Open standards adoption as a competitive game

An application of game theory for determining strategies for interoperability in systems management products

Balan Subramanian EMBA 2009 Product Manager Data Integration, IBM

Final paper submission for MBA 781A: Corporate rivalry and competitive games

Background
In this paper, I apply game theory concepts to determine strategies for open standards adoption for different systems management products in the marketplace. Systems management products are software products that keep track of , monitor and manage IT assets (such as computers, network routers, software licenses, running software instances etc.). Some products are low level and deal with monitoring various metrics on these IT assets. Other products are high level and handle the processes around these IT assets. The latter set of products fall into the category of IT Asset Lifecycle Management, a market segment estimated to grow to more than $1 billion in revenue in 2009 with a 24% growth rate1. The market today is composed of the Big Four IBM, HP, BMC and CA with a number of other smaller players including Novell, Symantec and others. This paper does not deal with price collusion. This is largely because of two reasons, a) While retail prices are available, most deals are made at a huge discount with favored customer considerations b) Price is largely not an issue in the systems management software area; products are bought for features, reliability, fit within a portfolio and more and more for their interoperability Interoperability has become a key selling point for companies providing systems management software both big and small because most customers are wary of being locked in with one software provider for all their needs and would rather choose to pick different products for different needs in their IT infrastructure management solution. For example, they may choose to pick a piece of software from IBM for their overall asset management, a product from HP for monitoring the systems performance, a product from BMC for monitoring their storage systems and one from CA to monitor their network hardware. Automation has always been a key selling point and continues to be so. Simply put, it means that customers do not want to enter details about each piece of hardware (most customers in this market have more than 1000 computers alone) but require automated discovery capability. Consequently most providers provide discovery products standalone or as part of their solutions.
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The Forrester Wave: IT Asset Life- Cycle Management, Q2 2009 by Evelyn Hubbert
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To encourage interoperability, a number of standards have evolved over time. A key standard is the CMDBf (Configuration Management DataBase Federation) standard that was built through a joint effort by the big four but for which actual implementation in products in spotty. The paper investigates why actual implementation is lacking and how competitors in this space can be forced to collude to implement CMDBf in their products.

The Problem
Imagine the case where the customer has an asset management solution for vendor A and a network management solution from Vendor B. The customer expects that the data provided by Vendor B to be automatically available in Vendor As asset management solution. Without this interoperability, Vendor As solution would have to discover these network assets using its own discovery solution which has many implications, 1) Parallel discoveries by both products that burden the customers IT infrastructure which is supposed to be doing something useful for the customer (other than be managed) 2) Customer having to pay for Vendor As discovery solution or get it for free from Vendor A which means Vendor A now has a problem in whether they charge this customer for their discovery solution or give it away for free 3) Vendor B has a natural inclination to get the customer to use their own asset management solution. Do they protect the data they find and make it available to only their solutions? The biggest problem though is the cost of adoption. Each vendor has to spend development resources to make themselves interoperable which in turn could help sales of some of their products but may indeed reduce their revenues from across the portfolio (because they sold a lot of the low level product which is lower priced than their higher level product which is overpriced).

Assumptions and Considerations

The key assumptions I made are, 1) There are only 2 companies in the market JCN and CND

2) Each company sells only 2 products a network management/discovery product and an asset management product 3) Functionally these products are on par with their competition The systems management market is quite dynamic and complicated even more so than the general enterprise software market. To simplify this exercise, I chose to focus on the following cost and revenue considerations, 1) Cost of standards adoption .i.e. implementing the standard in one or more products 2) Cost of being interoperable from a cross portfolio perspective 3) Additional revenue from being interoperable for a particular product 4) Bundle pricing for the asset management product and the discovery product Since it is difficult to obtain actual costs and revenues, I used relative numbers in their place; the relative numbers are indicative of real world prices at which the products are sold after traditional discounts.

Why is this a game?

