Standards and Standards-based Competition Leif Hommen CIRCLE leif.hommen @circle.lu.se

1. Standards and Standards-based CompetitionLeif HommenCIRCLE leif.hommen@circle.lu.se

2. Overview • VCR Standards: Beta vs. VHS • Cusumano, M.A, M. Yiorgos and R.S. Rosenbloom . 1992. “Strategic maneuvering and mass-market dynamics: The triumph of VHS over Beta”. Business History Review 66 (Spring): 51 – 94. • Competitive Strategy and Standards • Hill, C.W.L. 1997. “Establishing a standard: Competitive strategy and standards in winner-take- all industries”. The Academy of Management Executive 11 (2): 7 – 25 • Standards Wars • Shapiro, C. and H.R. Varian. 1999. “The art of standards wars”. California Management Review 41 (2): 8 – 32.

3. VCR Standards (1) • One of the classic cases of ’standards war’ is the 1970s battle over the VCR market waged between Sony (Beta) and JVC-Matsushita (VHS) • ’The facts are simple’: • Beta reached the market first, taking 58% of the emerging VCR market in 1975 – 77. • However, VHS gained the market lead in 1978. • Over the next years, Beta’s sales continued to increase – but market share fell steadily. • In 1984, Beta was outsold by VHS four-to-one, and began a rapid decline to extinction. • The ’second mover’, VHS, had managed to turn a slight early lead in sales into a dominant position.

4. VCR Standards (2) • The decisive factors ... were few’: • In cost and performance, the two designs were closely comparable (due to a ’common heritage’ in terms of their technical origins). • In timing, Sony (Beta) had a clear lead of two years – but moving first was not enough. • In forming alliances, JVC (VHS) was far more effective than Sony (Beta). • Establishing production capacity (via Matsushita) was another ’plus’ for VHS. • Aggressive marketing by JVC also ’pre-empted’ Beta from the lead market – Europe.

5. VCR Standards (3) • ’A few important moves made the difference’: • JVC created a winning alliance of VCR producers in Japan by ... showing humility and versatility, whereas Sony pressed commitment and reputation. • Matsushita waited until VHS provided a viable alternative, then abandoned its own design and invested massively in capacity while pushing to meet RCA’s requirement of a longer recording time. • JVC completed the sweep by moving ahead of Sony to enlist European partners behind VHS. • Sony lost out in the race for distribution rights and remained in a minority position in all 3 major markets.

6. VCR Standards (4) • The case supports theories of ”bandwagon” effects and ”network externalities” applied to the emergence of dominant designs in mass consumer markets. • Bandwagon effect: situations where early sales or licensing of one product lead to rising interest, and the build-up of momentum. • Network externalities: whether or not there is a usage pattern that depends on a complementary product, as well as to how and how much customers use it with the main product.

7. VCR Standards (5) • In the case of the VCR market, Sony’s ’first mover’ advantage was overturned because initial moves by JVC placed VHS in a far better competitive position in relation to these ’mass-market dynamics’ : • A first ”bandwagon” was formed around VHS when demand grew so rapidly that it outstripped the supply capacities of any one producer – but not the VHS ’coalition’. • A second VHS bandwagon arose from demand for a complementary product – pre-recorded tapes – as retail outlets chose to stock tapes in the most popular format.

8. Competitive Strategy (1) • Hill discusses basic competitive strategies • The theoretical point of departure is similar to that discussed in relation to the VCR case: product compatibility, increasing returns and lock-in. • Compatibility, critical for complementary products to work together, is usually ensured by standards. • In markets where compatibility is important to consumers, a product’s value to consumers is the function of availability of compatible products. • Availability of compatible products, in turn, is determined by the product’s installed base, which is often formed by complementary products. • What results is a set of self-reinforcing relationships:

9. Competitive Strategy (2) • Increasing Returns in the PC Industry Size of Installed Base + + Availability of Applications Software Future Demand + + Value of Machine to Consumer

10. Competitive Strategy (3) • Based on the self-reinforcing relationships shown above, a firm that succeeds in making its product a market standard will become even more successful in future. • Where two or more incompatible technologies of this kind compete, small changes in initial conditions can eventually lead to market dominance – and ’lock-in’ – for one of them (not necessarily the best). • Naturally, the outcomes of this kind of competition can be affected by strategy.

11. Competitive Strategy (4) • Strategic Options (for installed base): • Licensing (and OEM) Agreements • E.g., JVC & Matsushita in the VCR case • Entering into Strategic Alliances • E.g., Philips & Sony in CD disc players • Product Diversification • E.g., Apple saved by complementary products (including Apple laser jet) in desktop publishing • Aggressive Positioning • E.g., Philips’ launch of DCC tapedecks: a failed attempt to lower switching costs and ease transition based on ’backwards compatibility’

12. Competitive Strategy (5) • Benefits, Costs and Risks

13. Competitive Strategy (6) • Four factors – or contingencies – determine the appropriate option or mix of options to pursue: • Barriers to Imitation • High barriers favor a gradual approach • Capability of Potential Competitors • Firms with capabable rivals should try to co-opt them through licensing or entering into strategic alliances • Complementary Resources of the Firm • Firms without e.g., manufacturing or marketing need licensing agreements or strategic alliances • Supply of Complementary Products • If there are no available suppliers, firms may have to diversify into producing complementary products

