PlatformMediatedNetworks

ModuleOverview
November8,2007

NotesforInstructors
TheseslidesareavailablefordownloadasafilenamedPMN
Slides.pptathttp://www.people.hbs.edu/teisenmann/
Iveprovidedcommentsonmanyoftheslides,visibleasNotes
(fromtheViewmenu,selectNotesPage).
Feelfreetoadapttheslidesinanywayyouseefit.Inthespiritofopen
source,ifyoumakechangesoradditions,pleaseforwardacopytome
atteisenmann@hbs.edusoIcanpostthemforothers.Imalsohappy
toanswerquestionsabouttheslidesbyemail.
Theslidespresentconceptscoveredinanintroductorymoduleon
platformmediatednetworks,designedforuseinexistingcourseson
strategy,technologymanagement,marketing,entrepreneurship,or
ecommerce.ThemoduleisdescribedinPlatformMediated
Networks:ModuleNoteforInstructors,HBS#807067.
Forinstructorswhowishtodelvedeeper,themodulesmaterialsare
drawnfromacasebasedMBAelectivecourse,describedin
ManagingNetworkedBusinesses:CourseOverviewforEducators
HBS#807104.

Topics
1.
2.
3.
4.

Overview,Definitions,andCoreConcepts
NetworkMobilization
PlatformControl
PlatformEnvelopment

Our vision for the last 20 years can be summarized

in a succinct way. We saw that exponential
improvementsincomputercapabilitieswouldmake
greatsoftwarequitevaluableInthenext20years
the improvement in computer power will be
outpaced by the exponential improvements in
communications networks. The combination of
these elements will have a fundamental impact on
work,learningandplay.
BillGates
TheInternetTidalWave,May1995

1995

NetscapeIPO
RobGlaserlaunchesRealNetworks
VocalTecintroducesVoIP
Firstcablemodems
FCCauctionsdigitalmobilespectrum
PalmlaunchesPilot

1999
IBMembracesLinux
XMLiscreated,pavingthewayforweb
services
802.11b(WiFi)takesoff
Napsterlaunched
TiVOlaunched
6

2004:ExplosiveGrowthin

Googlesvaluation
Skype
RSS,podcasting
Blogs
Opensourcesoftware
Wikipedia
BitTorrent
7

PlatformMediatedNetworks
Networkusersaccessacommonplatformthat
facilitatestheirinteractions
Platforms=subsetofcomponentsandrules
employedbyusersinmostoftheirtransactions
Components=hardware,software,services
Rules=technicalstandards,protocolsforinformation
exchange,policies,andcontractsthatgoverntransactions

Usersrelyonaplatformwhendoingsoismore
efficientthanunmediatedbilateraldealings

Network
User
User A
A

User B

Platform
Components
- Hardware
- Software
- Services

Rules
- Standards
- Protocols
- Policies
- Contracts

Architecture

eBaysPlatform
Components

BrowserandInternetaccess(from3rdparties)
Websitedesign
Bidtrackingsoftware
Shippingservices(from3rdparties)
LinkstoPayPal(aneBayownedplatform)
Etc.

Rules

Registrationrequirements
Disputeresolutionprocesses
Feedbacksystem
Policiesforbidding
Etc.

10

NetworkEffects
Definition:Networksvaluetoauserdependsonthe
numberofothernetworkusers
Value=willingnesstopayfornetworkparticipation=
WTPforplatformaffiliation=caponplatformfees

Properties

Canbenegative,e.g.,duetocongestion
WTPtendstoincreaseasSshaped(logistic)functionof
networkgrowth
Networkeffectsaredemandsideeconomiesofscale,i.e.,
theyimpactrevenues
Networkeffectsarenotsupplysidescaleeconomies,whichimproveunitmargins
throughfixedcostleverage
However,manynetworkedbusinessesdoenjoystrongsupplysideeconomies

11

Platformmediatednetworksdonot
necessarilyencompass:
Physicalnetworks(e.g.,gasutilities)
Socialnetworks(e.g.,yourgolfbuddies)
Supplynetworks,akaecosystems,
comprisedoflargefirmsandtheirmost
committedsuppliersandcustomers
(e.g.,WalMart,Toyota)

12

WhyStudy
PlatformMediatedNetworks?
Largeandgrowingshareofglobal
economy
Distinctivemanagementchallenges

13

LargeandGrowingShareof
GlobalEconomy
Notjustdigitalindustries,also:
Financialservices,e.g.,ATMs,creditcards,stockexchanges
Transportation,e.g.,packagedelivery,airlines,travelagents,
reservationsystems,fuelcellpoweredcars
Retail,e.g.,shoppingcenters,barcodes/RFID
Energy,e.g.,grid+appliances,energytrading
Realestate,e.g.,homebuying
Healthcare,e.g.,HMOs
Enterpriseadministration,e.g.,recruiting,B2Bprocurement

60oftheworlds100largestcompaniesearnmostof
theirrevenuefromplatformmediatednetworks
14

