Copyright SDA Bocconi 2005 Competing Technologies, Network Externalities …n 1 Economia...

Copyright SDA Bocconi 2005 Competing Technologies, Network Externalities …n 1

Economia dell’Informazione:

Competizione tra sistemi


Yesterday

• L’adozione di un bene di rete implica un beneficio sociale maggiore del beneficio privato, cioè eistono esternalità positive.

• Esternalità di rete: per il consumatore il valore di un prodotto dipende da quante altre persone fanno parte del network.

• Le esternalità di rete conducono a rendimenti crescenti da adozione

• A causa dei rendimenti crescenti da adozione I pirmi momenti di vita di un network sono molto importanti

• Conseguenze di strategia e marketing


Today• L’offerta

• Il ruolo degli standard

• Interlinking

• Industrie monopolisitche (uno standard solo)

• Industrie oligopoliste (standard diversi in competizione)– Interlinking nel caso di reti fisiche o di telecomunicazioni– Interlinking nel casodi sistemi hardware/software

• Conseguenze strategiche


Supply side


Chess: the Italian Rules

Le regole italiane risalgono alla fine del XV secolo/ metà del XVII quando il centro del mondo scacchistico si spostò dall’Italia alla Spagna.

Le regole itliane sono diverse da quelle moderne per il “passar battaglia” e l’arrocco libero.

Le regole itliane rimasero in vigore fino alla fine del XIX secolo si ritiene che fu solo con il Terzo Campionato Nazionale di Scacchi tenutosi a Milano nel 1881 che si imposero definitivamente le regole internazionali.

Per tutto il XVII secolo, L’Itlia non introdusse lo standard europeo e perse la sua centralità nel mondo scacchistico internazionale.


Standard:

• un sistema di misura (Celsius, inches, two-digit year...)

• Una particolare misura (sizes of tapes, disks ...)

• the functions that a particular item must perform and the way in which it must perform them (keyboards, spreadsheets, word pr., credit cards)

• Parametri di input/output (prese)

• We are interested in de facto standard

• In molte industri si può ossservare la coesistenza di diversi standard

• Se coesistono diversi standard diventa importante il problema della compatibilià


Henry Ford: “You can have your model T in any color you want as long as it’s black”

“ you can have your VCR of any standard you choose as long as it is VHS”

“you can have your broad range of software applications on any operating systems as long as you choose Microsoft Windows”


Interlinking

• Interlinking: termine genercio per esprimere che due nodi di un network sono interconnessiit is a general term to express the idea that nodes in a network are connected

• Nelle reti di telecomuniczione l’interlinking èInterlinking means interconnection in communication network

• Nei sistemi hardware/software interlinking significa compatibilità

• L’Interlinking porta sempre vantaggi per I consumatori

• L’Interlinking risolve parzialmente il problema del raggiungimento della a massa critica iniziale


System competitions: compatibility or not?

• Con compatibilità ci sono delle economie di scala

• Con compatibilità ci sono esternalità di rete più grandi

• Senza compatibilità c’è più varietà

• La varietà porta ad aumentare il potere di mercato

• I consumatori pagano per la varietà

• Senza compatibilità ci può essere una situazione “winner takes it all”

• Che fare?


Compatibility and monopoly


Monopoly with communication network

• Standard economic theory suggests MR = MC

• But in network industries it can be useful for the monopolist to sacrifice profits in the short run for at least three reasons:

1. Achievement of critical mass

2. Exploitation of network externalities

3. Exploitation of switching costs


Monopoly in hardware/software systems

• In normal industry a monopolist wants to be a monopolist

• Why a vertical integrated monopolist could invite (subsidize) a competitors to enter the market and sell one of the component?


Compatibility and strategic interaction


Incentives of suppliers to interlink

The case of an incumbent supplier and a new entrant

• Incumbent might be reluctant in developing an interlinking…why?

• Incumbent wants to retain its advantages

• Incumbent should have the power to keep the entrants out of the market (even if the latter has a superior product)



The case of two large firms

• Interlinking decisions depend on the following three issues:

• Demand increase (why?)

• Competition increase

• The nature of competition



Firms can agree to interlink prior to begin competition

• It avoids a costly standard battle

• Competition to win customers more intense

• Agreement depends on:– There is a firm with a clear superior technology?– Start up problem?– When the shake-out is expected?


Strategic interaction: few famous cases

• Excess Momentum

• Excess Inertia

• The Battle of sex

• The Little Pesky brother

• Tweedledum and Tweedledee


Competition and Technical Compatibility

Firm 2

Old Technology

Old Technology

New Technology

(5,5) (2, 2)

(1, 4)

The fight over compatibility can lead to poor technical choices overall

New Technology

Firm 1

(6,7)

Excess Inertia

Two possible problems are Excess Inertia and Excess Momentum

• Fear of being incompatible can lead to the inferior Nash Equilibrium

• Neither firm switches because it thinks the other won’t switch

• Watch out: third competitors can be waiting…

Both staying the old technology

is an Equilibrium

Both switching to the new

technology is a superior Nash Equilibrium



Firm 2

Old Technology

Old Technology

New Technology

(6,7) (2, 2)

(1, 4)

In the case of excess inertia, each firm wants to adopt the same technology as its rival but, fearful that the rival won’t switch to the new technology, each wrongly stays with the old

New Technology

Firm 1

(5,5)

Excess Momentum

It is also possible that there is Excess Momentum and each wrongly switches to the New Technology

Again, fear of being incompatible can lead to the inferior Nash Equilibrium

Watch out: market can be not yet mature for new technology (backward compatibility issue)

