Ecommerce through Cooperation: Finding your Partners and Create an Emarketplace with Them

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E-commerce through CooperationFinding your
Partners and Create an E-marketplace with Them

• Ming-Hui Huang, PhD, Professor
• Department of Information Management
• National Taiwan University
• Director
• Management Research Program
• National Science Council

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Outline

• With Friends Like These The Art of Managing
  Complementors, HBR, 2006
• While analysis of competitors and suppliers is
  critical in formulating strategy, surprisingly
  few companies pay much attention to firms that
  sell complementary products
• Strategies for Two-Sided Markets, HBR, 2006
• Companies that make money by linking markets from
  different sides of their customer networks demand
  a new approach to strategy

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Managing Complementors

• In business, as in war
• Know yourself ? know your enemy ? and know your
  friends
• Suppliers and distributors are not the only
  partners
• Complementors
• Companies that independently provide
  complementary products to mutual customers
• Those that increase the value of each others
  offerings in customers eyes and the size of the
  pie
• Intel and Microsoft
• The most widely known complementors

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The Need

• The trend
• The need to focus on distinct advantages
• Become more dependent on third parties to create
  complete solutions for customers
• Examples
• The success of digital cameras depended heavily
  on the creation of affordable home photo
  printers, flash memory, and printing kiosks in
  retail outlets
• Electronics companies developing e-books will
  have to persuade traditional publishers to make
  their products available in electronic form at a
  price that consumers will find attractive

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The Tension

• The tension
• Complementors share the desire to expand their
  common market, buy their interests are often
  misaligned
• In their mutual desire to enlarge the pie, they
  may overlook the fact that the economics of their
  businesses and their strategies are radically
  different
• Conflicts
• Pricing, technology, and control of the
  marketboth in terms of which company has the
  most influence over customers and which one gets
  the bigger slice of the pie

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The Dark Side of ComplementorRelations

• Co-opetition
• Win-win When a complementor enters the game, the
  pie grows
• Tug-of-war The two struggle over whos going to
  be the main beneficiary
• If your complementor gets less of the pie, that
  leaves more for you
• An example
• Handsprings PDA (Visor) and third party modules
• Handspring priced the PDA at around 149249 and
  hoped modules priced at around 2550
• Modules were delivered at around 150250

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The Difficulty

• The fact
• Executives often overestimate common interests
  with complementors and UNDERESTIMATE THE
  POTENTIAL FOR CONFLICT
• The difficulties
• You can increase your leverage with suppliers by
  increasing your purchases with them
• You can increase your leverage with customers by
  tailoring your products in ways that lock them in
  
• Your complementors do not do business with you,
  which makes persuade them to meet your terms
  difficult

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Complementor Analysis

• Complementor analysis
• Understand complementors economics, business
  models, capabilities, incentives for cooperation,
  and potential areas of conflict
• The Apple, Intuit, and Windows PCs Example
• Apple makes money by selling its computers at a
  premium price and by keeping fixed costs low,
  e.g., 5 of sales to RD
• Intuit produces Quicken and TurboTax for Apples
  computers, pours 20 of its revenues into
  research
• Intuits need high volume to cover these costs.
  The vast Windows market is more attractive than
  the small Apple market

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Hard Power

• Hard power
• Resort to inducements or coercion to get what you
  want (carrots and sticks)
• Need sources of strength, such as market share,
  brand equity, control of distribution channels,
  or cash
• Examples
• Bill Gatess threat to halt development of Office
  for Mac UNLESS APPLE ADOPTED MICROSOFTS WEB
  BROWSER
• Sonys bid to attract developers to its video
  game platform by cutting industry-standard
  licensing fees in half

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Building Hard Power

• The concept
• Reduce your dependence on complementors by
  producing strategically significant complements
  in-house
• The benefits
• Control customers perceptions of the value of
  their products by determining the performance and
  price of key complements
• Profit from economies in marketing and sales and
  increase barriers to entry
• Complementary products may generate the lions
  share of profitsespecially if the complements
  are consumables such as the ink for HP printers

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When Should You Produce Your Own Complements?
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Disadvantages of Hard Power

• Hard power does little to build trust
• Discourage deep cooperation
• Inspire a backlash
• Complementors will limit their dependence on a
  more powerful partner and to strive to reshape
  the structure of the industry in their favor
• Therefore, relying heavily on hard power for an
  extended period of time can be costly