DistinctiveChallenges
Conceptsarenew:firstacademicpapersontwo
sidednetworkspublishedin2003
Platformmediatednetworksareverycomplex,but
oversimplificationiscommon
Overorunderestimatestrengthofnetworkeffects
Pricetonetworkssidesasiftheywereseparatemarkets

Errorscanbefatal

Yahoo,AmazonfailedinU.S.auctions
eBayexitedJapanandChina;failedtodislodgePayPal
NASDAQcollusion=$1billionfine;ECNentry
IBMspent$1+billiononOS/2
AppleforfeitedMicrosoftsposition
15

DistinctiveChallenges
BusinessModelDesign
WinnerTakeAllDynamics

16

BusinessModelDesign
ThisisliketheCambrianexplosion550millionyears
ago,whenmulticelledlifefirstappearedonthescene.It
wasthegreatestspeciationeverseen,butitwasalso
whichpeopleforgetthegreatestrateofextinctionever
seen.Weregoingtoseeallkindsofideastried,andthe
majorityofthemareprobablygoingtofail.

JeffBezos,CEOAmazon.com
(BusinessWeek,9/13/99)

17

18

DesigningBusinessModels
isDifficultDueTo:
Twosidednessofmostnetworks
Bifurcationofplatformroles
Rapidgrowth,precludingtrialanderror

19

OneandTwoSidedNetworks
Onesidednetworks:Transactionpartners
alternateroles,e.g.,emailerssend&receive,
tradersbuy&sell
Twosidednetworks:Usersarepermanent
membersofonedistinctgroupaside
whichtransactswithasecondgroup,e.g.,
Jobseekers+recruiters
Cardholders+merchants
20

Atwosidednetworkhas
fournetworkeffects
Side 1

Side 2

Platform

Asamesideeffectfor
eachside,i.e.,
preferenceregarding
numberofotherusers
onownside
Acrosssideeffectin
eachdirection,i.e.,
preferenceregarding
numberofuserson
otherside
Eacheffectcanbe
positiveornegative

21

PlatformRoles:SponsorsandProviders
Providersareusersprimarypointofcontact
withplatform
Sponsorsdonotdealdirectlywithusers;rather,
sponsorsholdpropertyrightsthatdetermine:
Whomaychangeplatformtechnology
Whomayparticipateinnetworkasaplatform
providerornetworkuser
22

VISA =
JOINTLY SPONSORED
SHARED PLATFORM

CARD
HOLDERS

MERCHANTS

ISSUING
BANKS

ACQUIRING
BANKS

VISA INTERNATIONAL

XBOX =
SOLE SPONSORED
PROPRIETARY PLATFORM

GAMER

DEVELOPER

CONSOLE

SDK

MICROSOFT
XBOX

23

DistinctiveChallenges
BusinessModelDesign
WinnerTakeAllDynamics

24

SchumpeterianCompetition:SerialWTABattles

VCRDVD+PVR+VOD
LPCDdownloadand/orsubscription
HumanmarketmakersECNs
1G2G3G
AnalogPOTSVoIP
BroadcastcableIPTV
AtariNintendoPlaystationXbox?
WiFiWiMax?
GasolinepoweredcarsFuelcellpoweredcars?
BarcodesRFID?
25

BluRayvs.HDDVD

26

WinnerTakeAll
Networkeffectsincreasingreturns
winnertakeall,i.e.,oneplatformprevails
Examples:Windows,eBay,PDF,DVD,fax,
realestateMLS
Winnertakeallimplieslosertakesnothing!
So,shouldyoushareplatformwithrivals?
Ifnot,shouldyouracetoacquirenetwork
users?
27

WTAImplications
Sharingandracingarebetthecompany
decisions,soorganizationaldesigniscrucial
Growthopportunitiescapitalmarket
bubbles
WTAmonopolypowergovernment
intervention

28

PlatformStructure
Winnertakeall:oneplatformservesthe
maturenetworkedmarket
Monohoming:mostusersonagivenside
affiliatewithasingleplatform
Multihoming:mostusersonagivenside
affiliatewithmultipleplatforms

29

PlatformStructureExamples
Network

Fax
DVDs
Mobile FeliCa
Real estate MLS
Windows desktop O/S
Online auctions
PDF
Instant messaging
Credit cards
Yellow Pages
Recruitment sites
Video games
Shopping mall
Subscription music
Multichannel TV (DBS
vs. cable)

Side 1
Users
Sender/receivers
Consumers
Cell phone users
Home buyers
PC users
Buyers
Readers
Sender/receivers
Consumers
Consumers
Job seekers
Consumers
Consumers
Consumers
Consumers

Side 1
Structure

Side 2
Structure

WTA
WTA
WTA
WTA
WTA
WTA
WTA
Mixed-mode
Mixed-mode
Mixed-mode
Mixed-mode
Mixed-mode
Mixed-mode
Mixed-mode
MonoMixed-mode
MonoMultiMonoMultiMonoMulti-