It is also a given that for any interoperability to work both sides must be enabled, and hence invested, in interoperability. However vendors may choose to make some of their products openly interoperable through open standards and others only interoperable with their own products through proprietary interfaces within their portfolio. This means that the success of one firms decision to be interoperable or not depends on whether the other firms decide to be interoperable or not. And it gets more complicated when there are multiple products.

Game components and potential payoffs

For this particular exercise, the various components of the game are: Players: JCN and CND Strategies Available: For each product in portfolio, invest and enable federation/interoperability through open standards or do not The two portfolios are represented as JCNasset, JCNnet/disc, and CNDasset, CNDnet/disc.
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The asset products are typically consumers of the data provided by the network management/discovery products. They can consume data from each other but typically customers would not purchase two products that do the same thing2. The payoffs are represented by the matrix below. Relative numbers are used since actual numbers are unknown at this point. The first number is the payoff for JCN and the second the payoff for CND. There is a third dimension here as to whether the customer already has one of these products from JCN or CND. To keep the exercise simple, I exclude this dimension for now. The rows and columns represent which products are enabled for interoperability. For example, JCNasset, JCNnet/disc means that both the asset management and monitoring/discovery products are enabled for open interoperability. CNDasset JCNasset JCN: 700 CND: 700 JCNnet/disc JCN: 440 CND: 1040 JCNasset, JCNnet/disc JCN: 1030 CND: 440 Neither JCN: -150 CND: 1640 CNDnet/disc JCN: 1040 CND: 440 JCN: 740 CND: 740 JCN: 1330 CND: 140 JCN: -150 CND: 1640 CNDasset, CNDnet/disc JCN: 690 CND: 780 JCN: 140 CND: 1330 JCN: 730 CND: 730 JCN: -150 CND: 1630 JCN: 1640 CND: -150 JCN: 1640 CND: -150 JCN: 1630 CND: -150 JCN: 750 CND: 750 Neither

The above table assumes that the cost of adoption for a consuming product is the same as the cost of adoption of a providing product. The values in the cells represent the additional cross-portfolio profit or loss that can be expected from both switching customers and new customers. The individual predicted profits and losses

The current motivation for CMDBf is for asset management products from different vendors to share data. However in the future, we should expect other products to share data directly with asset management products because customers will want to remove any unnecessary middle-men which do not provide any value other than storage and open standards enablement. While this is a reasonable assumption, it has not been validated and is used solely for the purposes of this exercise.

are added together first for JCN, followed by CND. A full explanation of how these values are calculated is in Appendix A There are also two more fundamental assumptions in regards to customer behavior, 1) Given a choice, customers will choose products that are enabled for interoperability 2) Customers are willing to replace an existing product if the replacement is interoperable and the incumbent is not.

Simultaneous move game

Since customers and analysts are very focused on interoperability and adoption of open standards, I assume first that vendors are taking independent actions without waiting for the other vendor to act first. Since the adoption costs are significant, they can either choose to enable either of their products or all of their products. The question to address is, Should they enable the product that has the potential to bring them most revenues individually (the asset management product in this case) first for interoperability knowing that the competitor is looking at the same option3?

Dominant strategies
Scenario 1: Vendors must provide support due to customer pressure Let us assume first that due to customer pressure vendors must implement the standard or risk being perceived as obsolete. This means that the Neither row and column must not be considered. CNDasset JCNasset JCNnet/disc JCNasset, JCNnet/disc 700, 700 440, 1040 1030, 440 CNDnet/disc 1040, 440 740, 740 1330, 140 CNDasset, CNDnet/disc 690, 780 140, 1330 730, 730

Note that the revenues from products are the same for either vendor. This is a price sensitive market especially in the current economic climate. Price differences are negligible and vendors dont compete on price.

