Research on Platform Strategy in the Network Context

1
Research on Platform Strategy in the Network
Context

• Jerome Chou
• 2005/5/20

2
Platform Strategy

• Conventional platform strategy
• Standards strategy
• The position of this research

3
Conventional Platform Strategy

• Product platform is the reused module across
  various products
• Focused on exploiting the benefit of having a
  platform module
• Leveraging the component variations
• Easier component innovations
• Mixing and matching
• Flexibility
• Reusing the platform module
• Economies of scale and scope
• Developing components concurrently
• Speed to market
• Henderson and Clark, 1990 Garud and Kumaraswamy,
  1995 Sanderson and Uzumeri, 1995 Meyer et al.,
  1997, 1998, 2001 Sanchez and Mahoney, 1996
  Sanchez, 1995, 1999
• Ignoring that a value network will form on the
  platform
• The network affects the platforms success or
  failure

4
Standards Strategy

• Types of standards
• Compatibility standard vs. quality standard
• Sponsored vs. unsponsored
• De facto vs. de jure
• Almost all standards are networks
• Theories of network economics
• Welfare perspective only good for policy making
• Excess inertia or excess momentum?
• Inferior technology wins?
• Major mechanisms for correcting inefficiency
  communication, preannouncement, sponsorship,
  compatibility
• Effective in changing the equilibrium but
  controversial in correcting the inefficiency

5
Standards Strategy cont.

• The root difficulty which standard is superior?
• Liebowitz Margolis, 2001
• Management perspective
• Managing the economic forces
• Network effects and collective lock-in
• Grindley, 1995 Shapiro Varian, 1999 Rohlfs,
  2001 Cusumano and Gawer, 2002

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Basic Strategies in the Market of Network Effects

• Be an architect
• Standards competition
• Benefit from providing the core module of a
  system
• Seek the platform leadership in the system
  evolution
• Baldwin Clark, 1997, 2000 Gawer Cusumano,
  2002
• Be a designer of modules that conform to some
  design rules
• The platform is treated as a controlled factor
• This research focuses on the former strategy

7
Network Effects

• Types of network effects
• Characteristics of markets of network effects
• Origins of network effects

8
Types of Network Effects

• Katz Shapiro, 1985 Economides, 1996 Rochet
  and Tirole, 2001 Farrell and Klemperer, 2004
• 1. Direct network effects
• Each users adoption payoff and her incentive to
  adopt increases directly because more others
  adopt the system
• E.g. communications network, speakers of a
  language

9
Types of Network Effects cont.

• 2. Indirect network effects
• Each users adoption payoff and her incentive to
  adopt increases as more complementary goods or
  services increase
• Hardware-software paradigm
• Multi-sided market
• At least, sellers and buyers
• Business models

10
Characteristics of Markets with Network Effects

• Information incompleteness
• Adoptions are in the future, or
• Adoptions are made simultaneously by others
• If assuming adopters have perfect foresight
• Tipping or stagnation
• Self-fulfilling expectations, multiple
  equilibriums
• Critical mass
• Price
• Asymmetric early power
• Path-dependence
• Lock-in
• Coordination problem
• Collective switching cost

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Origins of Network Effects

• Adopters utility from the product
• Externalities communication, interaction,
  transaction, conformism
• Stand alone utility quality, price, etc.
• Complementarities
• Cross-transaction complementarities
• Product in hands of consumers are directly
  complementary
• Complementarities are between 2 (or more) types
  of adopters
• Economies of scope between different consumers
  purchases
• Economies of scale (of the platform) passed
  through to the consumers
• Expectation how other consumers will decide?
• Expectation vs. reality

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Impacts of Network Effects on Business Strategy

• Shift toward Schumpeterian competition
• Toward the early stage of system development
• Competing for the installed base
• Pricing
• Expectation manipulation
• Compatibility (interlinking) maneuvering
• Weakening/strengthening the competitive advantage
  of a large installed base
• Competing for pivotal customers
• Designing complementarity into products
• Product development strategy
• Harvesting network effects
• Business model, firm boundary
• Role of standards bodies
• A reason in favor of monopoly market structure?

13
Settings of This Research

• Inefficiency of the welfare aspect is not a
  focus here
• The successful industry-wide platform sets
  standards and profits by the platform
• Broader specifications of standards wars
• Approach of case analysis
• Richer implications for managing network effects
• Investigating how network effects are
  incorporated into the product development
  strategy

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Settings of This Research cont.

• The platform strategy is chosen
• Component variety can be provided from inside or
  outside of the organization
• Users adoption has externalities (or has such
  potential)
• Before the stage of competing by pricing or
  advertising
• The early stage of system development
• Product strategy is more irreversible and less
  flexible than pricing and advertising
• Focus on platform development and business model
  building
• Knowing the early power matters a lot
• Having experienced bloody standards wars, how do
  modern platform contesters adapt?

15
New Platform Leaders

• Microsoft .NET, NTT i-mode, Apple iTunes/iPod
• They emerge from the diverse context
• Advancement of software and Internet technology
• Transforming of mobile communication service
• Struggling digital content industry
• Interpolation
• Do they manage network effects in platform
  development?