Side 2
Users
(Homogeneous network)
Movie studios
Retail stores, etc.
Home sellers
Application providers
Sellers
Document creators
(Homogeneous networks)
Merchants
Marketers
Recruiters
Game developers
Stores
Artists/labels
Programming networks

30

NetworkedMarketisMoreLikelytobe
ServedbyaSinglePlatformWhen:
Theplatformisanaturalmonopoly
OR

MultihomingcostsarehighAND
NetworkeffectsarepositiveandstrongAND
Demandfordifferentiatedfeaturesisweak
ORdominantplatformcanoffersuchfeatures
selectivelytouserswillingtopaypremium

31

Naturalmonopoly:minimumefficient
scaleofproduction>maturemarketsize

gure 2: Unit Cost Curves Showing Constant vs. Increasing Returns To Scale

Constant Returns
Long-Run ReturnRReturns
Unit Cost RReturns

Quantity

Increasing Returns
Long-Run
Unit Cost

Quantity

32

Naturalmonopoliesarerare,butevidentin
somenetworkedbusinesses
Past:localutilities(phone,power,
cableTV),railways,postaldelivery
Present
Internetcontentdeliverynetworks(e.g.,
Akamai,whichhas85%marketsharebasedon
hugeinvestmentinservers)
FailedLEOsatellitecommunications(e.g.,
Iridium,Teledesic)
33

StrengthofNetworkEffects
Networkeffectsarestrongerwhen:
Usersdemandnoveltyfromrepeatedtransactions(e.g.,DVDs)
Mobileusersrequiregeographiccoverage(e.g.,ATMs,WiFi,
refueling)
Participantsinamatchingnetworkhaveidiosyncraticneedsand
offers(e.g.,homebuying,executiverecruiting)

Accesstonetworkusersisnotvaluedequally
Someareextremelyvaluable(e.g.,friends,family)
Othersareworthlittle/nothing(e.g.,strangersinanothercountry)
Somehavenegativevalue(e.g.,telemarketers,stalkers)

Strongpreferenceforvarietyyieldslongtail
34

MeasuringNetworkEffects:ConjointAnalysis
Interviewselicitreactionstoproductattributes
includingnetworksizeusuallythroughpaired
comparisons
Hence,CONsideredJOINTly

Requiresconsumerstounderstandattributes,so
maynotbereliableforbreakthroughproducts
Studiesshouldbedesignedbymarketresearch
professionalsandcostbetween$50k$250k

35

Homingcosts:costs/investmentsincurredby
userduetoplatformaffiliation
Upfront

Searchandnegotiation
Accountsetup,e.g.,softwareconfiguration
Initialhardware&softwareinvestment;systemintegration
Training

Ongoing

Membershipandtransactionfees
Maintenancecosts;customerservicehassles
Tenureorvolumebasedbenefits

Exit

Accountterminationhasslesandcosts,e.g.,changing
emailaddress,movingfundsbetweenbrokerageaccounts
Contractseverancepenalties
Salvagevalueofhardware,software

36

SwitchingCosts
Outofpocketexpensesandinconveniencesincurredby
networkusers(orbyplatformprovidersontheirbehalf)
whenusersswitchfromoneplatformtoanother
Networkeffectsmaydeterorencourageswitching,
dependingontherelativesizesofrivalplatforms.
However,networkeffectsandswitchingcostsare
conceptuallydistinctandshouldnotbeconfused

37

Homingvs.SwitchingCosts
Mono-homing

Switching

1 SETUP + 1ONGOING

2 SETUPS + 1 TERMINATION + 1 ONGOING

2 SETUPS + 2 ONGOING

Multi-homing

38

Homingvs.SwitchingCosts
Usuallytheymovetogether,e.g.,satelliteradio(bothhigh),
packagedelivery(bothlow)
Sometimes,switchingcostishighbutmultihomingcostis
low
eBookreaders:costlytoswitchbecauseyoumustreplaceentire
library,butnotverycostlytomultihome
Emailaccount:costlytoswitchbecauseyoumustnotifyallyour
contacts,butnotverycostlytomultihome

39

Homingvs.SwitchingCosts
Whenpredictingwhetheranewnetworkedmarket
willbeservedbyasingleplatform,focusonmulti
homingcosts
Whenpredictingwhethertoracetoacquirenetwork
users,focusonswitchingcosts
Whenpredictingwhetheranestablishedplatformis
vulnerabletodisplacementbyanewplatform,focus
onbothmultihomingcostsandswitchingcosts

40

UsersPreferencesforDifferentiated
PlatformFunctionality
Usersegmentshavedifferentneeds
DBSpictureissharperthancables
Appealingforsportsandmovielovers?

DBSrequiresasettopboxforeveryTV
Aliabilityforlargefamilies?