If CND plays, CNDasset, JCN should play JCNasset, JCNnet/disc: Payoff for JCN is 1030 (> 700, 440) CNDnet/disc, JCN should play JCNasset, JCNnet/disc: Payoff for JCN is 1330 (> 1040, 740) CNDasset, CNDnet/disc, JCN should play JCNasset, JCNnet/disc: Payoff for JCN is 730 (> 690, 140) So playing JCNasset, JCNnet/disc is the dominant strategy for JCN If JCN plays, JCNasset, CND should play CNDasset, CNDnet/disc : Payoff for CND is 780 (> 700, 440) JCNnet/disc, CND should play CNDasset, CNDnet/disc: Payoff for CND is 1330 (> 1040, 740) JCNasset, JCNnet/disc, CND should play CNDasset, CNDnet/disc: Payoff for CND is 730 (> 440, 140) So playing CNDasset, CNDnet/disc is the dominant strategy for CND Hence for this game we have dominant strategy equilibrium. This problem is very similar to the classic prisoners dilemma problem. This means that all products will be interoperable which is good for customers however it reduces the potential payoff to both JCN and CND to the minimum. However note also that both products may choose to just enable their asset management products for interoperability and keep their network management / discovery products proprietary. In this case, their payoffs are still equal but reduced that if they made all their products interoperable. Note though, that the payoffs are even higher when both vendors make their least profitable product interoperable. Hence, an important conclusion from an interoperability perspective is for vendors to enable all their products for interoperability. If the two products used different standards or required different effort to enable interoperability, then it is desirable to enable the least profitable, most mature product first.

Nash Equilibrium
Scenario 2: Vendors may choose not to implement the interoperability standard Not doing anything to change the status quo is an option as well. In fact, it is an option that is explicitly exercised by each vendor. This is important because one vendor may explicitly choose to not do anything and the other vendor may choose to become partly or fully interoperable. CNDasset CNDnet/disc CNDasset, CNDnet/disc JCNasset JCNnet/disc JCNasset, JCNnet/disc Neither 700, 700 440, 1040 1030, 440 -150, 1640 1040, 440 740, 740 1330, 140 -150, 1640 690, 780 140, 1330 730, 730 -150, 1630 1640, -150 1640, -150 1630, -150 750, 750 Neither

First we look for any dominant strategies. JCN will get maximum payoff playing JCNasset or JCNnet/disc when CND plays neither. In all other cases, JCN will get maximum payoff playing JCNasset, JCNnet/disc. CND will get maximum payoff playing CNDasset or CNDnet/disc when JCN plays neither. In all other cases, CND will get maximum payoff playing CNDasset, CNDnet/disc. In this case, there are no dominant strategies. Next, we look for Nash Equilibrium. I evaluated cell as follows: If CND wants to do cell X would JCN want to do X as well and if JCN wanted to do X would CND want to do X as well. For example, evaluating cell B3 (1330, 140), if CND chooses CNDnet/disc, JCN will choose B3. However if JCN chooses B3, CND will choose to do both CNDasset, CNDnet/disc. So this is not Nash equilibrium.

For another example, evaluating cell D4 (750, 750): if JCN choose Neither, then CND will choose CNDasset or CNDnet/disc and if CND chooses Neither, JCN will choose JCNasset or JCNnet/disc. This is not Nash equilibrium as well. The only Nash equilibrium is cell C3 (730, 730). If JCN chooses JCNasset, JCNnet/disc, CND will choose CNDasset, CNDnet/disc (730 > 440, 140, -150). If CND chooses CNDasset, CNDnet/disc, JCN will choose JCNasset, JCNnet/disc (730 > 690, 140, -150). So the game has one Nash equilibrium which is both JCN and CND choosing to enable both of their products for interoperability. So in general both vendors must choose to enable their products for interoperability and must explicitly do so at the earliest opportunity.

