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Networks and Positive Feedback
John Morgan
Important Ideas
Positive feedback Network effects Returns to scale
Demand side Supply side
Positive Feedback
How system adjusts to perturbations Negative feedback: stabilizing Positive feedback: destabilizing
Positive feedback makes a market “tippy” – winner take all Examples: VHS v. Beta, Wintel v. Apple,
56k modems, DVD v DivX “Winner-take-all markets”
Sources of Positive Feedback
Supply side economies of scale Declining unit cost of supply Marginal cost less than average cost Example: information goods are all fixed cost
Demand side economies of scale Increasing value to users as market share increases A single standard: fax, email, Web Competing standards: VHS v. Beta, Wintel v. Apple,
56k modems, Codec “standards” in Digital Audio
Color fax machine You have a new technology for color
fax machines License it to many sellers Technology can only be used by
sender if receiver has color fax machine
So there is a strong network effect---value to user of technology depends on number of adopters
Setup Indicate your adoption of the technology by
standing up The number on your card shows that value v
(to you) of adopting if you are the only adopter In n people (including you) adopt, your value is
nv I will write the price of the fax machine on the
board Adopt when your value (strictly) exceeds the
price.
Analysis
Standalone values were 10,9,8,…,1
Analysis vn = p : marginal user wants to adopt n=10-v :everyone with greater value
than marginal user adopts Combine to give demand=supply
condition (10-n)n=p n=1, (10-1)1=9 n=2, (10-2)2=16 n=3, (10-3)3=21… n=9, (10-9)9=9
Takeoff occurs when p=9
Adoption Dynamics
Number of Users
Time
Launch
Takeoff
Saturation
Network Effects
Demand side economies of scale often referred to as network effects Real networks – telecom Virtual networks – network of users
Metcalfe’s Law: Value of network of size n proportional to n2
Experiment is an example of this
Expectations Matter What is the difference between success
and failure in tippy markets? Expectations Matter:
I want to join network that I expect to succeed
Central part of successful marketing is setting appropriate expectations Commitment can help Old economy example: Banks New economy example: Microsoft version
1.0 products
Virtuous Cycles and Death Spirals: 1-2-3 v Visicalc
“Death spiral”
Virtuous cycle
Value to User
Number of Users
Direct and indirect Network Effects
Value to me depends directly on number of adopters Fax machine, telephone, email
Value to me depends on adoption of some complementary product DVD player/ DVD disks eBook reader + content Palms and software
Are All Information Markets “Tippy”?
AOL Dell Google What are the key drivers of
network effects?
Network Effects–Likelihood of Tipping
Low ScaleEconomies
High ScaleEconomies
Low DemandFor Variety
Unlikely High
High DemandFor Variety
Low Depends
Chicken & Eggs
Fax and fax machines VCRs and tapes DVDs: A more complicated
problem Online dating
Igniting Positive Feedback
Evolution Give up some performance to ensure
compatibility, thus easing consumer adoption
Revolution Wipe the slate clean and come up
with the best product possible
Compatibility versus Performance
Performance
Compatibility
Evolution
Revolution
Evolution
Offer a migration path Examples
Microsoft Windows Intel Borland v Lotus
Build new network by links to old one
Important Considerations
Use creative design for migration Think in terms of whole system
Compatibility versus Performance
Performance
Compatibility
Evolution
Revolution
Migration “sweet spot”
Technical Obstacles
Converters and bridge technologies One-way compatibility or two way? Windows for Wordperfect users Importance of UI
Legal Obstacles
May need IP licensing Example: Sony and Philips had
advantage since they held the patents on CDs DVD players usually play CDs as well
Revolution
Grove’s law: “10X rule” But depends on switching costs Examples: Nintendo, Iomega Zip,
DVD, CD
Openness v. Control
Your reward = Total added to industry x your share
Value added to industry Depends on product and Size of network
Your share Depends on how open technology is
Openness Full openness
Anybody can make the product Problem: no champion Unix v BSD v Linux
Alliance Only members of alliance can use Problem: holding alliance together Conflicting incentives: China and DVDs
Control
Control the standard and go it alone
If several try this strategy, may lead to standards wars
iPod/iTunes v MP3 players
Generic Strategies
Control Open
Compatible ControlledMigration
OpenMigration
Incompatible PerformancePlay
Discontinuity
Lessons Positive feedback means strong
get stronger and weak get weaker Consumers value size of network Works for large networks, against
small ones Consumer expectations are critical Fundamental tradeoff:
performance and compatibility
Lessons, continued
Fundamental tradeoff: openness and control
Generic strategies Performance play Controlled Migration Open Migration Discontinuity
Lessons of history