Canfunctionalitybeofferedselectivelyto
userswillingtopayapremium?
TomatchDBSpicturequality,cablewould
havetoconverttoalldigitalarchitecture,so
selectivityisnotanoption
41

HomingLogic:AffiliateWithPlatform
WhenVP+IH
VP = expected value from ability to interact
with a potential transaction partner
I = value from platform, independent of
platform size
H = homing cost

42

MultiHomingLogic
ForplatformsAandB,calculateVP + I H
Considerincrementalvaluefromaccesstopotentialtransaction
partnersfrommultihomingonAandB,comparedtomono
homingwiththebestsingleplatform,A
BmayofferaccesstosomepartnersnotaffiliatedwithA
Duetodifferentiation,Bmayoffermorevalueforcertaintransactions
thanA

Compareincrementalvaluetoincrementalhomingcost

43

WTAPotential?
DVD:
WTA

CreditCards:
MultiHoming

Strengthof
NetworkEffect

Highformostuserson
Highformostuserson
bothsides,i.e.,consumers bothsides,i.e.,card
andstudios
holdersandmerchants

MultiHoming
Cost

Highforbothsides

Lowforbothsides

Demandfor
Inimitable
Features

Lowduetotechnical
standardizationofTV

High:revolvevs.
charge(i.e.,payinfull
withnopresetlimit)

44

MonoHoming+Multihoming
Example:OnlineSubscriptionMusic
Side1MonoHoming:
Consumers
Strengthof
NetworkEffect

High:wantaccessto
allmusic

MultiHoming
Cost

High:monthlyfees,
playlistmanagement

Demandfor
Inimitable
Features

Side2MultiHoming:
MusicCompanies
High:revenueincreases
indirectproportionwith
userbase

Low:duplicatedlegal
work,butzeroinventory
andmodestincremental
productioncostsdueto
digitaldistribution
Moderate:differences Low:musiccompanies
includequalityof
havesimilarneedsfor
editorialcontent,IM
DRM,promotional
integration
support,etc.

45

Topics
1.
2.
3.
4.

Overview,Definitions,andCoreConcepts
NetworkMobilization
PlatformControl
PlatformEnvelopment

46

BarrierstoNetworkUserAdoption
Businessstealingrisk:toomanyrivalsonyourside
Unlikeotherrisks,doesnotinvolveprovider/usertrust
Holduprisk:dominantplatformextractstoomuchvalue(e.g.,
MicrosoftOSforcablesettopboxormobilephones)
Strandingrisk:1)userbackswrongsideinWTAbattle;2)
platformfailstoinvest;3)nobackwardcompatibility
Integrationrisk:platformproviderintegratesintonetwork
userrole(e.g.,MicrosoftwithOffice&Halo)
Favoritismrisk:toattractusers,extractrent,orserveself
interest,platformproviderskewstermsinonesidesfavor(e.g.,
Covisint)
Relationshiprisk:In2sidednet,whocontrolsaccesstousers
onotherside?(e.g.,Xboxvs.EA;Autobytelloans)
47

WillingnessToPayandNetworkSize

WTP

D2

Biggernetworkismoreuseful
Existingcustomerswillconsumemore
Newprospectswilljoinnetwork

D3

P2
P3
P1
N2

Outwardshiftsbecomesmallerasexpected
networksizenearssaturationpoint,Ns,dueto
Lateradoptersnotasvaluableasearlyadopters
Congestion

D1
N1

D1istraditionaldemandcurveif
customers/prospectsexpectanetworksize
equaltoN1
Ifcustomers/prospectsexpectedabigger
network,N2,thendemandcurvewouldshift
outwardtoD2

N3

Ns

Network Size

48

BewareMetcalfesLaw
AccordingtoMetcalfesLaw,thevalueofanetworkgrows
withthesquareofgrowthinitsuserbase
InameshnetworkwitheachofNnodesconnectedtoeveryothernode,
thereareNx(N1)links,i.e.,~N2

But,Value=N2onlyif:
PercapitatransactionvolumesalsoincreasebyN2
EachusersWTPpertransactionremainsconstantashertransaction
volumegrows

Intherealworld:diminishingreturnssetinandconstraintson
attention/budgetprevail

49

UpwardSlopingDemand
inNetworkIndustries
WTP

D2

D3

Fulfilled Expectations
Demand Curve

P2
P3
P1

Fulfilledexpectationscurve
tracespricethatwouldexactly
fulfilldemand,foragiven
expectednetworksize
Curveisupwardslopingin
domainwherenetworkeffects
dominatepriceelasticity
effects

D1
N1

N2

N3

Network Size

50

MultipleEquilibriainNetworkIndustries
Assumecompetitivemarketwith
Price=MarginalCost
Markethasthreeequilibriumpoints:
N0,N1,andN2
N1isnotastableequilibrium

WTP

Fulfilled Expectations
Demand Curve

Marginal
Cost

N0

N1

N2

Network Size

Ifexpectednetworksize<N1,
firmscannotmakemoney,soN0
prevails
Ifexpectednetworksizeis>N1,
supplywillsurgetoN2

Implication:networkmarketsare
tippytheycanstall,andtheycan
growexplosivelyand
expectationsmatter!