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Exercising Hard PowerLessons from Microsoft and
Intel

• The background
• Two shared goals growth in the PC market and
  improvement in the Wintel standard
• Microsoft always fill Intel chips with more
  software
• Microsoft has the upper hand It needs Intel less
• The MMX fiasco
• Multimedia technology MMX (Intel) or 3DX (AMD)?
• Two competing standards?
• Microsoft demanded that Intel license MMX to
  other chip makers at no charge in return for its
  support
• Intel complies reluctantly MMX for everyone was
  better than MMX for no one

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The Limits of Hard Power

• Lessons learned by Intel
• The importance of understanding Microsofts
  business model
• Not to be too dependent on a complementor
• Diversify its business and make itself a swing
  player in Microsofts battle against Linux
• Support for Linux-the leading competitor to
  Windows
• Became a founding sponsor of the Open Source
  Development Labs driving corporations to adopt
  Linux
• The Lesson learned by Microsoft
• Risk a backlash by using hard power to take away
  a complementors intellectual property and
  competitive differentiation

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Soft Power

• Soft power
• Relies on persuasion through indirect means
• It leads others to want what you want instead of
  forcing them to do as you wish
• Sources of soft power
• The larger your market share is, the more
  attractive complementors are likely to find any
  offer you make
• Sharing information about future product plans to
  foster cooperation
• Enter into strategic commitments to further a
  common goal, e.g., jointly developing a new
  technology

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Building Soft Power The iTunes Example

• Persuasion
• Apple persuaded the major music companies to sell
  tracks to iPod users through the iTunes Music
  Store
• Technology
• Apples technology was designed to make it
  difficult for users to share downloads
• Product
• Has a hip product (the iPod) that would drive
  sales
• Marketing
• It promised that the combination of 99-cent
  pricing and Apples marketing prowess would yield
  millions of sales

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Building Soft Power The Limitations and
Advantages

• The limitations
• Soft power can fail facing a determined assault
• Netscape discovered in later years when Microsoft
  defeated it in the browser wars by using hard
  power to lure away complementors
• Soft power rarely produces sudden changes
• The precise effects can be difficult to trace
• The advantages
• For large companies, soft power often sets the
  stage for the more effective use of hard power
• For small companies, it may be their only choice

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Wielding Soft Power Lessonsfrom IBM and Linux
(1/2)

• Background
• The rise of Linux offered IBM a second chance to
  reduce its dependence on Microsoft
• Articulating a vision
• The vision Linux as an industrial-strength
  operating system that can overthrow Microsoft and
  Sun
• IBM and Linux tapped into a powerful anybody but
  Microsoft sentiment
• Fostering leadership
• IBM joined with Intel, HP, Computer Associates,
  and NEC to launch the Open Source Development
  Labs
• OSDL dedicated to accelerating the use of Linux
  in enterprise computing

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Wielding Soft Power Lessonsfrom IBM and Linux
(2/2)

• Contributing to the cause
• IBM has donated a vast amount of money, people,
  and intellectual property to the Linux community
• IBM assist SAP, a company with which IBM both
  competes and cooperates, on Linux projects
• It strengthens competition in some of IBMs
  business, but IBM gains by getting SAP to support
  Linux
• The benefits
• IBM has achieved its goals of improving Linux,
  giving Linux credibility, and putting pressure on
  Microsoft
• A weaker Microsoft and a trend toward turning the
  server OS into a commodity are good for IBMs
  server business

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Smart Power

• Combining hard and soft power
• Three factors determine the relative value of
  hard and soft power
• A companys capacity to exercise hard power
• The importance of having a large variety of
  complements
• The severity of the holdup problem, meaning the
  threat that one complementor may extract most or
  all of the value at the expense of others

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Smart Power Capacity

• Hard power
• The ability to coerce complementors depends on
  such assets as a leading market position, strong
  ties to other essential partners, and stockpiles
  of cash
• Consequently, the effective use of hard power may
  not lie within every companys grasp
• Soft power
• Options to smaller firms that lack the deep
  pockets
• Weaker players may have an advantage, because
  potential partners have less reason to fear that
  the velvet glove of soft power hides an iron fist

