Network Effects, Platforms, Standards, and Complex Systems

A/Prof Jeffrey Funk
Division of Engineering and Technology
Management
National University of Singapore
Network Effects, Platforms, Standards, and
Complex Systems
5th Session in MT5016
Sources: Shapiro and Varian, Information Rules; Rohlfs, Bandwagon Technologies; Paying
with Plastic, Evans and Schmalensee: Platform Leadership, Cusumano and Gawer; Five
Timeless Lessons from Bill Gates, Any Grove, and Steve Jobs, Cusumano and Yoffie

Business Model
 Value proposition: what to offer and how to
differentiate
 This partly depends on network effects
 Customer selection: whom to serve and not serve
 Value capture: dominant sources of revenue
 Scope of activities: what activities to carry out and
what relationships to have
This partly depends on the existence of
standards, particularly open standards
 Strategic control: how to sustain profitability (e.g.,
how to control architecture and standards)
This partly depends on who controls standards

We Live in a World of Complex
Interconnected Systems
 Almost everything is a system
 Plastic is produced by a system, called a chemical plant
 But the systems keep becoming more connected
 They are connected by interface standards that are
embedded in products
 Some interface standards and products become bottlenecks,
have large impact on how systems work
 These types of products are called platforms, many of the
most valuable firms offer platforms and control standards
 The value of many platforms is a function of network effects

What are Platforms and Standards?
Windows Platform Android Platform
Interface
Standards

Outline
 What are network effects?
 What are standards?
 How are standards chosen?
 What are “standards wars” and what impact do they
have on competition? Key issues:
 Performance vs. compatibility
 Open vs. closed
 Key tactics and assets
 Various examples

What are Network Effects (NE)?
 Effect that one user of a good or service has on value of that
product for other people
 Direct effects
 Value of product depends on number of users
 Examples: telephones, facsimile machines, Internet mail, SMS,
Social Networking (FB), Instant Messaging Sites (What’s App)
 Indirect effects
 Value of a product depends on number of complementary products
 Old examples: Software & hardware for computers, video games,
music, video players, mobile phone standards
 New examples: Mobile phone Apps (Apple, Uber), Wearable
Computing, Internet of Things, Smart Homes, Smart Cities
 Number of complementary products often depends on number of
users

Other Examples of Indirect Network Effects (NE)
Industry Product Network Effects
Real
Estate
Property sales Buyer, seller
Rentals Renter, owner
Media Newspapers, Magazines Reader, advertiser
Network television Viewer, Advertiser
Portals and Web
Publications
Web surfer,
advertiser
Shopping Malls Merchant, shopper
Payment
System
Charge/debit card Cardholder,
merchant

How do NEs Impact on Purchasing Decisions?
 Products competing in
market segments with
no NE
 Consumers/customers
base their purchase
decision on the intrinsic
value and utility of the
product to them
 Competition on the
basis of features, price,
promotion, after sales
service, etc.
 Products competing in market
with NE
 Consumers/customers base
purchase decisions on the size of
the installed base and/or the
(actual or projected) accessibility,
quality, and functionality of
complementary products and
services
 Competition on the basis of the
size of the installed base,
availability of complementary
products and their suppliers’
competence and support

With Strong Network Effects, Market Share Itself Creates
Value
Value to
consumer
Actual (or anticipated) size of the installed base
Value of Network Effects
Driven product
Conventional product (e.g.,
automobile)

While the competing products lose value
Competi-
tiveness of
competing
standard
Installed base of products that work with your
standard
Network Effects-
Driven product
Conventional product

Winner Take-All from Network Effects
1
Probability
next consumer/
producer
chooses
technology A
Assumption:
Only two technologies,
A and B, and consumers
have same needs
0
(1) When A’s
probability is
higher than its
market share, A
tends to converge
to 1 (winner-take-
all)
(2) When A’s
probability is lower,
it tends to converge
to 0 (loser-gets-
nothing)
(1)
(2)
A’s Market Share

When Network Effects are Strong,
but not strong enough for winner-take
1
Probability
next consumer/
producer
chooses
technology A
0
The result is two
or three
technologies that
co-exist
A’s Market Share
equilibrium