51

ThePenguinProblem

52

ThePenguinProblem
(Farrell&Saloner,1986)

Innewmarkets,uncertaintyishigh;individualshave
differentexpectationsaboutlongtermdemand
Ifuserbaseisfragmented,userscannotcommunicate
expectationsorcoordinatebehavior.Networkmay
stall,evenwithstrongnetworkeffects!
Noonemovesunlesseveryonemoves,sonoone
moves,likepenguinsafraidtobefirsttodiveforfood

53

Twowaystocategorizeplatforms:
Structure:Proprietary,Shared,Joint
Venture,Licensor
Function:Connectivity,Variety,Matching,
PriceSetting

54

CategorizationBasedonPlatformFunction
Connectivity:platformfacilitatespointtopointexchangeofinformation,
physicalgoods,orpassengers(e.g.,fax;Fedex)
Morepointsconnectedmorevaluablenetworkmorepointsetc.

Variety:platformelicitssupplyofavarietyofcomplementsfromone
networksideandpromotescomplementconsumptionbytheotherside
(e.g.,console+games;creditcard+merchantlocations)
Morecomplementsmoredemandsideusersmorecomplementsetc.

Matchingnetwork:platformmatchestransactionpartnerswith
heterogeneousneedsandoffers(e.g.,realestate;onlinedating)
Morebuyersmoresellersimprovedoddsofsuitabletransactionmore
buyersetc.

Pricesettingnetwork:platformfacilitatesexchangeofwelldefined
itemsvalueddifferentlybytradingpartners(e.g.,stockexchange,
gamblingbookmaker)
Morebuyersmoresellersreducedpricevolatilitymorebuyers
etc.

55

CategorizationBasedonPlatformFunction

One-Sided

Multi-Sided

Partners Identity
Generally Known in Advance

Partners Identity Generally Discovered

Through Transaction

Connectivity

Price-Setting

Phone, fax, IM, SMS, email, Ethernet, etc.

Package/freight delivery
Passenger air and rail lines
Secure document delivery (e.g., Tumbleweed)
Online invitations (e.g., eVite)

Securities and commodity exchanges

Online /offline auctions
Wholesale electric power markets
Gambling bookmakers

Variety

Matching

DVDs, VCRs, HDTV, CD audio, video game

consoles, satellite radio, etc.
World Wide Web
Internet content delivery (e.g., Akamai)
Internet-based media players (e.g., PDF)
PC, smart phone, PDA operating systems
Media aggregators (e.g., Yo uTube)
Ad-supported media (e.g., TV networks)
Wi-Fi: sides = end users & access points
Barcodes or RFID for product ID
Credit cards, email payments (e.g., PayPal)
Fuel cell-powered cars & refueling stations
ATMs
Shopping malls
HMOs
Electric grid: sides = outlets & appliances

Real estate brokerage

Online and offline travel agencies
Online car buying
Online and offline insurance brokerage
Mutual fund supermarkets (e.g., Schwab)
Business-to-business online exchanges
Executive search, online recruitment
Yellow Pages, paid search (e.g., Google)
Nightclubs, online personal ads and dating
services, marriage brokers, brothels
Markets for expertise (e.g., Yahoo Answers)

56

KeyChallengesinNetworkMobilization
Connectivity
Ensure reliability
Optimize reach (infrastructure investment
to extend network vs. incremental revenue)

Price Setting
Balance users different needs for:
Anonymity
Transparency with respect to most recent
price and best current offer
Transaction speed
Flexibility to trade with preferred partners

Variety

Matching

Optimize price structure, exclusivity

Optimize price structure, exclusivity

Elicit complement supply despite:

Build user trust

Risky platform-specific investments

Address worries about business stealing

Conflict with large users over rent

division, end user relationship control

Manage concerns about conflicts of

interest, ownership of data, etc.

Concerns about platform provider

integration into user role

Help end users find complements

Avoid disintermediation, off-exchange

trading

57

InternalizingExternalities
Externality=benefitorharmexperiencedbyBduetoAs
actions,withnocompensatingpayment
Positiveexternality:Iadmireyourflowers
Negativeexternality:yourpigpenisupwind

Networkeffectsareexternalities
Threeapproachesforinternalizingexternalities
#1:Sidepaymentsbetweenusers,e.g.,Ibuygrandmasvideophone
#2:Intwosidednetwork,permanentsubsidizationofoneside
#3:Intertemporalinternalization:sponsorprimesthepumpwith
discountstoearlyadopters;thisleadsotherstoreviseexpectations/WTP

For#2and#3,proprietaryplatformistypicallyrequired;
otherwise,freeridersexploitsubsidy
Exception:sponsorscandictatepricingtermsthatunderwritesubsidies,as
withcreditcardsandrealestate

58

StrategiesforNetworkMobilization
Pricing

Permanent:shouldonesidebesubsidized?
Penetration:shouldplatformprovidersraceto
acquirenetworkusers?