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Framework for Studying Cases

• Network Effects Grid
• Positive Feedback Loops

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Network Effects Grid
18
Positive Feedback Loops
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Microsoft .NET

• Extending from the open Internet standards
• Strengthening the direct network effect by
  designing MSN Messenger into the platform
• Skype?
• New Web Services platforms
• Improving the weak indirect network effect
• Microsoft design layers of platforms to engage
  ISVs of diverse technological capabilities and
  business objectives
• Targeting at the programmer (network) with Visual
  Studio.NET
• Design MSN as a helping distribution channel of
  Web Services of ISVs
• Leading the WS-I and making peace with Sun Java
• Managing the service variety with market
  mechanism implemented in MSN

20
Analysis of .NET Strategy
21
NTT DoCoMo i-mode

• Free riding on the direct network effect of
  Internet e-mail
• Strengthening the direct network effect
• i-Shot, i-Motion
• Strengthening the indirect network effect
• Use of cHTML
• Market segmenting and prioritizing on the
  subscriber side
• managing the portal menu as a market
• Interlinking with heterogeneous platforms
• e-wallet (i-mode Felica)
• Benefit by playing the role of platform
• Expand (innovate) the supporting functions of
  i-mode

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Analysis of i-mode Strategy
Managed portal menu Involved handset design

• Variety of services from
• 4000 official sites
• 74000 voluntary sites
• Other forms of alliances

Value to subscribe and use i-mode services

• Target prioritizing
• Comfortable pricing scheme
• Near 60 of market share of Japanese wireless
  market
• Cheap and 2G-comparable handsets
• Expensive wirelined Internet access in Japan

• E-mail
• i-Shot
• i-Motion

Reasonable profit sharing with content providers
Installed base of i-mode handsets

• Opportunities of
• Using i-mode as the selling channel
• Low cost of the wirelined Internet content
  conversion
• Providing location-based content
• Using handset as ID and a paying tool

• Color display
• Embedded camera
• FOMA

Selection of C-HTML and Java
Integration of contactless IC chip
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Apple iTunes/iPod

• Free riding on the direct network effect of MP3
  file-sharing network
• Strengthening the desired direct network effect
• iMix
• Small scale file-sharing
• Strengthening the lock-in effect
• Use of AAC format with DRM
• iPod with huge storing capacity
• Fostering the indirect network effect
• Accommodating CD burning and MP3 file-sharing
• Persuading the major record labels
• Making profit by the complementary iPod
• Restructuring the music industry

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Analysis of iTunes/iPod Strategy

• iTunes enables end-users to
• Easily search and purchase songs
• Easily organize songs

• Song Variety
• Above 1 million authorized songs from EMI,
  Sony/BMG, Universal, and Warner Bros and 600
  independent artists and record labels
• Millions of unauthorized MP3

Value of adopting iTunes and iPods

• Complementarity between iTunes and iPod
• Limited music sharing on the LAN

• iMix
• Link Maker

• Free download of iTunes
• Porting iTunes onto Windows
• Allying with Pepsi, AOL, and HP
• Unbundle songs on CDs
• .99/song
• 9.95/album

65 cents out of 99 cents to the licenser
Installed base of iTunes/iPod
Opportunities of selling digital music via the
Internet
Importing and/or converting songs with Apple
Lossless
(-)
P2P networks on which a lot of MP3 files are
being exchanged
Unlimited CD burning
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Platform Strategy Making Framework
A. Plan new functions for the platform
C. Manage the variety of complements
B. Manage the released design opportunity
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A. Plan New Functions for the Platform
The function obviously enables users to interact

yes
Invert it into the platform
Start A new function is proposed
Search for new functions
no
Users store reusable information for themselves
Help complementors design it
no
no
Search for new functions to improve the
platforms appropriability
Ability of attracting complementors is improved
yes
Users exchange information resulted by using the
function
no
yes
B. Manage the released design opportunity
yes
Existence of a de facto standard of storing format
Inver it with a proprietary storing format
Inver it, adopting the de facto standard as the
storing format
no
yes
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B. Manage the Released Design Opportunities
Compete with the complementor in providing that
component
The complement is becoming another platform
yes
yes
Complement variety resulted from the spillover
design opportunity is small
Start
no
no
Existence of an opportunity- providing network
Enlarge the installed base by marketing means
no
C. Manage the variety of complements
yes
Weak appropriability if links with the
opportunity-providing network
Link with the opportunity-providing network
A. Search for new functions to improve the
platforms appropriability
yes
no
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C. Manage the Variety of Complements
Start
Encourage end-users to produce and share their
diverse applications
yes
The variety can be increased by end-users
diverse applications
Some complementors bargain power for value share
increases
no
no
yes
B. Manage the released design opportunity
The variety can be increased by complementors
diverse innovations
yes
Weak demand for various complements
no
yes
no
Extend the platforms function to support more
other variety of complements
A. Search new functions of platform potential
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Competitive Advantage Gained
Diligently seeking possibilities of network
effects and its lock-in consequence
A. Plan new functions for the platform
Interlinking to opportunity-providing platforms
with calculated appropriability
B. Manage the released design opportunities
C. Manage the variety of complements
Managing the platform evolution and improving the
appropriability
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Future Research