Small Change in Support, Large Change in Share…
 Support by movie distributors in 2007 for new movie discs
 HD DVD: Paramount, Universal, Warner Brothers
 Blu-ray: Sony, Disney, MGM, Warner Brothers
 50-50 split in hardware sales in 2007
 Warner Broth removed support for HD on Jan. 4, 2008
causing market share for Blu-ray hardware to jump to
 90% in week of January 12
 63% in week of January 19 despite heavy discounts by HD DVD
suppliers (Source: NY Times, Feb. 5, 2008, HBS Case)
 By mid-February
 Toshiba stopped production of HD DVD
 Walmart and NetFlix would only supply Blu-ray

Winner Take all Markets for
Products/Platforms* and Firms
 Search
 Google
 Social networking
 Facebook
 Phones
 Apple iPhone and Android phones
 Phone messaging services
 Depends on country: What’s App, Viber, Weibo, Line
 Taxi Services
 Depends on country: Uber, Didi Dache
 Hosted services for selling products
 E-bay
 Amazon
*No accepted term – people
use product,
technology, platform, standard

Older Examples of Winner Take all Markets for
Standards/Firms (for a certain time period)
 Computers
 IBM System/360 in mainframes
 Wintel in PCs (Windows and Intel microprocessor)
 Oracle data base software
 UNIX in workstations, Portable memory formats
 Internet
 HTML, URLs, etc.
 Cisco’s IOS for operating systems in routers
 Paypal for online micropayments
 Documents – e.g., Adobe
 Vector Graphics – e.g., Flash

Other Old Examples
 Telecommunication
 GSM for second generation mobile phone systems
 WCDMA for third generation mobile phone systems
 Various facsimile and modem standards
 Transportation
 Railroad gauge
 Specific airports as airline hubs (to a lesser extent)
 Container sizes, Automobile fuels, i.e., gasoline
 Consumer Electronics
 B&W and Color Television standards
 Music: records, cassette tapes, CDs, MP3
 Movie/Video: VHS, DVD (both 1G and 2G)
 Video game consoles

In Future
 To what extent will there be winner take all for
following?
 Transportation companies (e.g., Uber)
 Other sharing economy examples: grocery (Instacart) or
restaurant (Zomato)
 Wearable Health: Jawbone
 Internet of Things: Hortonworks (supplier of Hadoop software)
 Smart Homes
 Smart Cities
 Automated Vehicles: Google
 Electric Vehicles: Tesla
 Massively Open Online Courses

Winner Take All is Most Common when There
are High Switching Costs
 The costs that a user incurs when they change products – high
switching costs can lead to lock-in
 Can’t sell your product because users are locked in
 Can’t use other products because you are locked in
 Highest switching costs for enterprise products
 Wintel computers
 SAP or Oracle software
 Smaller switching costs for consumer products, but can be
large when they are summed over all users
 Thus, were large for music and movie technologies/standards
 Why are there high switching costs for telephone numbers?
 What about Uber and other demand-based economy apps?

Implications of Winner Take All
 Investors are willing to invest heavily on products or
services with strong network effects
 Facebook is classic example
 Also Twitter, What’s App, other messaging and Internet
services
 Many members of billion dollar startup club have strong
network effects
 Investors don’t expect early profits
 Instead, they want many users
 They believe that money can be extracted later, small
amounts per user
 Extracting value is seen as different skills than creating
value

Suppliers Shouldn’t Overestimate Importance of
Network Effects and Lock-In
 Internet Bubble broke in 2000
 One reason bubble occurred
is because firms thought that
 Network effects were very strong
 Users were willing to pay
a higher price for services
from the leaders and would be “locked-in” to early leaders
 And thus firms needed to obtain market share quickly
 Lock-in hasn’t occurred to this extent
 In fact, leading Internet firms became successful after
bubble burst (now they benefit from NEs and lock-in)
 Is there a bubble now in billion dollar startup club?
NASDAQ
Composite

Network Effects are Easy to Misunderstand!
 Even the experts make mistakes
 Just remember critical questions:
 What emphasis do consumers/customers base their
purchase decision on the
 intrinsic value and utility of the product to them
 size of the installed base and/or the (actual or projected)
accessibility, quality, and functionality of complementary
products and services?
 What are the extent of the switching costs?

