Platforms, Network Effects, and Competing in a Winner Take All World

Platforms, Network Effects, and Competing in a Winner Take All World Introduction: -Network Effects: also known as Metcalfe’s Law or network externalities, this concept is when the value of a product or service increases as its number of users expands -Examples of products with strong network effects present include social networks, game consoles, wikipedia articles etc -Platforms: products and services that allow for the development and integration of software products and other complementary goods, effectively creating an ecosystem of value-added offerings. Windows, iOS, the kindle and the standards that allow users to create facebook apps are all platforms -Building networks is powerful, building networks of firms that enhance the networks value, even more so and thats what Platforms promise Platforms are Powerful, but Where Does All That Value Come From? -The value derived from network effects comes from three sources: EXCHANGE, STAYING POWER, AND COMPLEMENTARY BENEFITS Exchange: -Exchange is important in creating value because users can potentially communicate with more people -Every product or service subject to network effects fosters some kind of exchange Staying Power -Staying Power: the long term viability of a product or service -Staying power, or longer term viability, of a product or service is particularly important for consumers of tech products as consumers do not want to invest time and effort into a product they arent sure will be supported in the long term -This concept is directly related to switching costs and thus switching costs can strengthen the value of network effects as a strategic asset. -The higher the value of the user’s overall investment, the more they’re likely to consider the staying power of any offering before choosing to adopt it. Similarly, the more a user has invested in a product, the less likely he or she is to leave. -TCO: Total Cost of Ownership:An economic measure of the full cost of owning a product (typically computing hardware and/or software). TCO includes direct costs such as purchase price, plus indirect costs such as training, support, and maintenance. -Staying power is important for consumers of technology products because investment over time usually greatly exceeds the initial price paid for a product or service. A user invests in learning how to use a system, buying and installing software, entering preferences or other data, creating files-all of which mean that if a product isn't supported anymore, much of this investment is lost. Complementary Benefits -Complementary Benefits: products or services that add additional value to the network (how to books, software, addons, even labor) -It is important to have these as a firm because the more you have the more value your product/service has and people want to invest their time and resources where they’re likely to reach the biggest market and get the greatest benefit. (Accountants learn excel rather than other spreadsheet software bc Excel is the most widely used) -Products or services that encourage others to offer complementary goods are sometimes called platforms -API: application programming interfaces, allow third parties to integrate their products and services allowing those firms to spend their time and money to enhance your own firms offerings -Example: Apple has extended iOS into all sorts of products so that even when a consumer purchases something like a lock for their house, this lock may have some kind of integrated functionality through iOS that allows it to be locked/unlockled from a users apple device, thus adding value to the apple device itself -Because things can be integrated quickly like they were across iOS, software based ecosystems can grow VERY QUICKLY -Key Takeaway: These three value-adding sources—exchange, staying power, and complementary benefits—often work together to reinforce one another in a way that makes the network effect even stronger. When users exchanging information attract more users, they can also attract firms offering complementary products. When developers of complementary products invest time writing software—and users install, learn, and customize these products— switching costs are created that enhance the staying power of a given network. Understanding Network Structure -One Sided Market: networks that derive most of their value from a single class of users. Example: messaging apps, because you choose which messaging app you want to use based upon how many of your contacts you can reach -Same side exchange benefits: benefits derived by interaction among members of a single class of participant, network effects derived from USERS attracting more USERS OR SUPPLIERS attracting more SUPPLIERS -Two Sided Market: network markets that comprise two distinct categories of participant, both of which are needed to deliver value for the network to work -Cross Side Exchange Benefit: when an increase in the number of users on one side of the market creates a rise in the other side (video game market, as the number of players on a particular console increases so to does the number of developers producing games for that console and vice versa The Positive Feedback Loop of Network Effects: One-Sided, TwoSided, and Sometimes a Bit of Both -Mobile payment apps are also an example of two sided markets because as more firms begin to accept the app as a form of payment more users will download the app and also as more users have the app more firms will accept it as a form of payment -Its also possible for a network to have both same-side and cross-side benefits. Xbox benefits from cross side benefits when it comes to attracting developers and players, but also same side when it comes to attracting