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ISOM1380 2020W Pt3 Students
ISOM1380 2020W Pt3 Students
Network Externalities
Lecture Note 3
1
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)
3
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
4
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
5
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
6
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
7
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
8
ChotuKool: the $69 fridge
for rural India
9
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
10
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
12
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
13
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
15
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
16
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?
20
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