14. Competitive Strategy (7) • Given these contingencies, firms can choose among four main strategies: • Aggressive Sole Provider • E.g., Xerox in Japan should have adopted a more aggressive positioning stance to pre-empt rivals • Passive Multiple Licensing • E.g., Dolby in the audio player market – low fees forestall rivalry & scale of adoption generates profit • Aggressive Multiple Licensing • E.g., JVC-Matsushita and VHS in the VCR case • Selective Partnering • E.g., IBM’s partnership with Intel and Microsoft to develop the PC; Philips & Sony in CD disc players

15. Competitive Strategies (8)

16. Standards Wars (1) • Shapiro & Varian cover much of the same ground as Hill, though they discuss some different examples (especially older cases). • However, in addition to addressing ’strategy and tactics’, these authors also take up some additional questions: • Classification of standards wars • Identification of ’seven critical assets’ • ’Main lessons’ on standards wars

17. Standards Wars (2) • Classification of standards wars

18. Standards Wars (3) • The classification shown above yields three main types: • Rival Evolutions • E.g., DVD vs. Divx (both compatible with CDs) • Evolution vs. Revolution • E.g., Ashton Tate’s dBase IV vs. Paradox in dektop software during the 1980s • Rival Revolutions • E.g., Nintendo 64 vs. Sony Playstation (or AC vs. DC, for a more historical example)

19. Standards Wars (4) • Seven key assets in network markets: • Control over an installed base of users • Intellectual property rights • Ability to innovate • First-mover advantages • Manufacturing capabilities • Strength in complements • Brand name and reputation

20. Standards Wars (5) • Control over an installed base of customers (Example: MicroSoft) • Large numbers of loyal or locked-in customers favor an ’evolution’ strategy – as well as blocking rivals and forcing them into risky ’revolution’ strategies • Intellectual property rights (Example: Philips’s and Sony’s respective patents in DVDs and CDs) • Legal protection against imitation by competitors • Ability to Innovate (Example: NBC in color TV) • Resources & capabilities that enable the firm to out-engineer the competition. • First-mover advantages (Example: Netscape in browsers) • Technological and market leadership based on previous product development work.

21. Standards Wars (6) • Manufacturing capabilities (Example: Compaq and Dell in computers) • Efficient production can yield critical cost advantages. • Strength in complements (Example: Intel’s promotion of new standards for PC components in order to sell CPUs) • Acceptance of complementary products stimulates sales in ’the market in question’ • Reputation and brand name (Examples: Microsoft, HP, Intel, Sony, and Sun) • Instant credibility in the marketplace

22. Standards Wars (7) • Two crucial marketplace tactics: Pre-emption & Expectations Management • Pre-emption is based on an early lead and positive feedback • Techniques: Early product launches, marketing aimed at ’pioneers’, penetration pricing (below cost), etc. • Expectations Management is about establishing credibility with customers • Techniques: Announcing upcoming products to freeze rival’s sales; assembling allies and making ’grand claims’ for your product.

23. Standards Wars (8) • Defending a dominant (’winning’) standard: • Stay on your guard (e.g., avoid growing rigidities like those of France’s Minitel) • Offer customers a migration path (e.g., Microsoft’s ’embrace and extend’ philosophy towards ’improvements’) • Commoditize complementary products (e.g., Intel’s support for innovation in complementary products) • Compete against your own installed base (e.g., Intel’s constant efforts to ’drive innovation faster’) • Protect your position (e.g., Microsoft’s use of license clauses to ensure that OEMs shipped Windows ’95) • Leverage installed base (e.g., control over an interface to extend leadership from one side to the other.) • Stay a leader (e.g., Cisco’s use of all profits from estabished products to buy up firms developing the next generation)

24. Standards Wars (9) • Rear-Guard Actions (for those who ’fall behind’): • These strategies often entail defending remaining ’niche markets’, but they may also involve ’leapfrogging’. In either case, customer management is a key concern. • Adapters and Interconnection • Negotiating access to the ’larger network’ is vital. (E.g., Atari & Nintendo). So is performance (E.g. Digital’s Intel ’emulator’ for its Alpha chip.) • Survival Pricing • A temptation that should be resisted (E.g., Quattro Pro vs. Lotus 1-2-3 and Microsoft Excel in 1993) • Legal Actions • ”If all else fails, sue.” (E.g. anti-trust action against Kodak)

25. Standards Wars (10) • Summing up: • First, It is important to understand what type of standards war you are waging. • The key factor here is compatibility between new rival technologies and established products • Three main types of standards war: • Rival Evolutions • Evolution vs. Revolution • Rival Revolutions

26. Standards Wars (11) • Second, seven critical assets determine the strength of your position: • Control of an installed base • Intellectual property rights • Ability to innovate • First-mover advantages • Manufacturing abilities • Presence in complementary products • Brand name and reputation.

27. Standards Wars (12) • Third, some ’main lessons’ for strategy and tactics: • Assemble your allies beforehand • Consumers, suppliers of complements, even competitors • Pre-emption is a critical tactic • Rapid design, early deals, and penetration pricing • Managing consumer expectations is crucial in network markets • Early announcements, prominent alliances, and visible commitments to your technology • When you have won, don’t rest easy • Backward compatibility should not block product improvement • If you fall behind, avoid survival pricing, it just signals weakness. • Instead, establish a performance advantage, or use converters / adapters to interconnect with dominant standard.