What are Standards
 A Standard is a set of technical
specifications adhered to by a producer,
either tacitly or as a result of a formal
agreement
Source: David and Greenstein, The Economics Of Compatibility Standards: An Introduction To
Recent Research, Economics of Innovation and New Technology, Volume 1, Issue 1-2, 1990

Types of Standards
 Reference and minimum quality standards
 Provides a signal that a given product conforms to the
content and level of certain defined characteristics (e.g., ISO
9000)
 Today’s focus: Interface or compatibility standards
 Assures user that intermediate product or component can be
successfully incorporated in larger system
 What will be the composition of the system and the
interfaces between the components
Think of puzzles or Lego blocks

Examples of Interface Standards
 Mobile phones: between
 Phones and base stations
 Operating systems and apps
 Music and video systems: between
 phonograph record and stylus,
 magnetic tape and read-write head
 optical disk and read-write system
(laser and photodiode)
 MP3 player and Internet
 Computer systems: between hardware, operating system and
application programs
 Transportation systems: between train wheels and rail gauge
 Trading systems: money

Examples of Interface Standards (continued)
 Wireline Communication systems, between
 modems and computers
 facsimile machines and telephone system
 Broadcasting systems
 between transmitters and receiver (e.g., television, radio)
 Electric power: between power station, transmission
system, and home appliances
 Automobiles and fueling station
 between fuel source and method of propulsion
 between nozzle and fuel tank
 In future: Internet of Things, Wearable Health,
Messaging Apps, Smart Homes, Smart Cities, Automated
Vehicles, Sharing Economy,

Data acquisition:
sensors, ICs
Data transport:
cellular, satellite,
Wi-Fi, Bluetooth,
Zigbee,
Data analysis
and
interpretation:
Big Data
What will be the Standards for the Internet of Things?
(e.g., what will be the application programming interfaces between each block)
Example of Usage-Based Insurance for Automobile
Decision
Making by User
Firms
Data acquisition:
Speeds,
acceleration,
location and thus
type of road
Data transport:
cellular
Data analysis
and
interpretation:
Characterize
Driving
Behavior
Decision
Making by User
Firms:
Determine rates
Will they capture most of the value?

Standards for IoT
 Still not yet determined
 But IBM, G.E. and others announced standard for core
elements of technology framework for data analysis in IoT
 They will develop products and services based on Hadoop
 method for distributing, managing and processing very large and often
disparate amounts of data
 open-source software http://nyti.ms/1vbzWEK
 several startups (HortonWorks and Cloudera are or have been
members of billion dollar startup club) have released products
 If Hadoop becomes standard,
 competition will shift to another interface
 Hortonworks or Cloudera may release closed versions of standard
 Who will be the big winner(s)?

Standards in Wearable Health
 Many stand-alone products
exist (Apple iWatch and
Apple Health, Google Nest
AndroidWear, Samsung Live
Gear, InfraV, Jawbone, Body
Media)
 But stand-alone devices will
probably not win
 Which standards will
connect products and win?
 May depend on which
products attract final users
and suppliers of
complementary products

Standards for Wearable Health (2)
 Attracting final users will partly be determined by
good design choices
 Body media focuses on the body because more data can be
collected
 Jawbone focuses on the wrist because the wrist device
seems more aesthetically appealing
 Which will attract the most data analyzers, e.g., hospitals,
clinics, insurance companies? And other suppliers,
including those of integrated circuits and sensors
 Later parts of the battle will be determined by alliances,
compatibility, and openness (more on this later)

Standards for Messaging Apps
 MessagingApps have become important platforms for
additional services
 Not just messaging
 Other services particularly in China and Japan: send and receive
money, make payments, check into hotel, buy train tickets
 Thus, income from messaging apps may become large
 How much larger?
 How many more services?
 This is one reason why FB paid $19 billion forWhat’sApp
 Which messaging app will become the global standard?
 The more users, the more valuable to
 Other users
 businesses

