Standards Battles and

Network Externalities

Lecture Note 3

Prof. Se-Joon Hong

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 Lecture Note 3
 Short case: ChotuKool Project
 The World’s smallest refrigerator
 Why dominant designs (standards) are selected?
 Learning effects
 Network externalities
 Fossil fuel vs. fuel cell story
 To introduce you the concept of complementary goods (assets)
 this concept will keep coming back throughout this course
 Multiple dimensions of technological value
 Vaporware
 Monopoly vs. network externality value?
 ChotuKool Project
 Godrej & Boyce
 chotuKool: A small, portable, cheap refrigerator
 Originally designed for rural families of India
 Low income, no reliable access to electricity, had no
means of refrigeration, migratory lives
 A huge market potential & a meaningful difference in
people’s QOL

(www.chotukool.com)

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 ChotuKool Project
 Very difficult project
 Reducing the cost of a conventional compressor-
based refrigerator by enough was very difficult
 Having the refrigerator lightweight was more
important than they thought (people keep moving to
follow the availability of work)
 People had low refrigeration needs (because of the
lack of refrigeration)
 People fear of unstable, unreliable power supply

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 ChotuKool Project
 Needed an innovative approach
 Instead of compressor technology, thermoelectric
cooling (running a current between two
semiconductors)
 Much lower power requirements, very small and
lightweight
 Able to operate for several hours on a 12-volt
battery
 Low price: 35-40 percent cheaper

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 ChotoKool Project
 Further innovative ideas
 Cool design (many decorative skin colors and
sophisticated shape): positive word of mouth among
rural communities
 Welcomed by urban customers too (positive
influence on rural customers): perfect for picnics,
parties, use in cars,…
 Dramatically different distribution system:
collaboration with India Post which had offices in
every rural area of India
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 Aftermath
 Although chotuKool won several design awards,
people didn’t consider it a major success
 Approx. $50 price was still too expensive for most poor
rural families
 However, it turned out to be much more popular than
anticipated among hotels, food stalls, and other small
shops because it enabled these small shops to offer
higher valued products or to keep products fresh longer,
thereby increasing their profits
 Also became a popular lifestyle product among affluent
urban population
 It demonstrated G & B’s innovative capabilities to the
world

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 Some Lessons
 G & B learned that to radically reduce the cost of a
product might require completely rethinking the
technology
 It learned that customers who had adapted their
way of life to the lack of a technology might not
adopt that technology even if it was made far less
expensive
 Never underestimate the value of making a product
work for multiple market segments, including those
who might not be initially obvious as customers

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ChotuKool: the $69 fridge
for rural India

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 Standards Battles and
Design Dominance
 Many industries experience strong pressure to
select a single (or few) dominant design(s)
 Dominant design = Standard
 There are multiple dimensions shaping which
technology rises to the position of the dominant
design
 Firm strategies can influence several of these
dimensions, enhancing the likelihood of their
technologies rising to dominance

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 Why Dominant Designs
are Selected
 Many industries exhibit increasing returns to
adoption
 The more a technology is adopted, the more
valuable it becomes
 Two of the primary sources of increasing
returns are
 Learning effects
 Network externalities

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 Learning Effects
 The more a technology is used, the more it is
developed and the more effective and efficient
it becomes
 A technology that is adopted usually generates
revenue that can be used to further develop and
refine the technology
 As knowledge and experience of the technology
accrue, firms can improve the technology itself, its
applications, and its implementation

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 Learning Curve
 As individuals and firms repeat a process, they learn to
make it more efficient, producing new solutions to
reduce costs or waste rates
 Performance (productivity) increases, costs decrease
 Automobiles, semiconductors, even heart surgery techniques