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Smart Power Variety

• Hard power
• If your industry depends on tight integration
  with one vital complement
• Concentrate on one or a few complementors and
  attain the perfect product match
• Consistently maintain the upper hand in any
  one-on-one relationship
• Soft power
• If the more the merrier when it comes to the
  range of complements that customers can buy, and,
  as a result, the number of complementors
• Relies on the creation of public goods, which can
  be extended to additional complementors at little
  cost

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Smart Power Hold Up

• Hard power
• If, for their products to become a good match
  with yours, partners must make large,
  irreversible, and highly specific investments,
  they are bound to be wary of getting trapped in a
  relationship
• Then the cost of using hard power is likely to
  soar as complementors seek reassurance that
  youre committed to making the relationship
  workand insurance against the possibility that
  youre not
• Soft power
• Consequently, as the danger of holdup rises, soft
  powerparticularly measures to reduce risk and
  build trustcan go a long way

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Smart Power Combining hard and soft power

• Smart power is neither hard nor soft. It is both
• Soft power initially
• Initially, Apple relied on soft power to persuade
  the music companies into making their libraries
  available
• Hard power in contract renewal
• The 80 market share for legal downloads gave
  Apple the upper hand
• The music companies wanted 1.50 or 2.00 per
  track, but Apple wanted to keep the .99 price
• Given iTunes dominance, the music companies had
  to relent

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A triangular relationship

• Subsidy side
• A group of users who, when attracted in volume,
  are highly valued by the
• Money side
• The other user group
• Platforms
• Products that bring together groups of users in
  two-sided networks
• Provide infrastructure and rules that facilitate
  the two groups transactions

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The Dynamics of Two-Sided Networks

• Same-side network effect (negative)
• Increasing users on one side of the network makes
  it less valuable to users on the same side
• Cross-side network effect (positive)
• Increasing users on one side of the network makes
  it either more valuable to the users on the other
  side

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Two-Sided Markets
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Challenge 1 Pricing the Platform

• Traditional pricing
• In competitive industries, prices are determined
  by the marginal cost of producing an extra unit,
  and margins tend to be thin
• In industries with high barriers to entry, the
  price ceiling is set by customers willingness to
  pay, and margins are more likely to be fat
• Platform pricing
• Platform providers choose a price for each side,
  factoring in the impact on THE OTHER SIDES
  GROWTH AND WILLINGNESS TO PAY

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Challenge 1 Platform Pricing

• Generate cross-side network effects
• Set a lower price for subside-side users to
  develop network effects
• The money side pays a higher price
• Attract enough subsidy-side users so that
  money-side users will pay handsomely to reach
  them
• Generate same-side network effect
• Drawing users to one side helps attract even more
  users to that side

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Challenge 1 Ability to capture cross-side
network effects

• The concept
• Your giveaway will be wasted if your networks
  subsidy side can transact with a rival platform
  providers money side
• Netscapes web browser
• The company subsidized its browser to individuals
  in the hope of selling Web servers to companies
  operating Web sites
• However, Web site operators didnt have to buy
  Netscapes server in order to send pages to
  Netscapes big base of users they could buy a
  rivals Web server instead

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Challenge 1 User sensitivity to price

• The concept
• Subsidize the networks more price-sensitive side
  and charge the side that increases its demand
  more strongly in response to the other sides
  growth
• Adobes Acrobat software
• The PDF network consists of two sets of users
  using different software
• Writers create documents. They value the huge
  audience of readers, pay a fee for their software
• Readers view them. They are very price sensitive
  they pay nothing for their software

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Challenge 1 User sensitivity to quality

• The concept
• Rather than charge the side that strongly demands
  quality, you charge the side that must supply
  quality
• Video games
• Game developers incur high fixed costs to deliver
  good quality
• Hence they need for a consumer subsidy to pay
  back these costs
• Platform providers make sure game developers meet
  high quality standards by charging a high royalty
• The royalty helps weed out games of marginal
  quality

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Challenge 1 Output costs

• The concept
• If a strong willingness to pay does not
  materialize on the money side, a giveaway
  strategy with high variable costs can rack up
  large losses
• FreePC
• Provided computers and Internet access at no cost
  to consumers who agreed to view Internet ads
• However, few marketers were eager to target
  consumers who were so cost conscious
• FreePC abandoned its offer after incurring 80
  million in losses

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Challenge 1 Same-side network effects

