Today’s class

1. Today’s class 6. Technological competition 6.1 Management of innovation 6.2 Network effects and standards/IM takeaways

2. IM update since early 2005 • 08/05: Google introduces Google Talk; stated goal is interoperability using open standard (Jabber) • Agreements to get systems to work together: • Yahoo and Microsoft since 09/06 (announced 10/05) • Google and AIM: announced 12/05 following Google’s 5% investment in AOL, not yet implemented • 12/06: IBM Lotus Sametime can chat with AIM, Google Talk • Market shares (users) in August 2005: AOL 52%, Yahoo 24%, MSN 18%, Other 6% • Enterprise IM market largely separate & growing

3. Network effects • When value for buyer increases with number of others who use the same product or standard. Distinguish • Direct: ability to use the product, e.g. IM • Indirect: through supply of complementary products, e.g. computer OS & applications software, videos, DVDs • As installed base of users grows, value to new buyers increases. • With strong enough network effects, tendency towards one standard: “tipping” of market • Limited opportunities for niche players, e.g. Apple in computers

4. How strong are the network effects? • How strong are forces toward standardization? • How much do consumers have to invest? • Compare IM, DVDs, Word • How strong are direct network effects? E.g. Word processing • Indirect effects: how costly is it for producers of complementary good/service to support different standards? • Compare DVDs (hardware vs. studios, retail/rental), digital camera memory cards (stores) • Difficult to tell if use of product is unknown in advance • E.g. VCRs: time-shift viewing or movie rentals?

5. The best of all worlds: owning the standard • Best example: Wintel • Bill Gates in 1995: “We look for opportunities with externalities – where there are advantages to the vast majority of consumers to share a common standard. We look for businesses where we can garner large market shares, not just 30-35%” • Otherwise, three basic options:

6. 1. Agree with others on a standard • Standard-setting bodies, mutual agreements: DVDs in mid-90s • Key questions: How will you make money? What advantage do you have? • Firms with small market shares much more likely to push for standard: Microsoft, Yahoo vs. AOL • Even if both sides want standard because pie bigger: hard to agree on how to divide pie

7. 2. License your standard to others • Or “open standard”: Jabber in IM, IBM in PCs • Advantage: higher probability of acceptance by market • Problem: you may create your own competition. How will you make money? • Example: Philips’ introduction of CDs in early 1980s • No or small advantage in player production or CD pressing • Probably made most of its money through royalties

8. 3. Go alone • Multiple standards can coexist if network effects weak • IM, music downloads • Big difference for Apple between Mac and iPod/iTunes • Problem: • Hard to tell in advance how strong network effects will be • Consumers don’t want to be stranded with loser technology • Even more reluctant when a better version of existing technology arrives, e.g. new-generation DVDs • Very difficult if complementary product (e.g. software) will be provided by other firms • Difference between Sony in DVDs and Apple in music

9. “War of attrition” • Situation in which two or more parties struggle until all but one quit, concede, run out of money, or die • Like the $20 auction • Idea introduced by evolutionary biologist John Maynard Smith (1974): animals fighting for prey • In business, occurs when two firms/standards fight for market where only one fits • Markets with large EOS (natural monopolies) • Markets with strong network effects

10. Logic of the war of attrition • War continues as long as expected value of winning ≥ costs of continuing fight • Even if past losses large, fighting continues because costs are sunk • Uncertainty essential: no point in wasting money if eventual winner is known • If A has committed to stay in, it’s best for B to quit, and vice versa • Problem: commitment is difficult. What costs are truly sunk, what decisions truly irreversible? • While fighting continues, each tries to influence rivals’ and customers’ perceptions about who will win

11. Tactics in standards wars • Be first! AOL in IM • Penetration pricing: low/zero introductory price • IM, Netscape, Adobe, cell phones • Leverage existing installed base • AOL, Yahoo: ISP users; Microsoft: integration with OS • Expectations management • Public statements about commitment, financial strength, superiority of product, new complementors on board, etc. • Spread fear, uncertainty, doubt about rivals: Microsoft vs. AIM

12. Classic example of war of attrition: U.K. Satellite TV market in late 80s • 1986: British Satellite Broadcasting obtains license to start satellite TV in 1989 • 1988: Rupert Murdoch announces entry of Sky Television • High sunk/fixed costs => only room for one firm • Before and after start of service: • Advertising/PR campaigns to persuade buyers • Escalation of bids on film rights (high sunk costs) • Frantic efforts to sell dishes, to lock in buyers and build installed base • Actual entry dates: Sky in February ‘89, BSB in April ’90 • Demand well below expectations due to buyer reluctance • 10/1990: Sky loses £2M/week, BSB £6-7M/week • 11/1990 Both merge to form BSkyB; before collectively lost £1.25B