What About Taxi Apps?
 Can they become platforms for other services?
 Truly ride sharing apps?
 Uber calls its service ride sharing, but usually just one passenger
 Can someone offer cheaper services that involve multiple passengers?
 Can these services be more convenient than conventional bus or train
services?
 Will supplier’s knowledge of starting and ending points enable it to
devise better bus services?
 Logistics
 Can taxi apps be used for delivering packages?
 Or having third parties do other work?
 Part of high valuations for taxi companies and for other sharing
economy and demand-based services come from logic of network
effects and expanded services

Standards Impact on Many of the Firms
in the Billion Dollar Startup Club
Software(33)
cloud, big data, ads,
security, database
e-commerce (25)
fashion related sites
Consumer internet (22)
taxis, social networking, food
Financial services (11)
Hardware: phones, wearable
computing (10)
Other (13)
Large impact, how
will software fit
together?
Will impact on
some of these
Large impact:
Payments, P2P lending
require standards
Hardware will probably
not be stand-alone

The Ultimate Standard
 Have you seen the movie “InTime”
 http://www.ifc.com/fix/2011/08/in-time-
trailer-justin-timberlake (up to 1:00)
 What does this have to do with standards and
making money?

Types of Interface Standards and
How they are Chosen
 1. Unsponsored standards
 The originator nor any subsequent sponsoring agency
holds a proprietary interest (e.g., to some extent UNIX,
Linux, Hadoop)
 Disadvantage of open source software
 2. Sponsored standards
 Where one or more sponsoring entities holding a direct
or indirect interest, creating incentives for other firms to
adopt particular sets of technical specifications (e.g.,
www consortium, CDs, DVDs, Wintel PCs, facsimiles)

Types of Standards and How they are Chosen
 3. Standards agreements
 These are arrived at within and published by voluntary
standards-writing organizations (ANSI, ISO, IEEE, etc.)
 Sponsored standards (CDs, DVDs, and those for telecom,
Internet) are sometimes addressed in these agreements
 4. Mandated standards
 These are implemented by government agencies that have some
regulatory authority
 Few interface standards are mandated anymore (some
telecommunication and broadcasting standards but many other
standards (building, accounting, environmental, safety) are
mandated

Another way to Classify Standard Setting:
De facto vs. de Jure Standards (1)
 Defacto
 Both unsponsored (1) and sponsored (2) standards emerge
from market-mediated processes
 Dejure
 Both standards agreements (3) and mandated standards (4)
are a consequence of political/committee deliberations or
administrative procedures which may be influenced market
processes without reflecting them in any simple way

De facto and de Jure Standards (2)
 De jure: created by the lawful exercise of power
 In the past, most broadcasting and telecom standards
 De facto: determined by a combination of better
performance, network effects, openness, backward
compatibility, and/or biz model. Examples include:
 PCs (Wintel)
 Music (CDs)
 Movie (VHS, DVD)
 Phone (iOS, Android)
 Instant messaging (What’s App, WeChat)

De facto and de Jure Standards (3)
 Importance of de Jure standards is declining
 Power of national committees have declined
 Importance of market has increased
 Although need for agreements on standards have increased,
thus making committees more important (>1000 for mobile
phones)
 Many standards are created in a committee but market determines
winner (e.g., many mobile phone standards)
 Many standards/platforms are created by single firms (Apple,
What’s App)

Standard Wars
 Battle between rival technologies to become
recognized “standard”
 Winner-take all standards sometimes leads to winner
take all firms
 Large benefits to having your technology become a
standard
 one key method of strategic control
 control how different products interact with each other
 Thus firms invest a lot of money and time to make (or
try to make) their technology a standard
 First key issue is performance vs. compatibility

Compatibility
Performance
(relative to Price)
Evolution
Revolution
Improved design
and adaptation
Performance (relative to Price) Versus Compatibility
(as compared to existing technology)