Both staying the old technology

is a superior Equilibrium

Both switching to the new

technology is a Nash

Equilibrium



Firm 2

Old Technology

Old Technology

New Technology

(5,4)

(6,5)

New Technology

Firm 1

(10,7)

Battle of the Sexes

Firm 1 choosing technology 1 and Firm 2 choosing

technology 1 is the Nash Equilibrium

preferred by Firm 1

Firm 1 choosing technology 2 and Firm 2 choosing technology 2 is the Nash Equilibrium preferred by firms 2

Assume there are two technologies, Firm 1’s technology 1 and Firm 2’s technology 2

In Battle of the Sexes firms still agree that there should be a common standard but each wants its own technology to be the standard

STRATEGIES:

build an early lead by establishing a large installed base; and convince the suppliers of

complements to adopt your preferred technology

(8,12)



Firm 2

Old Technology

Old Technology

New Technology

(3,3) (6, 7)

(8, 5)

New Technology

Firm 1

(2,2)

Tweedledum and

Tweedledee

Firm 1 choosing technology 1 and Firm 2 choosing technology 2 is the Nash Equilibrium preferred by Firm 2

Firm 1 choosing technology 2 and Firm 2 choosing technology 1 is the Nash Equilibrium preferred by Firm 1

Again, assume there are two technologies, technology 1 and technology 2, but technology 2 is probably betterIn Tweedledum and Tweedledee, the firms want to differentiate their products by choosing different strategies but each wants to be the one with the superior technology 2

STRATEGIES similar to before:build a large installed base of the preferred technology with your name on it; and make sure that you have lined up suppliers of complements so that you are the one who gets to adopt that technology



Firm 2

Old Technology

Old Technology

New Technology

(12,4) (16,2)

(15,2)

New Technology

Firm 1

(10,5)

Pesky Little Brother

If Firm 2 chooses technology NEW then Firm 1 wants to use technology NEW, as well

If Firm 2 chooses technology OLD then Firm 1 wants to adopt technology OLD, too

In Pesky Little Brother, Firm 2 is the dominant firm (big brother) that wants to limit competition from Firm 1 (little brother) by adopting a different technology. Firm 1 always wants compatibility

There is no Nash Equilibrium (in pure strategies)

Firm 2 may frequently change or update its technology to lose its “little brother”

Firm 1 should not be annoying


Systems Competition and Industry Standards

• The Excess Inertia, Excess Momentum and the Battle of Sexes cases apply to market settings where the network gains from compatibility and “connectedness” is large:

– both firms want to adopt a common technology– Difficulty in agreeing which technology both should use

• Sometimes firms do not have a preference to make their technology the common standard, but they generally prefer either compatibility or incompatibility

– Again the trade-off between increase in demand and in competition– Firm size matters!


Interlinking with hardware/software systems


Case 1: reciprocal compatibility

• Reciprocal compatibility increases demand…

• …but it increase competition as well

Which effect is going to prevail?


Case 2: asymmetries in compatibility choice with vertical integrated firms

• There can be the case when one firm wants compatibility, while the other prefers incompatibility;

• If there is a conflict we expect incompatibility to win (why?);

• But is incompatibility is that good the best strategy?


Case 3: Compatibility and variety


Compatibility and variety

• Consider the previous figures

• Firms A1 and A2 are producing two brands of a good

• Firms B1,…,Bn produce a complementary good

• If A1 and A2 do not have compatibility B firms has to develop two versions of the good

• This means higher fixed costs

• Higher fixed costs means less variety of B goods

• What A1 and A2 are going to do?


Strategic variables I

• Cost reduction gained from compatibility

• Type of competition

• Increase in demand

• Increase/ decrease in variety


Strategic variables II

• Losses from reduced monopolistic power

• Your relative technological position

• Your relative size

• Your reputation


Personal Computers

• The rise and decline of IBM PC

• The role of misjudgements"I think there is a world market for maybe 5

computers." [Tom Watson, Founder of IBM]

• Microsoft vs. Apple

• Unbundling of software and hardware

• Pricing strategies


North vs. South in Railroad gauges

• Different widths of rail tracks (gauges)– North standard (smaller) vs. South standard

• Railroad gauges standardization faced 3 obstacles:

– Costly– Each group wanted the others to make the move– There where workers gaining from this incompatibility

• How standardization was achieved (1890)?– Institutional factors


Lessons from this case study

• Incompatibilities arise by accident and can persist for many years

• Network markets tend to tip towards the leading standard

• Seceding from the standard-setting process can leave you in a a weak market position

• A large buyer can have crucial influence

• Those left with less popular technology should develop an adapter or write off assets and join the bandwagon


RCA vs. CBS(Color television)

• In 1941, RCA leader of B/W sets

• CBS was developing a color tv system but…

• FCC adopted CBS as standard

• RCA fighted:– Sell as many B/W sets as possible– Criticize CBC to slow adoption– Strong R&D efforts

• Historical events: Korean war


• 1953 RCA won the war: RCA technology was the standard (back-ward compatible) but…

• …by 1963 only 3% of TV households had colour set: a $130 million investment showed no profit

What was wrong?


Lessons

• Adoption of a new technology can be slow if price/performance ratio is unattractive

• First mover advantage need not to be decisive

• Victory in a standard war often requires building an alliance

• A dominant position in one generation of technology does not necessarily translate into dominance in the next generation

Copyright SDA Bocconi 2005 Competing Technologies, Network Externalities …n 1 Economia...

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