• The concept
• Exclude some users from the network when there
  are negative same-side network effects
• Sellers would be happy to see fewer direct rivals
• Autobytel
• Forwards consumers queries to a single dealer in
  any given geographic territory
• Covisint
• A B2B exchange organized by auto manufacturers
• Many auto parts manufacturers, concerned about
  downward pricing pressure, refused to participate

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Challenge 1 Users Brand Value

• The concept
• The participation of marquee users is important
  for attracting participants to the other side of
  the network
• A platform accelerate its growth by securing the
  exclusive participation of marquee users
• Visa
• and they dont take American Express marketing
  campaign
• It can be expensive especially for small
  platforms to convince marquee users to forfeit
  opportunities in other networks

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Similar Network, Different Pricing Video game
industry

• Video game end users are subsidized
• Platform providers like Sony PlayStation and
  Microsoft Xbox priced consoles at or below cost
• Game developers are on the money side
• They pay a royalty to console manufacturers of as
  much as 20 of a games retail price
• Teenage users
• Price sensitive and quality conscious
• Gamers
• Need for quality is stronger than teenagers
• Need for large numbers of consumers

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Similar Network, Different Pricing PC industry

• End users are the money side
• Paying well above cost for the platforms
  essential element its OS which comes bundled
  with PCs offered
• Application developers are the subsidy side
• They pay no royalties and receive free software
  development kits from the OS vendors
• Typical users are less price sensitive
• PCs are purchased for work

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Challenge 2 Winner-Take-All Dynamics

• A networked market is likely to be served by a
  single platform
• When the following 3 conditions apply
• Multi-homing costs are high for at least one user
  side
• Network effects are positive and strong
• Neither sides users have a strong preference for
  special features

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Challenge 2 Multi-homing costs are high

• The concept
• Homing costs comprise all the expenses network
  users incur to establish and maintain platform
  affiliation
• When users make a home on multiple platforms,
  they increase their outlays
• PC
• The vast majority of PC users rely on a single
  operating system
• Using multiple operating systems is expensive in
  terms of the additional hardware, software, and
  training required

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Challenge 2 Network effects are positive and
strong

• The concept
• Network effects are positive and strongat least
  for the users on the side of the network with
  high multi-homing costs
• Cross-side network effect
• When such effects are positive and strong,
  network users will tend to converge on one
  platform
• Same-side network effect
• When such effects are positive, a single platform
  is likely to prevail
• For example, when users of a software program
  need to share files with one another

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Challenge 2 No preference for special features

• The concept
• In cases where special features are not
  important, users will tend to converge on a
  single platform
• If certain users have unique needs, then smaller,
  differentiated platforms can focus on those needs
• American Express
• Earns high margins despite having issued only 5
  as many credit cards as Visa
• No preset spending limit a valuable feature for
  business travelers
• Visa cannot match this feature, because the loans
  it extends to cardholders

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Challenge 3 The Threat of Envelopment

• During the dot-com boom, nascent B2B exchanges
  agonized over whether to CHARGE FEES TO BUYERS,
  SELLERS, OR BOTH
• Change business models
• Find a bigger brother
• Sue

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Challenge 3 Change business models

• Reals response to Microsofts envelopment attack
  was to switch its money side
• Ceding the streaming media business, Real
  leveraged existing relationships with consumers
  and music companies to launch Rhapsody, charging
  10 per month for unlimited streaming to any PC
  from a library of a half-million songs
• Real now profited from consumers, rather than
  subsidizing them

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Challenge 3 Find a bigger brother

• When bullied on the playground, a little guy
  needs a big friend
• Real found allies through partnerships with cable
  TV system operators and cellular phone companies
• Changing vendors would force music subscribers to
  configure new music players and recreate
  playlists
• Cellular carriers can afford to subsidize digital
  music playback on their phones, since doing so
  would be likely to reduce cell phone churn rates.
  That would present a big threat to Apples money
  side.

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Challenge 3 Sue

• Antitrust law for two-sided networks is still in
  dispute. It does not fully reflect the economic
  imperatives of platform-mediated networks
• Dominant platform providers that offer bundles or
  pursue penetration pricing run the risk of being
  charged with illegal tying or predation
• Real brought Microsoft to antitrust court and
  then in 2005 received a 760 million payment from
  Microsoft to end the lawsuit
• Sun Microsystems and Time WarnerNetscapes
  current owner reaped similar bounties after
  they challenged Microsofts anticompetitive
  behavior in court