Types of Standards Wars: Degree of
Compatibility with Existing Technology
Compatible
Incompatible
Compatible Incompatible
Revolution
Versus
Evolution
Rival
Revolutions
Evolution
Versus
Revolution
Rival
Evolutions
Rival Technology
YourTechnology
Source: Shapiro
and Varian

Types of Standards Wars
Compatible
Incompatible
Compatible Incompatible
New versions of
mobile communica-
tion standards (e.g.,
5G), wearable health?,
messaging apps?
Rival Technology
YourTechnology
New versions of
Windows or
Medical Devices
Smart Watch vs.
updated versions
of iPhone or
Android
Microsoft Office vs.
free versions of word
processing, power point,
spreadsheet, Prezi

Closed versus Open Strategy
 Closed Strategy
 Do not release specifications about interface standards
 Control everything about interface standards
 Open Strategy
 Release specifications about interface standards
 Work with other firms
 Tradeoff between degree of openness & control
 must be open to obtain users and obtain cooperation from
producers of complementary products due to importance of
network effects
 as degree of openness increases, unit profits may decline

Openness (Two Definitions) Increases as One
Moves Down this slide
In Specifications
 Do not release any specifications
and make all hardware and
software (most closed)
 Only make software or hardware
 Release some information about key
interfaces
 Release all information but control
updates
 Fully open standard and standard
setting process
Number of Firms
 One firm controls
standard (most
closed)
 Members of alliance
control standard
 All firms have access
to standard

Merchant
Merchant
(98%)
Consumer
Visa,
MasterCard
Acquirer
(0.4%)
(e.g., First
Data)
Consumer
Issuer
(e.g., Banks)
American
Express,
Discover
1 (Shop)
2 3
3
2
2
3
Bill/Pay
1 (Shop)
3 2
Bill/Pay
Closed-Loop System
Open-Loop System
2: Authorization
3: Settlement (interchange fee in this case is 1.4% and merchant discount is 1.8%)
Together
Share 1.4%
Credit Cards
(example of greater openness with more firms): Visa and Master Card enabled
acquirers and issuers to sign up merchants and consumers, i.e., more open

Key Tactics in Standards Wars
 Preemption
 Announcing a product or service before it is ready in order to
reduce interests in a competitor’s products or services
 Expectations management
 Assemble allies
 Convince large companies or governments to support your
service and then everyone expects you to win
 Governments (e.g., European governments in case of GSM)
 Large corporations in case of video and software formats
 Discounting the service for a specific set of users or
providers of complementary services (previously
discussed)
 Document readers (Adobe)
 Video and music players

Key Assets in Standards Wars
 For benefitting from network effects
 Control over an installed base of users – Microsoft in operating
systems
 First-mover advantages – Apple, Google
 For convincing other firms to align their technology with
your technology or users to adopt your technology
 Strength in complements – Apple with media companies
 Brand name and reputation – Apple, Google, IBM
 For benefiting from technology being part of standard
 Intellectual property rights –Qualcomm in phones
 For reducing need to have your technology in standard
 Ability to innovate – Apple
 Manufacturing capabilities – Japanese firms previously had
advantages

Standards Battle in the US Railroad Gauges
 Although some governments chose the width of the railroad
gauge (e.g., Japan, Europe), the U.S. government did not
 By accident different size gauges (width of rail line) were used
in different parts of the U.S.
 In 1860 (beginning of U.S. North-South Civil War)
 50% of rail gauge was 4 feet 8 inches (the northern states)
 50% was 5 feet (the southern states)
 No real issues of openness (all were open) or
compatibility/performance comparison with
previous technology
 Key issue was network effects and winner take all
 North built railroad to west during and after Civil War
 Network effects caused 4 feet 8 inch gauge to win and South
changed all of its railroad lines to 4 feet 8 inches

Color Television
 U.S. Government
 chose RCA’s (owned NBC) technology
as black-and white standard in 1940
 Initially chose CBS’s technology as color standard in 1951
 But CBS technology was not backward compatibility with
B&W TVs
 And manufacturers refused to make color TVs
 RCA proposed color TV standard that was compatible
with B&W TV in mid-1950s
 U.S. government changed to RCA technology in mid-1950s
 But took many years (until 1968) for color TVs sales to
pass those of B&W TVs – issue of cost and critical mass