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 Firm’s Learning Rate
 Why one firm reaps great improvement in a
process while another exhibits almost no
learning?
 The firm’s learning rate is affected by several
factors:
 The nature of the task
 Firm strategy
 The firm’s prior experience
 Prior Learning and
Absorptive Capacity
 A firm’s investment in prior learning can accelerate
its rate of future learning by building the absorptive
capacity
 Absorptive capacity: A firm’s ability to recognize,
assimilate, and utilize new knowledge
 A firm often tries a number of unsuccessful configurations
before finding a solution; this experimentation builds a
base of knowledge that enables the firm to more rapidly
assess the value of new technologies and methods
 The effects of absorptive capacity suggests that firms
that develop new technologies ahead of others may have
an advantage in staying ahead
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 Absorptive Capacity
 In-house R & D helps to build the firm’s
absorptive capacity
 External sourcing vs. Internal sourcing of innovation
 Empirical research suggests that external sources of
information are more likely to be complements to
rather than substitutes for in-house research and
development
 Research indicated that firms that had their own R &
D were also the heaviest users of external
collaboration networks
 Honda
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 Fast and Serious
 What can the McLaren racing team teach us?
 Business transformation
 Maximize its core competency and experience to
explore new biz opportunities
 Open minds + IT advance & trend + continuous
learning by doing + experimenting + learning from
prior experiences
 McLaren Racing
 Has long had a reputation as a data-obsessed
racing operation
 When a McLaren car is on the track, more than 120
sensors transmit a torrent of information on tire
pressure/wear, torque, temperature, and downforce
(vertical pressure) vitally important in cornering
 Has decades of experience figuring out what information
is important and what is merely noise  exact challenge
in the big data era
 Decided to build businesses around its expertise it’s
developed in data analysis and simulation
 McLaren Applied Technologies
(MAT)
 In 2005, McLaren launched a consulting firm
MAT
 Has been involved in various projects
 Healthcare monitoring, oil drilling, airport scheduling,
manufacturing, drug research, new product design,..
 CMO
 Contract manufacturing organization
 A company that serves pharmaceutical
companies on a contract basis to provide drug
manufacturing services
 Major pharmaceutical companies outsource
manufacturing to CMOs to more focus on drug
discovery and drug marketing
 Samsung Biologics and SK Biotech are rapidly
growing into major CMOs, why?