users through Xbox Live bc you will want to play on the console your friends are on -Apple also did this when it allowed its one sided messages app to become a platform to incorporate third party app developers that added all sorts of new capabilities (emojis and animations and games etc) thus giving it some cross side benefits How are these markets Different? -When network effects are present, competition in an industry can be fundamentally different than in conventional ones where no network effects are present 1. Network Markets experience early, fierce competition because of the positive feedback loop in which the biggest networks become even bigger. As soon as bandwagons form among consumers new consumers begin to overwhelmingly favor the leading product over rivals which just makes the firms even more aggressive in the early stages 2. These firms are also often winner take all/most, exhibiting monopolistic tendencies in which one firm dominates all rivals. The natural state of markets where strong network effects are present is for there to be one major player. This also increases not only how much the firm can charge customers but also how much bargaining power it has over its partners (Itunes and record labels for example) 3. The best product or service does NOT always win. (PS2 had more users than Xbox even tho reviews always claimed Xbox was a better system. However, since PS2 had more users it continued to attract more developers offering more games. Winning customers away from a dominant player in a network industry isn’t as easy as offering a product or service that is better. Any product that is incompatible with the dominant network has to exceed the value of the technical features of the leading player, plus (since the newcomer likely starts without any users or third-party product complements) the value of the incumbent’s exchange, switching cost, and complementary product benefit 4. Technological Leapfrogging: Competing by offering a new technology that is so superior to existing offerings that the value overcomes the total resistance that older technologies might enjoy via exchange, switching cost, and complementary benefits, can be very tough because of the reasons mentioned in #3 Good for innovation? - The fact that network effects create a dominant standard/firm is NOT necessarily bad for innovation. While it is true that network effects limit competition AGAINST the dominant standard, innovation WITHIN a standard may actually blossom -For example, Microsoft being the clear dominant OS means that developers invest in learning to write software for Windows because they know it will be compatible with a large amount of users. Same case with Apple’s iPhone and the app store. Previously there were so many different types of mobile devices offering apps that developers were deterred because writing marketing and maintaining multiple product version is costly and risky. However, with the dominant standard that the iPhone brought, many new developers were now able to produce things for one device that would be widely used Competing When Network Effects Matter -When planning for market dominance its critical to know if network effects exist, how strong they are, where they come from, and how they might be harnessed to your benefit Strategies for Competing in Markets with Network Effects 1. Move Early ● Being first allows your firm to start the network effects snowball in your favor and can be enough to ward off any competitors that come after you if youve established yourself well enough early on ● Exchange depends on the ability to communicate, markets with different languages serve as “greenfields” for a different firm to tap into if you do not get there first ● Cool ideas do not automatically make network effects happen 2. Subsidize Adoption ● Firms sometimes offer subsidies to initial customers (like cashback on a payment app) in order to garner a larger network early on in the hopes that network effects will kick in later ● Sometimes however even offering your product/service for free is not enough to gain new users especially when their is already another established dominant firm whose customers have a high perceived switching cost (ie the network effects of having more users on the other firm makes people choose to not go to the new one) 3. Leverage Viral Promotion ● Since all products/services foster some sort of exchange its often possible to leverage a firms customers to promote the product or service ● VIral promotions are also often linked to subsidies (recruit a friend bonuses) but also provide the additional benefit of leveraging a trusted friend to provide adoption inertia ● Social Proof: the positive influence created when someone finds out others are doing the same thing. This is a very powerful tool when it comes to overcoming customer trust issues ● Social media incentivization through the use of things like pictures and hashtags can also be a very effective form of viral promotion by users 4. Expand by Redefining the Market ● Bigger markets attract more users (and in 2 sided markets more complements as well) so it makes sense to redefine the space youre selling to to bring in more users (Wii marketing its game system to groups other than just young males) ● Blue Ocean Strategy: popularized by W Chan Kim and Renee Mauborgne, this idea states that firms should avoid competing in the blood red waters where the sharks of highly competitive firms vie for every available market scrap and instead should seek the blue waters of uncontested, new market spaces. This strategy often works best when combined with strategic positioning benefits, thus if your firms claim in the new market is easily immitatable then holding off rivals will be tough ● Convergence: when