Color Television (continued)
 Openness versus control
 Both CBS and RCA licensed their technology (similar
openness)
 Choice of RCA’s technology provided it with important
licensing fees and temporary manufacturing advantages
 Compatibility and Performance
 Performance advantages of first color TVs did not make up
for lack of compatibility with B&W TVs

Video Cassette Recorders (VCRs)
 Ampex introduced first VCR in mid-1950s for
broadcasters
 Many firms (including Japanese ones)
introduced simpler and cheaper VCRs
(Helical design) for training etc. in mid-1960s
 Reductions in price created consumer market in early 1970s
 Consumers used them to record television programs
 Pre-recorded movies did not have strong sales until early 1980s
 Sony and Matsushita/JVC introduced incompatible systems in mid-
1970s
 Sony’s (Betamax) system appeared first and achieved early lead in sales
 But Matsushita/JVC’s system (VHS) had longer recording times and more
manufacturers
 Sales of VHS units passed Beta in 1977, Beta discontinued in mid-
1980s

Video Cassette Recorders - continued
 Network Effects
 they emerged as pre-recorded movies became available; this
caused winner take all for VHS
 However, since recording television programs drove diffusion of
VCR, network effects did not initially apply to VCRs
 Compatibility and Performance
 Backward compatibility with Ampex Quadruplex was irrelevant
as only broadcasters used Quadruplex
 But many argue performance advantage of VHS (longer
recording time) led to its greater diffusion than Betamax
 Others argue that VHS’s greater openness (JVC/Matsushita
licensed more producers of hardware) was key to success

Personal Computers
 Initial competition
 First PC released in 1975
 Apple, Commodore, Tandy released PCs in 1977
 Apple and CP/M compatible (OS) machines were leaders by
1978
 Apples machine used proprietary technology such as OS
 IBM PC
 IBM introduced open-modular product in 1981 that used
external technology (e.g., Microsoft and Intel) that is
summarized on the next slide

IBM’s PC included:
 Operating System from Microsoft
 Hybrid 8- and 16-bit microprocessor from Intel
 8-bit capability provided compatibility with software written
for CP/M OS
 16-bit capability enabled software superior to that used in
Apple computer: Word Perfect replaced Word Star in word
processing software, Lotus 1-2-3 replaced VisiCalc in
spreadsheets
 But other manufacturers introduced clones
 Microsoft (and Intel) became big winners through
control of key interfaces. Subsequently, they have
introduced products that are backward compatible

Personal Computers - continued
 Network Effects
 Increased in importance following release of IBM PC
 Openness of IBM machine contributed to its success
 But openness enabled Microsoft, Intel to become big winners
 Lessons:
 IBM should have pursued more closed policy
 Apple should have pursued more open policy
 Compatibility and performance
 IBM PC was not compatible with previous generations of
computers (but compatible with some previous PCs)
 But for many users IBM PC was superior in terms of
performance-price ratio to mainframe and mini-computers

Outline (and Learning Objectives)
 What are standards and complex systems?
 How are standards chosen?
 What are network effects?
 What is a critical mass of users?
 What are “standards wars” and what impact do they
have on competition? Key issues:
 Performance vs. compatibility
 Open vs. closed
 Key tactics and assets
 Various examples (mobile phones)

Mobile Phones (1)
 Single transmitter systems introduced in 1920s for
police, taxi, fire, military, etc.; public systems
introduced in 1950s
 But single transmitter/receiver restricted number of users
 Dividing system in cells and reusing frequency
spectrum in each cell increased system capacity and
reduced the cost
 First cellular systems introduced in late 1970s in
Scandinavia and later in U.S.
 interface standards determined interaction between base
stations and phones
 U.S. standard (AMPS) became global standard

Mobile Phones (2)
 Digital services first introduced in 1991 (GSM
standard)
 First successful mobile Internet service in 1999 in
Japan
 required many different standard standards
 Compatibility between different standards and thus integral
design
 As processing power and memory capacity increased, it
became possible to
 design phone systems and phones in a modular way
 use interface standards from PC Internet
 and now we have the iPhone and the Google phone