Sequential move game

It is entirely possible though for a vendor to wait till another vendor implements the interoperability standard. In fact, the situation with many open standards in software is one of wait and watch, never implement first. While companies are quick to collaborate on a standard, if it is a new standard which did not grow out existing, pervasive implementations, then they drag their feet on actually implementing because no short term gain can be immediately realized. Modeling this as a sequential move game will provide the supporting statements to either invest now or wait and help us understand if there is a first mover advantage. There are many questions that can be answered by a game tree, 1) Is there a first mover advantage? 2) What should the first move be? Why? 3) If I can restrict future moves of a competitor what should my move be now? 4) Is there a benefit or cost to choosing not to enable interoperability as an explicit choice? Typically, smaller vendors may choose to wait till a bigger vendor implements the standard so as to avoid the chicken-and-egg problem. This can also happen if a vendor is unable to make an investment now or if it is unsure on what potential benefit it can realize from that investment given that any investment action will probably be followed by an action by a competing vendor.
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Game tree

Look forward, reason back

Evaluating the game tree requires us to in essence to look at what one vendors competitor will do tomorrow in response to their actions today. So we first look at the bottom of the tree to find out the best actions that the competitor would choose. In this case, the numbers highlighted in orange represent the best choices CND could make assuming JCN moves first, to counter each of JCNs options. Given that JCN knows that these are the choices CND could make, JCN now has to pick the best first move that will make CND react in a way that maximizes its own profit. The best alternative again turns out to be that, JCN implements interoperability for all its products CND follows suit by implementing interoperability for all its products

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Other derivations from the game tree

The game tree provides more insights on potential for greater profits. It shows us that, 1. If JCN goes to the market with just interoperability support in one of its products, a. CND will not stay at the status quo (if they did they would have losses) b. CND will probably implement interoperability in both of its products biting heavily into JCNs profits 2. If JCN chose to wait, and effectively communicated this, CND can then implement interoperability in all of its products and cause JCN losses. 3. If JCN and CND can collude in some way, perhaps by stalling the standards approval, or by sending explicit signals on not immediately implementing the standard they can continue to make more profits splitting up the upcoming demand. 4. One vendor must act now. If they wait, it is possible that the other vendor will implement interoperability support across the portfolio and force the vendor who had the original choice, to react immediately. 5. If JCN is able to time its implementation of interoperability at a time when CND cannot react maybe due to engagements on other fronts, at its weakest time, a. JCN can gain huge profits by implementing interoperability in just one of its products b. It probably doesnt make sense to implement interoperability across the portfolio because it provides minimal incremental profits. 6. When the first mover chooses to implement anything and can force the competitor to implement nothing or fewer products that interoperate, the profits are huge. This is because of the fact/assumption that, Customers are drawn to using product type B from the vendor who has implemented interoperability standards in product A because, a. Competitors offering in type B is useless to this customer who has already product A (due to its interoperability support) because if he buys type B offering from competitor, it cannot work with their product A purchase because this offering would have no interoperability support

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b. A perception that a vendor is starting to support open standards in one of its products will sway purchase decisions even if the choice of product currently does not support open standards

Future work:
1. Investigate how JCN could bundle their asset management solution (Tivoli Asset Management for IT and Tivoli Common Change and Configuration Management Database) with their discovery solution (Tivoli Automated Discovery and Dependency Manager) and price it in a way that encourages the purchase of both of the solutions from JCN in spite of their individual abilities to interoperate with products from other vendors. 2. Investigate how bundling changes customer buying habits and hence changes the outcome of the game. I suspect that there will be more first mover advantage due to the natural pull caused by bundling and hence greater benefits from fewer costs of interoperability enablement. 3. Extend the game tree to multiple levels that allow staged implementation of interoperability and investigate the risks/benefits of a staged approach.

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Appendix A: Calculating potential payoffs