two or more markets once considered distinctly separate begin to offer similar features and capabilities (media players and mobile phones merging into one) ● Envelopment: firm seeks to make an existing market a subset of its product offering (Ipod capabilities were baked into the iPhone) 5. Alliances and Partnerships ● Firms can also use partnerships to grow market share for a network, often these efforts involve rivals coming together to take out a leader (Citi ATMs vs the rest of the banks who teammed up to deploy ATMs after) ● Lyft, Ola, Didi, and GrabTaxi all operate in different regions so they share tech, local market knowledge, and business resources with the leading firm in each nation while also allowing users to book cabs from each others apps in all regions that they operate. They do this in an effort to stave off Uber who is trying to expand globally 6. Leverage Distribution Channels ● Sometimes you have to find creative or new ways to get your product to consumers. Sun and their programming language Java needed to get the JVM downloaded onto peoples computers for their language to even mean anything so they came up with the solution of bundling the language with Netscape essentially sneaking the program onto everyones computer. Microsoft also does this by bundling its WMP and internet explorer with its operating system, although it has run into legal trouble for this as governments view such bundling activities as anticompetitive and european regulators have actually forced microsoft to unbundle these products ● Another way is to create a new distribution channel just as apple did when it opened its retail Apple Store, many thought it was a bad move but now it it among the worlds most successful retail outlets on a sales per sq ft basis 7. Seed the Market ● The process of allocating a good to specific customers in order to stimulate the internal dynamics of the market, enhance the diffusion process and encourage faster adoption of the product throughout the entire population ● Sony did this when it subsidized the cost of the PS3 in order to put Blu Ray players in them because it had a large stake in the Blu Ray DVD industry 8. Encourage the Development of Complementary Goods ● Can be done through developer subsidy or other free or discounted service (charge lower royalties or offer a period of royalty free licensing, free software development kits (SDKs), training programs, co marketing dollars, or even startup capital to potential suppliers. ● Microsoft and Apple both do this by providing markets for developers to sell their products/games without having to spend big to reach millions of potential customers ● Firms like Oculus and Slack have multi million dollar funds specifically for encouraging developers to build goods that are compatible with their platform, Apple has also created a programming language called Swift that has become one of the worlds most popular and in demand programming languages that is also compatibile with apple software 9. Leverage Backwards Compatability ● Backwards Compatibility: the ability to take advantage of complementary products developed for a prior generation of technology ● If you fail to make things backwards compatible you give up a major source of advantage-the switching cost built up by prior customers. This is because doing so essentially wipes their slate clean and since theyre starting completely new in this technology they may look to competitors who offer better/cheaper products ● Adaptor: product that allows a firm to tap into the complementary products, data, or user base of another product or service 10.Rivals: Be Compatible with the Leading Network ● Companies should want to make new products compatible with the leading standard so that they can incorporate any work done by the competitors on their product into the firms own new one as add-on content 11. Incumbents: Close Off Rival Access and Constantly Innovate ● Firms that control dominant networks will make compatability difficult for rivals who try to connect with their systems ● One way to do this is to constantly innovate your product so people trying to make theirs compatible have to “hit a moving target” ● Apple and Mac do this well by constantly iterating on their technology while also actively looking out for third parties who try to clone mac hardware and suing them 12. Large Well Known Followers: Preannouncements ● Large firms that find new markets attractive but dont yet have products should preannounce efforts in order to cause potential adaptors to sit on the fence, delaying purchasing decision until the new effort rolls out. These only work if the firm is large enough to pose a credible threat to current market participants. ● Thus, startups often lack the ability to delay user purchases ● FUD: tech industry acronym for the impact firms try to impart on markets through preannouncements, stands for Fear, Uncertainty, and Doubt ● The Osborne Effect: When a firm preannounces a forthcoming product or service and experiences a sharp and detrimental drop in sales of current offerings as users wait for the new item. Beware of this when preannouncing Too Much of a Good Thing? - Network effects in which users attract more users are only a good thing as long as a firm can earn money from this cycle. Sometimes though a network effect attracts too many users and a service can be so overwhelmed that it becomes unusable, creating Congestion Effects - Congestion Effects: When increasing numbers of users lower the value of a product or service. Happens most often when a key resource becomes increasingly scarce - While network effects can attract positive complementary products, a dominant standard may also be the first place where virus writers and malicious hackers choose to strike