Participation

Exclusivity:shouldplatformprovidersseek
exclusiverelationshipswithsomeusers?
Integration:shouldplatformprovidersbecome
networkuserstoavoidchicken&eggproblem?
59

60

PricingPuzzles
WhatexplainsLadiesNight?
Whydosimilarindustrieschargedifferent
sides?
Videogames:endusersubsidized;developer
pays
PCs:enduserpays;developersubsidized

61

AssumemonopolistservesmarketsAandC
Marginalcost=0
WithnonetworkeffectbetweenAandC,monopolistpriceseachproductto
maximizePxQ

Case 1: No Network Effect

Market A

PA

PC

P*A

Market C

P*C

Q*A

QA

Q*C

QC

62

Case 2: Positive Cross-Side Network Effects

Compare((P^AxQ^A)(P*AxQ*A)(P*BxQ*B))to
((P^BxQ^B)(P*BxQ*B)(P*AxQ*A))
DemandoneachsidegrowsifQMAXissoldontheothersideatazeroprice.
Chargethesidethatmosthighlyvaluesgrowthintheotherside.
Side A

P^A

Side B

P^B
P*B

P*A

Q*A Q^A
QMAXA

Q*B

Q^B

QMAXB

63

StrategiesforNetworkMobilization

PermanentSubsidies
AcceleratedGrowthStrategies
Exclusivity
VerticalIntegration

64

65

66

RacingtoAcquireUsers
Firmsracetoacquirecustomerswhentheyface:
Increasingreturnstoscale
Highswitchingcosts

Latemoveradvantagese.g.,reverseengineering,
freeridingonpioneersmissionarymarketingmay
discouragepreemptiveinvestment
Willinvestorsfundracingstrategies?

67

RacingtoExploitIncreasingReturns
Withoutincreasingreturns:
Maximize:Profit=RevenueCost
Implies:MarginalRevenue(MR)MarginalCost(MC)=0
MR=MC

Withincreasingreturnsduetonetworkeffects:

Willingnesstopay(WTP)=f(Numberofotherusers)
So,addingauserboostseveryotherusersWTP
MR+NPVofextrarevenuefromotherusers=MC
Tomaximizeprofit,youshouldpricelower(reducingMR)
orinvestmoreinmarketing(increasingMC)
Inotherwords,youshouldracetoacquirecustomers!
68

Highswitchingcostsalsoencouragefirms
toracetoacquirecustomers
Inanotherwisecompetitivemarket,afirmshouldearnprofit
equaltothesumofswitchingcostsconfrontingitscustomers
$100pricejustcoverscostsofproducing/deliveringoneunit
Assumeconsumersbuyoneunitofproductinperiods1and2
Ifswitchingcostsare$50,thenfirmAcanpriceat$149.99toits
existingcustomersinperiod2.
TostealAscustomers,FirmBmustfullycompensatecustomersfor
switchingcosts
However,$150isthebestpriceBcanofferandstillrecoveritscost

Theseeconomicswillfuelaracetoacquireunaffiliated
customersinperiod1:eachfirmwillpriceat$50.01

69

ThePayofffrom
RacingtoAcquireCustomers

I*

Asinvestmentrises,NPVofa
newcustomereventually
declinesdueto:
Broadeningbeyondnatural
segments
Prematurelysolicitingprospects
Retaliatoryresponses
Scalabilityconstraints

I*correspondstoLifetime
ValueofCustomer=0forthe
lastcustomeryouacquired
AverageLVCshouldbepositive

70

LifetimeValueofaCustomer
Rule:acquirecustomersuntilLifetimeValueofaCustomer(LVC)=0for
lastcustomeracquired,i.e.,PVofvariablecontributionmargin=customer
acquisitioncost(includingincrementalcapitalexpenditures)
LVCdoesnotallocatefixedcosts.IfLCVispositive,butyoudonthaveenough
customerstocoverthepresentvalueoffixedcosts,youllneverearnaprofit!
LVCprovidesaguidelineformarketingspending;itisnotasubstitutefor
detailedcashflowanalysis

IssueswithLVCinnetworkedindustries

Issue#1:LVCshouldincludenewcustomersimpactonothercustomers
willingnesstopay
Issue#2:HardertocalculateLVCintwosidednetworks(e.g.,Monster.com)
Issue#3:Withsomeconnectivitynetworks(e.g.,FederalExpress),variable
costsdependonuserdensity,soyoumustprojectcustomerbasetocalculate
LVC

71

Whatmightexplaindeparturesfromlong
termvaluemaximizinginvestmentlevels?
Investment<I*

I*

Resourceallocationprocesses
Fundingconstraints
Antitrustconstraints

Investment>I*
Inadvertent:Overconfidence
Deliberate:Exploitovervaluation

72

Managingthrougha
speculativevaluationcycle
Can/shouldmanagersexploitovervaluation?
Currencyforacquisitions(Google)
Buffer(Akamai)

Howwilldifferenttypesofinvestorsreacttobust?
Privatevs.publicequity(e.g.,Fedexvs.UPS)
VCvs.strategicinvestor
Family(e.g.,Cox)

73

StrategiesforNetworkMobilization

PermanentSubsidies
AcceleratedGrowthStrategies
Exclusivity
VerticalIntegration

74

Topics
1.
2.
3.
4.

