Network Economics and Strategy

1
Network Economics and Strategy

• Old economy
• Driven by economies of scale, leads to
  oligopolies (e.g. automobile industry)
• New economy
• Driven by economics of networks, leads to
  monopolies (e.g. Microsoft)
• Real vs. virtual networks

2
Positive feedback

• The value of connecting to a network depends on
  the number of other people already connected to
  it
• Network externalities or demand-side economies of
  scale
• Markets with presence of positive feedback also
  known as tippy

3
Network externalities

• Network partners and strategic alliances
• Externalities (positive)
• Metcalfes law
• The value of a network is proportional to the
  number of people on the network proportional to
  n2 n
• Justifies the existence of subsidies in certain
  cases, e.g. to encourage universal service

4
Tradeoffs

• Evolution vs. Revolution or Compatibility vs.
  Performance
• Openness vs. Control

5
Evolution

• Offer a migration path that reduces switching
  costs
• Technical obstacles
• Use creative design
• Think in terms of the system
• Converters and bridge technologies

6
Revolution

• Offer compelling performance 10X better to start
  a revolution

7
Strategies in Network Markets
8
Performance Play

• Striking technology
• Generally an outsider
• Examples, Nintendo, Palm
• Risky strategy

9
Controlled migration

• New and improved but compatible technology
• Examples
• Windows 98
• TurboTax

10
Open Migration

• Low switching costs
• Improved technology, compatible with older
  versions and other systems
• Examples fax machines, modems
• Favors efficient manufacturers -HP

11
Discontinuity

• New technology
• Incompatible with existing technology but
  available from several manufacturers
• Favors companies efficient in manufacturing
• Floppy disks

12
Example Railroad Gauges

• South 5 foot gauge
• North 4 foot 8 1/2 inches gauge
• Obstacles to standardization
• Costs to change width of existing tracks
  (switching costs are high)
• Each group wanted others to move (inertia)
• Workers who depended on different gauges resisted
  change (special interests)

13
Lessons

• Incompatibilities can arise almost by accident
  yet persist
• Network markets tend to tip toward the leading
  player
• Seceding from the standard setting process can
  leave you in a weak market position
• A large buyer (U.S. government) can be very
  influential
• Those left with less popular technology will cut
  losses adaptors or adoption of new technology