinuity

Take Aways

Successful Strategies in Standards-Oriented Markets Are often a “Hard” Sell“

Giving away profits to customers and competitors

Profits are in the future — losses are upfront!

“Tipping” the Market

Key is to create customer value by first building the “right” type of installed base (lead users, encouraging complements, etc…)

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

Debate the Product Development Tradeoffs — Earlier and Oftener