DefinitionsandCoreConcepts
NetworkMobilization
PlatformControl
PlatformEnvelopment

75

PlatformRoles:SponsorsandProviders
Providersareusersprimarypointofcontactwith
platform
Sponsorsdonotdealdirectlywithusers;rather,
sponsorsholdpropertyrightsthatdetermine:
Whomaychangeplatformtechnology
Whomayparticipateinnetworkasaplatform
providerornetworkuser

Eachrolemaybefilledbyonefirmormany;
sometimes,asinglecompanyfillsbothroles
76

PlatformTypes

One
Sponsor

Many
Sponsors

OneProvider

ManyProviders

Proprietary

Licensor

Macintosh
Monster.com
Playstation
JointVenture
CareerBuilder
Orbitz
Covisint

Windows
AmericanExpress
ScientificAtlanta
Shared
Linux
Visa
RealEstateMLS
77

KeyDesignDecision
Preserveproprietarycontrolofnewplatform,e.g.,eBay,
FederalExpress,Google?
Or
Shareplatformwithrivalswhooffercompatiblebut
differentiatedplatformproductsandservices,e.g.,
barcodes,WiFi,DVD?

78

OutcomesVary
Proprietaryplatformsmayprevail
Akamaivs.ContentBridge
eBayvs.FairMarket

Sharedplatformsmayprevail

Citibankvs.CirrusATMnetworks

Proprietaryandsharedplatformsmaycoexist
MacintoshandLinux
AmericanExpress(until2004)andVisa

79

DecisionRules
Aspiringplatformproviderswithabigedge(e.g.,via
strongpatents)shouldalmostalwayspursueproprietary
approach
Whenmanyevenlymatchedfirmscansimultaneously
launchanewplatform:
Winnertakeallpropensityencouragessharedapproach
Freeriderproblemsencourageproprietaryapproach

80

IfaProprietaryPlatform
ServestheEntireMarket
Userswillworryaboutholdupbymonopolist
Prospectiveproviderswillworryaboutlosing
100%oftheirinvestmentiftheyarenotthe
winner

81

FreeRiderProblemswith
BigUpfrontInvestments
UserSubsidization

CentralizedInfrastructure

82

WTAPotential?

Yes
Free
Rider
Issue?

Yes

No

ProprietaryFavored

ProprietaryFavored

Proprietaryexamples:
PayPal,YellowPagesin
smallercities
Sharedexamples:WWW,
realestateMLS
SharedFavored

No

Sharedexamples:DVD,
fax,barcodes,WiFi,SMS

Proprietaryexamples:video
games,paidsearch
Coexistenceexamples:
NYSE/ECNs;creditcards
CoexistenceCommon
Coexistenceexamples:
Symbian+Blackberry;Linux
+Mac

83

CompetingonaSharedPlatform

84

CompetingonaSharedPlatform
Pulledtogetherbypositiveimpactonplatformadoptionand
eachfirmssurvivalodds

Fearofpenguineffect
FearofWTAoutcome(e.g.,mobileFeliCa)
FearofBalkanization(e.g.,prestandard11n)
Fearofoutsidethreats(e.g.,mobilephoneOEMsvs.Microsoft)

Pulledapartbyreductioninappropriabilityofplatformrent

Concernabouttoomanyrivals
Desiretoincorporateowntechnologyinstandard(802.11)
Desiretodifferentiateastandardizedproduct(e.g.,J2EE;802.11)
FrictionbetweenIPownersandfreeriders(e.g.,RANDZ)
Propensitytoformcoalitionsthatexcludecloserivals(e.g.,KDDI+
JCBvs.DoCoMo+Sumitomo)

85

ValueCaptureStrategiesfor
SharedPlatformProviders
RestrictMembership
Canbackfireifexcludedpartiessponsorcompetingplatform,e.g.,Sunvs.
IBM/Microsoftinwebservices

ProfitfromIP
Iftoolow,IPrichfirmsmayavoidplatform
Iftoohigh,IPpoormayavoidplatformandstalematesmayoccuras
firmsvietocontributetechnology

ProfitfromImplementation
FreelycontributeIPtosecuretimetomarketadvantageordevelop
proprietaryextensionstoindustrystandards
But,proprietaryextensionsmaysplinteraplatform,e.g.,Unix

86

KeySkills

Timing:Toosoon=ignored;toolate=blocked
IPManagement:Avoidsubmarinepatentsandpatentthicketsvia:
Standardsettingorganization(SSO)disclosurerules
Patentpools
Patenthoardingtoensuremutualassureddestruction

Diplomacy:Tacticsincludeappeasement,intelligencegathering,
logrolling,bluffing,burningbridges,irrationalcommitmenttodogma,etc.
SSOdelegatesrequireraremixoftechnicalprowessanddiplomacyskills;their
loyaltiesareoftendividedbetweenprofessionandfirm

OrganizationalDesign:Adhocvs.establishedSSOs;forumshopping;
SIGs;etc.