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 Network Externalities
 The benefit from using a good increases with
the number of users (installed base) of the
same good
 Network externalities are common in industries that
are physically networked (e.g. Internet, telephone)
 Network externalities also arise when compatibility
or complementary goods are important
 Many people choose to use Windows in order to maximize
the number of people their files are compatible with, and
the range of software applications they can use
 Complementary Goods
 Additional goods and services that enable or
enhance the value of another good
 For example, the value of a video game console is
directly related to the availability of complementary
goods such as video games, peripheral devices, and
services such as online gaming
 Fossil fuel vs. fuel cell technology
 Hydrogen Economy?
 Fuel cell technology vs. Internal combustion
engines
 Network Externalities
 A technology with a large installed base attracts developers
of complementary goods; a technology with a wide range of
complementary goods attracts users, increasing the installed
base. A self-reinforcing cycle ensues
 Government Regulation
 Occasionally, a dominant design is put in place
through government regulation
 In some industries, the consumer welfare benefits of
having a single dominant design prompts
government regulation, imposing a standard
 NTSC color standard in TV broadcasting, GSM
technology for European wireless telephone
standard, WCDMA for 3rd generation mobile service
 The Result: Winner-Take-All
 Natural monopolies
 Firms supporting winning technologies earn huge
rewards and may dominate the product category
through several product generations; others may be
locked out of the market
 Standards battles are high-stakes games resulting in
big winners and big losers
 A dominant design can direct future technological
inquiry in the area, thus influencing the nature of
the technological discontinuity that will eventually
replace it
 The Result: Winner-Take-All
 Technologically superior products do not always
win
 The firms that win are usually the ones that
know how to manage the multiple dimensions
of value that shape design selection
VHS vs. Beta
 Multiple Dimensions of Value
 The value of a technology to customers is
multidimensional
 In many industries, the value of a technology is
strongly influenced by the combination of:
 Technology’s stand-alone value
 Network externality value
A Technology’s Stand-Alone Value
 Includes factors such as
 Productivity, convenience
 Ease of use
 Aesthetic qualities, image, fun
 Cost
 Such dimensions of value across multiple
stages of the buyer experience cycle
 Purchase, delivery, use, supplements, maintenance
and disposal
 Network Externality Value
 Includes the value created by
 The size of the technology’s installed base
 The availability of complementary goods
 A new technology that has significantly more
stand-alone value than the incumbent technology
may offer less overall value because it has a
smaller installed base or poor availability of
complementary goods
 NeXT Computers were extremely advanced
technologically, but could not compete with the network
externality value of Windows-based PCs
 Multiple Dimensions of Value
 Customers weigh a combination of
 Objective info (e.g. actual technological benefits,
actual info on installed base or complementary
goods)
 Subjective info (perceived benefits/installed
base/complementary goods)
 Future expectations (anticipated benefits/installed
benefits/complementary goods)
 A customer’s perceptions and expectations of a
technology can be as important as (or more
important than) the actual value of the technology
 Multiple Dimensions of Value
Value attributed to each dimension may be disproportional
 Multiple Dimensions of Value
 Perceived installed base may greatly exceed actual
installed base, or customers may expect that a
technology will eventually have a much larger
installed base than competitors
 Firms can take advantage of the fact that users rely on
both objective and subjective info in assessing the value
of a new technology
 Firms can manage users’ expectations of the
technological benefits, future installed base and
availability of complements
 Samsung vs. LG in electric dryers market 2019
 Vaporware
 Products that are not actually on the market
and may not even exist but are advertised
 Firms use vaporware to manage customers’
expectations
 Vaporware may buy a firm valuable time in bringing
its product to market
 Examples: Sony PlayStation vs. Nintendo 64; Intel
vs. AMD; 2.5G mobile service vs. 3G service
 Competing for Design Dominance
 We can graph the value a technology offers in both
standalone value and network externality value:
 Once Again
 Technologically superior products do not always win
 Knowing how to manage the multiple dimensions of
value is very important
 Often, relatively small historical events may have a
great impact on the final outcome
 Other factors, unrelated to the technical superiority may also
play important roles
 Timing, luck, how and by whom the technology is sponsored
 Path dependency: When end results depend greatly on the
events that took place leading up to the outcome; it is usually
impossible to reproduce the results
 Are Winner-Take-All Markets
Good for Consumers?
 Traditionally, economics emphasizes the benefits of
competition (antitrust law), but increasing returns
of adoption make this a complicated issue
 Let’s think about Microsoft
 Some say MS clearly showed anticompetitive behavior
 But others say MS behaved appropriately, creating great
compatibility among computers and more applications
(i.e., network externalities suggest users sometimes get
more value when one technology dominates)
 Now Google, Facebook?
 Are Winner-Take-All Markets
Good for Consumers?
 Should the government intervene when
network externalities create a natural
monopoly?
 One way is to compare the network externality
benefits with corresponding monopoly costs
 Network externality benefits to customers rise with
cumulative market share
 Potential for monopoly costs to customers (e.g.,
higher price, less product variety, restricted
alternative innovations, etc.) also rises with
cumulative market share
 Are Winner-Take-All Markets
Good for Consumers?
 Curve shapes are different;
Network externality benefits
often exhibit the s-shape,
while potential monopoly
costs likely to grow
exponentially
 Where monopoly costs
exceed network externality
benefits, intervention may be
warranted. Optimal market
share is at point where lines
cross
 Are Winner-Take-All Markets
Good for Consumers?
 The steepness of the monopoly cost curve is largely
a function of the firm’s discretionary behavior; a firm
can choose not to exploit its monopoly power, thus
flattening the monopoly costs curve
 For example, people may argue that MS does not charge
the maximum price for its OS that customers would be
willing to pay
 However, people may also argue that MS has taken
advantage of its near-monopoly power by controlling the
evolution of the industry through selectively aiding some
complementors and suppliers