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![Page 1: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/1.jpg)
Information Rules:
A Strategic Guide to the Network Economy
Lock-In effect &
Networks externality
Seungkyoon Shin
![Page 2: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/2.jpg)
Information Rules Spring 20002
Recognizing Lock-In
• Cost of switching
• Compare– Ford v. GM– Mac v. PC
![Page 3: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/3.jpg)
Information Rules Spring 20003
What’s the Difference?
• Durable investments in complementary assets– Hardware– Software– Netware
• Switching cost and lock-in are ubiquitous in information systems
• Supplier wants to lock-in customer• Customer wants to avoid lock-in• Basic principle: Look ahead and reason back
![Page 4: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/4.jpg)
Information Rules Spring 20004
Examples of lock-in
• Bell Atlantic and AT&T– 5ESS digital switch used proprietary operating
system– Large switching costs to change switches
• Computer Associates– Vender Level Locking– System Level Locking
![Page 5: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/5.jpg)
Information Rules Spring 20005
Small Switching Costs Matter• Look at lock-in costs on a per customer basis• Phone number portability• Email addresses (Mail Forwarding issue)• Hotmail (advertising, portability)
– $400 mil for 9.5 mil subscribers
• ACM, CalTech– Provide forwarding service to approach possible donors
![Page 6: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/6.jpg)
Information Rules Spring 20006
Valuing an Installed Base
• Customer C switches from A to "same position" w/ B– Total switching costs = customer costs + B's costs
• Example– Switching ISPs costs customer $50 new ISP $25
– New ISP make $100 on customer, switch
– New ISP makes $70 on customer, no switch
• In a competitive market, Profit=switching costs
![Page 7: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/7.jpg)
Information Rules Spring 20007
Profits & Switching CostsIn General:
• Profits from a customer =
total switching costs + quality/cost advantages• In commodity market like telephony, profit per
customer = total switching costs per customer• Use of this rule of thumb
– How much to invest to get locked-in base– Evaluate a target acquisition (e.g., Hotmail)– Product and design decisions that affect switching
costs
![Page 8: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/8.jpg)
Information Rules Spring 20008
Classification of Lock-In
• Durable purchases and replacement: declines with time
• Brand-specific training: rises with time• Information and data: rises with time• Specialized suppliers: may rise• Search costs: learn about alternatives• Loyalty programs: rebuild cumulative usage• Contractual commitments: damages
![Page 9: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/9.jpg)
Information Rules Spring 20009
Durable Purchases
• Telephone switches, Mainframe, OS • After-market sales (supplies, maintenance)• Depends on (true) depreciation• Usually fall with time due to depreciation• Watch out for multiple pieces of hardware
– Supplier will want to stagger vintages
– Contract renewal
• Technology lock-in vs. vendor lock-in
![Page 10: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/10.jpg)
Information Rules Spring 200010
Brand-specific Training
• When personnel are trained
• General training/brand specific training
• How much is transferable?
• Software, an obvious example
• Competitors want to lower switching costs– Borland’s Quattro Pro help for Lotus 123 users– MS Word and WordPerfect help
![Page 11: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/11.jpg)
Information Rules Spring 200011
Information & Databases
• Data files– Insist on standard formats– S/W and database– Whether information can be easily ported over
to another system
• Zip - CD - DVD Transition
![Page 12: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/12.jpg)
Information Rules Spring 200012
Specialized Suppliers
• If durable equipment or S/W is highly specialized, it will be hard to find alternatives
• Pentagon: Joint strike fighter project– Structuring competition among suppliers– Boeing, Lockheed Martin, McDonald
• IBM– Dual sourcing– Intel and AMD
![Page 13: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/13.jpg)
Information Rules Spring 200013
Search Costs• Consumers’ Search Cost
– Psychological costs of change– Time and efforts– Risk to customers
• Suppliers’ Search Cost– Promotional cost– Cost of actually closing the deal– Cost of setting up a new account
– Risk to suppliers• Example of Risk: Credit Cards
– $100 million in receivables is worth about $120 million– Market valuation of “loyalty”
![Page 14: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/14.jpg)
Information Rules Spring 200014
Loyalty Programs• Constructed by firm (artificial lock-in)
– Frequent flyer programs– Getting more popular in E-Commerce– Keep track of history sales: consumer information
• Personalized Pricing– Gold status
• Example: Amazon and Barnes and Noble– Amazon Associates Program v. B&N's Affiliates
program
• Add nonlinearity?