A: CNDasset 1: JCNasset JCN: (-50 + 500) + (250) CND: (-50 + 500) + (250) 2: JCNnet/disc JCN: (-100) + (50 10 + 500) CND: (-10 + 100 + 1000) + ( - 50) 3: JCNasset, JCNnet/disc JCN: (-10 + 500) + ( 10 + 50 + 500) CND: (-10 + 500) + (- 50) 4: Neither JCN: -100-50 CND: (-10 + 1000 + 100) + (500 + 50) B: CNDnet/disc JCN: (-10 + 100 + 1000) + ( 50) CND: (-100) + (50 10 + 500) JCN: (0 + 500) + (250 10) CND: (0 + 500)+ (- 10 + 250) JCN: (-10 + 100 + 1000) + (-10 + 350) CND: (-100 ) + (-10 + 250) JCN: -100-50 CND: (1000 + 100) + (-10 + 500 + 50) C: CNDasset, CNDnet/disc JCN: (-10 + 500) + ( - 50 + 250) CND: (-10 + 500) +(50 10 + 250) JCN: (-100) + ( 10 + 250) CND: (-10 + 100 + 1000) + ( - 10 + 250) JCN: (-10 + 500) + (-10 + 250) CND: (-10 + 500) + (-10 + 250) JCN: -100-50 CND: (-10 + 1000 + 100) + (-10 + 500 + 50) JCN: (-10 + 1000 + 100) + (-10 + 500 + 50) CND: -100 -50 JCN: (500) + (250) CND: (500) + (250) JCN: (1000 + 100) + (-10 + 500 + 50) CND: -100 -50 D: Neither JCN: (-10 + 1000 + 100) + (500 + 50) CND: -100 -50

Asset management products are new whereas network monitoring/discovery products are mature. This means that the customers switching costs are higher to switch vendors for the latter than for the former. This is represented as a 100% probability of switching for asset management products and a 50% probability of switching for network monitoring/discovery products. Assume also that the market of new customers for both asset management and network management products is X. If a product is interoperable, X will go to that product (.i.e. all new customers will pick that up). If not, they will pick from whatever they have already. Assume for network management, X is 500 and for asset management it is 1000. A1: Both vendors make no additional profit from each other but rather a loss of -50 which is the cost of adoption for the asset management product. New customers of either product will split down the middle. B1: Now JCN has its asset management product enabled for interoperability and CND has its network management product enabled for interoperability. This means multiple things:
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CND customers who are using (or would have chosen) CNDasset will switch to JCNasset because it is interoperable and it allows them to use their current CNDnet/disc product with the JCNasset product. This is also because CNDasset product is not interoperability enabled which is rule 1 for product selection. This leads to a switching profit of 100 for JCN and a loss of 100 for CND.

JCN customers who are using JCNnet/disc will switch to CNDnet/disc since their JCNasset solution will continue to work with the CNDnet/disc product. This represents a loss of 50 for JCN and a profit of 50 for CND.

New customers of asset management will buy JCN asset management and new customers of network management will buy CND asset management.

C1: Now both of CNDs products are now enabled and JCNasset is also enabled Customers of JCNasset will stay put Customers of JCNnet/disc will switch to CND. Represents a loss of 50 to JCN and gain of 50 to CND New customers of asset management will split down the middle New customers of network management will go to CND

D1: If CND does not implement interoperability for any of its products and JCN does for its asset management product then, All new product sales for asset management will go to JCN All new product sales for network management will also go to JCN because customers would want something that interoperates with JCNs asset management solution. If they bought CNDs network management product then they wouldnt be able to use it with JCNs asset management product since the CND product has no interoperability. Existing CND customers will move to JCN products because of a preference for interoperable products. A2: JCN will lose asset management customers to interoperable CND product but will replace CND network management product with their own because of interoperability. New customers will pick JCN for network management and CND for asset management
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B2: Since both vendors have interoperable products, no change is expected. However, New product choice will be down the middle for both products

C2: JCN asset management customers will switch to CND. New customers will choose CND for asset management and split down the middle for network management. D2: Same as D1 A3: Asset management selection wont change. New customers will split down the middle on asset management. On network management, CND customers will switch to JCN. B3: CND asset management customers will switch to JCN. No change in network management current customer behavior. New customers will pick JCN for asset management and split down the middle for network management. C3: No customer movements since all products are interoperable. New customers will split down the middle for all products. D3: Same as D2 except slightly more cost to enable interoperation for two products A4, B4, C4: Similar to D1, D2 and D3 except that CND and JCN are reversed D4: If both vendors do neither then they split all new sales down the middle with no extra cost to implement interoperability.

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