• Follow-up of the three cases
• Internet telephony
• WLAN and 3G
• P2P

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Fulfilled Expectations
Economides, 1996
32
Customer Demand
33
Perfect Foresight
Oz Shy, 2001
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Customer Demand
35
Stagnation
P
Q
36
Path-dependence
Arthur, 1989
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Economies of scope between different consumers
purchases

• Direct network effect
• Metcalfes Law
• Marginal cost constant or decreasing
• Marginal benefit 2n
• Indirect network effect
• Mixing and matching
• Marginal cost cost of an additional one
  component
• Marginal benefit
• Increase the component variety by one, but
• Increase the system variety by (m(n1)-mnm)
• Indirectly increase the marginal benefit
• Finding the greatest common denominator of the
  system configuration for the seller to unite a
  mass market

38
Compatibility Maneuvering

• One-way compatibility (benefit only flows in) is
  always preferred
• Reciprocal compatibility cannot be achieved
  unilaterally
• If the compatibility is only reciprocal, in
  general, the large network prefers
  incompatibility, and
• The small network prefers compatibility
• If the system variety is preferred by customers,
  the oligopoly platform contesters will prefer
  compatibility (Economides, 1991)
• If different companies are best at providing
  different components, then the winning seller on
  each component can profit more in compatible
  competition (Einhorn, 1992)
• What asset the firm has also influences its
  compatibility preference

39
Competing for Pivotal Customers

• Direct network effect
• Those who value the network size the most
• Those who can generate positive externalities the
  most
• Indirect network effect
• Sellers are motivated by opportunities (the
  installed base)
• Buyers are motivated by the variety, quality, and
  price of complementary goods and services

40
Evidence Obvious interaction functions

• Microsoft .NET
• MSN Messenger
• NTT DoCoMo i-mode
• E-mail, i-shot, i-motion

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Evidence Users store reusable information

• Microsoft .NET
• Web Services enabled Office, .NET Passport,
  Alerts
• NTT DoCoMo i-mode
• Embedded camera, i-mode Felica
• iTunes
• iTunes software jukebox, iMix, Link Maker

42
Evidence Users store and exchange information

• Microsoft .NET
• Web Services enabled Office
• NTT DoCoMo i-mode
• Embedded camera
• iTunes
• iTunes software jukebox, iMix, Link Maker

43
Evidence Users store but not exchange information

• Microsoft .NET
• .NET Passport, Alerts
• NTT DoCoMo i-mode
• i-mode Felica (latent problem)
• Apple iTunes
• Do not encourage users exchange songs stored in
  iPods

44
Evidence A de facto storing format exists

• NTT DoCoMo i-mode
• Embedded camara
• Apple iTunes
• iTunes software jukebox, Link Maker

45
Evidence No de facto standard exists

• Microsoft .NET
• Web Services enabled Office
• File formats of Office per se are de facto
  standards
• Apple iTunes
• iMix

46
Evidence Appropriability improvements of
platforms

• Microsoft .NET
• .Net Passport requires users to register and
  sign-in
• NTT DoCoMo i-mode
• The born strong appropriability
• Apple iTunes
• One-way conversion of MP3 and WMA to AAC format
• Limited file-sharing function on the LAN
• iPod
• Use AAC format
• Big storage capacity

47
Evidence Platform competes with complements

• Microsoft case
• IE vs. Navigator
• C vs. Java
• Preempt design opportunities of Web Services
  technology platforms

48
Evidence Opportunity-providing Networks

• Windows
• Big installed base
• Internet
• Big installed base
• As a service channel
• As a content source
• Mobile phone service network
• Big installed base
• Ready appropriability
• Linux
• Copyleft (high appropriability)
• MP3 file-sharing network

49
Evidence Platform links with an
opportunity-providing platform

• Microsoft case
• Link all lines of products with the Internet
  platform by .NET strategy
• NTT DoCoMo case
• Link with the Internet for sourcing masses of
  content providers by choosing cHTML, Java, and
  SSL to adopt
• Apple case
• Port iTunes onto Windows and Linux platforms
• Link with MP3 file-sharing network by adopting
  MP3 format (but with one-way conversion)

50
Evidence Mechanisms to reduce transaction cost
from variety

• Microsoft .NET
• Build the transaction platform MSN to help
  end-users find and transact with Web Services
  providers
• NTT DoCoMo i-mode
• Let the market to determine the list and order of
  services on the portal menu so that users can
  find useful services easily
• Apple iTunes
• Use software to help users search, buy, and
  organize music of all kinds

51
Evidence Variety produced by end-users diverse
applications

• Microsoft case
• Web Services enabled Office
• NTT DoCoMo case
• E-mail, i-shot, i-motion
• Apple case
• iMix