![Page 15: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/15.jpg)
Information Rules Spring 200015
Suppliers and partners
• Bilateral, or two-sided lock-in
• Railroad spur lines
• Customized software– Game for the Nintendo 64 platform– S/W for Apple computer
![Page 16: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/16.jpg)
Information Rules Spring 200016
Follow the Lock-in cycle
Brand Selection
SamplingLock-In
Entrenchment
![Page 17: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/17.jpg)
Information Rules:
A Strategic Guide to the Network Economy
Networks and Positive Feedback
![Page 18: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/18.jpg)
Information Rules Spring 200018
Old and New
• Industrial Economy– Populated with oligopolies– Economies of Scale
• Information Economy– Temporary monopolies– Economies of Networks
![Page 19: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/19.jpg)
Information Rules Spring 200019
Important Ideas
• Positive feedback
• Network effects
• Returns to scale– Demand side– Supply side
![Page 20: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/20.jpg)
Information Rules Spring 200020
Positive Feedback
• Strong get stronger, weak get weaker
• Negative feedback: stabilizing
• Makes a market “tippy”
• Examples: VHS v. Beta, Wintel v. Apple
• “Winner take all markets”
![Page 21: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/21.jpg)
Information Rules Spring 200021
Sources of Positive Feedback
• Supply side economies of scale– Declining average cost
– Marginal cost less than average cost
– Example: information goods, Automobile industry
• Demand side economies of scale– Network effects
– In general: fax, email, Web
– In particular: Sony v. Beta, Wintel v. Apple
![Page 22: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/22.jpg)
Information Rules Spring 200022
Network Effects
• Real networks: – Fax machines, compatible modems, email
• Virtual networks– Mac users, CD-ROM driver, Nintendo 64– Computer (both S/W and H/W) buyers are picking a
network, not simply a product. E.g. user group
• Number of users– Metcalfe’s Law: Value of network of size n
proportional to n2
• Importance of expectations
![Page 23: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/23.jpg)
Information Rules Spring 200023
Lock-In and Switching Costs
• Network effects lead to substantial collective switching costs
• Even worse than individual lock-in
• Due to coordination costs
• Example: QWERTY
![Page 24: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/24.jpg)
Information Rules Spring 200024
Don’t Get Carried Away
• Network externalities don’t always apply– ISPs (but watch out for QoS)– PC production
• Likelihood of tipping– See next slide
![Page 25: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/25.jpg)
Information Rules Spring 200025
Likelihood of Tipping
Low ScaleEconomies
High ScaleEconomies
Low DemandFor Variety
Unlikely High
High DemandFor Variety
Low Depends
![Page 26: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/26.jpg)
Information Rules Spring 200026
Chicken & Eggs
• Fax and fax machines
• VCRs and tapes
• Internet browsers and Java
![Page 27: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/27.jpg)
Information Rules Spring 200027
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
![Page 28: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/28.jpg)
Information Rules Spring 200028
Evolution
• Offer a migration path– Failure of CBS
• Examples– Microsoft– Borland v Lotus
• Build new network by links to old one
• Problems: technical and legal
![Page 29: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/29.jpg)
Information Rules Spring 200029
Technical Obstacles
• Compatibility/Performance Trade-off
• Use Creative design
• Think in terms of system (NBC/CBS)
• Converters and bridge technologies– One-way compatibility– Office 97/95– Boland Q-pro/Lotus 1-2-3
![Page 30: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/30.jpg)
Information Rules Spring 200030
Legal Obstacles
• Need IP licensing
• Example: – Sony and Philips CDs– Amazon.com’ banner ad
![Page 31: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/31.jpg)
Information Rules Spring 200031
Revolution
• Users will bear the switching cost when production is so much better than what people are currently using
• Groves’ law: “10X rule”
• But depends on switching costs
• Example: Nintendo vs. Sega
![Page 32: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/32.jpg)
Information Rules Spring 200032
Openness v. Control
• “Open” approach: offering to make the necessary interfaces and specifications available to others
• “Control” approach: keeping your system proprietary
• The goal is to maximize the value of your technology, not control
![Page 33: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/33.jpg)
Information Rules Spring 200033
To maximize the value…
• Your reward = Total value added to industry x your share of industry value
• Value added to industry– Depends on product and– Size of network
• Your share– Depends on how open
![Page 34: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/34.jpg)
Information Rules Spring 200034
Openness
• More cautious strategy than control
• Full openness– Anybody can make the product– Problem: no champion
• Alliance– Only members of alliance can use– Problem: holding alliance together
![Page 35: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/35.jpg)
Information Rules Spring 200035
Control
• Control standard and go it alone
• A strategy for Market leaders: AT&T, MS, and Intel
• If several try this strategy, it may lead to standards wars
![Page 36: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/36.jpg)
Information Rules Spring 200036
Generic Strategies
Control Open
Compatible ControlledMigration
OpenMigration
Incompatible PerformancePlay
Discontinuity
![Page 37: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/37.jpg)
Information Rules Spring 200037
Performance Play
• Introduce new, incompatible technology
• Examples– Palm Pilot– Iomega Zip
• Attractive if– Great technology– Outsider with no installed base
![Page 38: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/38.jpg)
Information Rules Spring 200038
Controlled Migration
• Compatible, but proprietary
• Examples– Windows 98– Pentium chips– Upgrades and update of S/W programs
![Page 39: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/39.jpg)
Information Rules Spring 200039
Open Migration
• Many vendors, compatible technology
• Little switching cost for customers
• Examples– Fax machines– Modems
![Page 40: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/40.jpg)
Information Rules Spring 200040
Discontinuity
• New technology, but incompatible with existing technology
• Supplied by many vendors
• Examples– CD audio– 3 1/2” disks
![Page 41: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/41.jpg)
Information Rules Spring 200041
Lessons on Lock-in
• Switching costs are ubiquitous
• Customers may be vulnerable
• Value your installed base
• Watch for durable purchases
• Be able to identify 7-types of lock-in
![Page 42: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/42.jpg)
Information Rules Spring 200042
Lessons on Network and Positive feedback
• 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
![Page 43: Information Rules: A Strategic Guide to the Network Economy Lock-In effect & Networks externality Seungkyoon Shin.](https://reader035.fdocuments.net/reader035/viewer/2022062620/551b126855034607418b539c/html5/thumbnails/43.jpg)
Information Rules Spring 200043
Lessons, continued
• Fundamental tradeoff: openness and control
• Generic strategies– Performance play– Controlled Migration– Open Migration– Discontinuity
• Lessons of history