 Let’s look at the history of the mobile phone industry
in more detail

Batteries
Key Interface Standard in Mobile Phone Industry
Phone
Manufacturers
Displays
Interface defined by air-interface
standards such as GSM and CDMA
Chips
Software
Operators
Base Stations
Switching Equipment
Network Software
Retail Customer
Source: Adapted from (Steinbock, 2003; Peppard and Rylander, 2006)

Type of
Mobile
Dates Generation of
Technology
Global
Standard(s)
Single
transmitter
/receiver
Early 1900s Wireless Telegraph Not applicable
From 1920s Wireless Voice
(police, military)
Not applicable
Cellular 1970s,
1980s
1G
Analog
AMPS (U.S.)
1980s, early
1990s
2G Digital GSM (Europe)
Late 1990s 3G W-CDMA
2000s Mobile Internet PC Internet-based
standards
Evolution of Technology and Standards in Mobile Phones

Competition Between 2G Digital Phone Systems
 Europe
 Countries agreed to develop single standard in 1987
 Began awarding new licenses in 1989
 Non-European countries began adopting GSM in early 1990s
 Services started in 1992
 U.S.
 Finalized specs for standard (D-AMPS) in 1989
 But no new licenses! And incumbents didn’t invest in digital
 Alternative from Qualcomm (CDMA) later emerged and U.S.
government allowed service providers to use any technology
 Japan
 NTT DoCoMo created the Japanese standard in cooperation only
with Japanese manufacturers (i.e., no openness!)

Compatibility
Performance
Evolution
Revolution
Improved design
and adaptation
Qualcomm’s Technology (CDMA) vs. GSM in late 1990s
Qualcomm
GSM updates

Qualcomm’s CDMA Technology
 Successful IP strategy
 Charges the same licensing fee for use of its patents in both its
3G CDMA (e.g., cdma2000) technology and the most widely
used version of CDMA technology (W-CDMA)
 Qualcomm makes lots of money
 Unsuccessful standards strategy
 W-CDMA is much more widely used than Qualcomm’s 3G
technology
 Qualcomm’s partners (Motorola, Lucent, Nortel) have lost
significant share of the infrastructure market because of the lack
of success in Qualcomm’s 3G technology

New Standards Continue to Emerge
 Network standards (between base station and phone)
 4G
 Cognitive Radio
 WiFi
 WLAN
 Content and Application related standards
 2D Bar Codes
 Payments and tickets (Wallet Phones)
 3D content
 Operating System (which connects applications with content)
 We will talk about operating systems next week

Conclusions (1)
 Network effects have a large impact on value proposition
for some products
 Some very large, some not so large
 But when effect is large, large impact on competition and profits
 Network effects impact on many products that involve
interface standards
 Interface standards technically define interfaces between
different modules or building blocks in complex systems
 Relatively open standards facilitate vertical disintegration
and thus new types of scope of activities (next week)
 But small amounts of control can lead to high profits for
some firms
 Thus monitoring, participating and succeeding in standards
are critical issues in defining business models

Conclusions (2)
 The choice of standards is not just due to technical
performance (intrinsic value) but also due to network
effects (favors early installed base)
 Levels of openness and backward compatibility, and
other tactics that lead to an early installed base (i.e.,
network effects) are also important
 degree of network effects can differ dramatically among products
and systems
 strong network effects can lead to early leader becoming
standard
 very strong network effects can lead to high switching costs

Conclusions (3)
 Although different types of standards require different
types of strategies, degree of openness and compatibility
play critical roles in all standard setting
 Openness increases chance of adoption but may decrease profits
 Backward compatibility also increases chances of adoption
 Performance advantages can overcome backward
incompatibility (i.e., there is a tradeoff between performance
and compatibility)
 Who pays and how much (methods of value capture) are critical
in building a critical mass of users for your system/product and
the standards included in the system/product

Network Effects, Platforms, Standards, and Complex Systems

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