87

Topics
1.
2.
3.
4.

DefinitionsandCoreConcepts
NetworkMobilization
PlatformControl
PlatformEnvelopment

88

PlatformEnvelopment
PlatformEnvelopment:Entrybyoneplatformprovider
intoanothersmarket,combiningitsownfunctionalitywith
thetargetsinamultiplatformbundlethatleverages
commoncomponentsand/orshareduserrelationships
Envelopmentisapowerfulforceshapingtheevolutionof
platformmediatednetworks
Pathtoplatformleadershipchangethatdoesnotrequire
Schumpeteriancreativedestruction
Driverofindustryconvergence
Strategyforcrosslayercompetition

89

PlatformEntrenchment
Singleplatformoftendominatesduetodemandandsupplyside
scaleeconomies,e.g.,Windows,eBay,PDF
Dominantplatformsoftendifficulttodisplaceduetonetwork
effectsandswitchingcostsTosucceed,entrantsgenerallymust
offerrevolutionaryproducts,e.g.,ECNs,fuelcellcars,IPTV,
VoIP,WiMax
Hence,platformleadershipchangeoftenentailsserialwinner
takeallbattles,withsuperiornewplatformsdisplacingoldones
Platformenvelopmentisasecondpathtoplatformleadership
changethatdoesnotrequireSchumpeteriancreative
destruction
90

Platformprovidersservingseparatemarketsmay
shareusersandcomponents
Users

Platform
A
Platform
B

Users

Platform
A
Platform
B

91

PlatformEnvelopment

Platform
A
Platform
B

BentersAsmarket
withamultiplatform
bundle
Aisvulnerableifit
cannotmatchan
appealingbundle

92

EnvelopmentinSubscriptionMusic

AT&T

Apple
Yahoo
Rhapsody

Labels

Consumers

Priorto1999,RealPlayerdominates
streamingmedia
MicrosoftsWMPenvelopsRealPlayer,
bundlingstreamingserverintoNTatno
extracost
Reallaunchessubscriptionmusicservice
Rhapsody
Yahoodiscountssubscriptionmusic,
crosssellingviaportal
Applecouldbundlesubscriptionservice
intoiTunes,leveragingiPod
AT&TWirelessbundlesYahoo
subscriptionmusicwithcellphoneservice

Real
Microsoft

93

ConvergenceEnvelopment

94

Xbox360vs.PS3

95

Cablevs.Telco

96

CrossLayerCompetitionEnvelopment
Applications
Applications

Middleware
Operating Systems
Operating Systems
PCs
PCs
Components

Components

97

TelephoneandTelegraph
Onenewspaperaccount
describedAT&T,inits
slowbutsteady
envelopmentofthe
telegraphindustry,asa
quietoctopus.
Hochfelder,
BusinessHistoryReview,
2002
98

Mechanism:Bundling

EfficiencyGains:Transactionandproductioncostsavings;improved
userexperience
PriceDiscrimination:Reducesheterogeneityinconsumersaggregate
valuations
StrategicAdvantages:Extendmarketpowerintocomplementmarket;
protectcoremarketbyforeclosingrivalsaccesstokeycomplement

99

Foreclosure

Conglomeration

(Cross Layer)

(Convergence)

Intermodal

Relationship

Complements

Functionally unrelated Weak substitutes

Examples

Microsoft vs. Real

eBay vs. PayPal
Microsoft vs. Adobe

Cable vs. Telco

DoCoMo vs. JCB
iPhone vs. Blackberry

Monster vs. LinkedIn

UPS vs. Federal Express
Blockbuster vs. Netflix

Efficiency
Gains

Economies in
marketing
Avoid double
marginalization

Only viable with

strong production
cost synergies

Production cost
synergies
Some economies in
marketing

Price
Discrimination
Benefits

Limited

Moderate to strong

Limited

Strategic
Advantages

Extend market
Limited
power, defend core

Neutralize emerging
threat

100

DefendingAgainstEnvelopment
Matchbundle,butbundlevs.bundlecompetitioncanbefierce
Findabigbrotherviamerger(e.g.,ScientificAtlanta+Cisco;
Lotus+IBM)oralliance(e.g.,RealNetworks+Comcast,Cingular)
Cedeandredeploy,e.g.,RealNetworksshiftsfromstreamingto
subscriptionmedia
Sue,e.g.,Novell,RealNetworks,Netscape,Sunvs.Microsoft

101