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Networks and Positive Feedback: Information Rules

This document discusses network effects and positive feedback in technology markets. It explains that network effects occur when the value of a product increases with the number of users, and that this can lead markets to "tip" towards one solution over others through positive feedback loops. The document analyzes strategies for standards adoption like controlled migration, open migration, and performance plays, noting the tradeoffs between openness, control, compatibility and performance. Historical examples are provided to illustrate how network effects have impacted technology standards.

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Loga Nathan
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69 views

Networks and Positive Feedback: Information Rules

This document discusses network effects and positive feedback in technology markets. It explains that network effects occur when the value of a product increases with the number of users, and that this can lead markets to "tip" towards one solution over others through positive feedback loops. The document analyzes strategies for standards adoption like controlled migration, open migration, and performance plays, noting the tradeoffs between openness, control, compatibility and performance. Historical examples are provided to illustrate how network effects have impacted technology standards.

Uploaded by

Loga Nathan
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Information Rules:

A Strategic Guide to the Network Economy

Networks and Positive Feedback


Carl Shapiro
Hal R. Varian
Important Ideas
• Positive feedback
• Network effects
• Returns to scale
– Demand side
– Supply side

Information Rules 2 Spring 98


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”

Information Rules 3 Spring 98


Sources of Positive Feedback
• Supply side economies of scale
– Declining average cost
– Marginal cost less than average cost
– Example: information goods
• Demand side economies of scale
– Network effects
– In general: fax, email, Web
– In particular: Sony v. Beta, Wintel v. Apple

Information Rules 4 Spring 98


Network Effects
• Real networks
• Virtual networks
• Number of users
– Metcalfe’s Law:
Value of network of size n proportional to n2
• Importance of expectations

Information Rules 5 Spring 98


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

Information Rules 6 Spring 98


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

Information Rules 7 Spring 98


Likelihood of Tipping

Low Scale High Scale


Economies Economies
Low Demand Unlikely High
For Variety
High Demand Low Depends
For Variety

Information Rules 8 Spring 98


Chicken & Eggs
• Fax and fax machines
• VCRs and tapes
• Internet browsers and Java

Information Rules 9 Spring 98


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

Information Rules 10 Spring 98


Evolution
• Offer a migration path
• Examples
– Microsoft
– Intel
– Borland v Lotus
• Build new network by links to old one
• Problems: technical and legal

Information Rules 11 Spring 98


Technical Obstacles
• Use Creative design
• Think in terms of system
• Converters and bridge technologies
– One-way compatibility

Information Rules 12 Spring 98


Legal Obstacles
• Need IP licensing
• Example: Sony and Philips CDs

Information Rules 13 Spring 98


Revolution
• Groves’s law: “10X rule”
• But depends on switching costs
• Example: Nintendo

Information Rules 14 Spring 98


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

Information Rules 15 Spring 98


Openness
• Full openness
– Anybody can make the product
– Problem: no champion
• Alliance
– Only members of alliance can use
– Problem: holding alliance together

Information Rules 16 Spring 98


Control
• Control standard and go it alone
• If several try this strategy, may lead to
standards wars

Information Rules 17 Spring 98


Generic Strategies
Control Open

Compatible Controlled Open


Migration Migration

Incompatible Performance Discontinuity


Play

Information Rules 18 Spring 98


Performance Play
• Introduce new, incompatible technology
• Examples
– Palm Pilot
– Iomega Zip
• Attractive if
– Great technology
– Outsider with no installed base

Information Rules 19 Spring 98


Controlled Migration
• Compatible, but proprietary
• Examples
– Windows 98
– Pentium
– Upgrades

Information Rules 20 Spring 98


Open Migration
• Many vendors, compatible technology
• Examples
– Fax machines
– Some modems

Information Rules 21 Spring 98


Discontinuity
• Many vendors, new technology
• Examples
– CD audio
– 3 1/2” disks

Information Rules 22 Spring 98


Historical Examples of
Positive Feedback
• RR gauges
• AC v. DC
• Telephone networks
• Color TV
• HD TV

Information Rules 23 Spring 98


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

Information Rules 24 Spring 98


Lessons, continued
• Fundamental tradeoff: openness and control
• Generic strategies
– Performance play
– Controlled Migration
– Open Migration
– Discontinuity
• Lessons of history

Information Rules 25 Spring 98

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