February 11, 2003 John Roberts 1

Stanford GSBSloan Program

Strategic Management

11: Demand-Side Increasing Returns

Sony Corporation

February 11, 2003 John Roberts 2

• DSIR-- the positive spin:– The benefits to any user (consumer or firm)

from a product depend on the number of others using“related” technologies/products.

• DSIR-- the negative spin:– The pressure on any user (consumer or firm) to

use a product depends on the number of others using“related” technologies/products.

February 11, 2003 John Roberts 3

• Two drivers of DSIR:

– Network effects: the value of the item to a user depends positively on the number of other users (first-order network effects)

– Compatible complement effects: the user (implicitly) values compatibility of the item with complements, the value or supply of which depends on the number of users (second order network effects).

February 11, 2003 John Roberts 4

• Strategic challenge/opportunity in markets with network externalities:– Expectations are crucial: adoption depends on

how many others are expected to adopt the (compatible) item.

This chicken and egg/coordination problem means that many such items never get adopted.

However, it also means that, once adopted, there tends to be strong ‘lock-in’.

- Key importance of switching costs

February 11, 2003 John Roberts 5

• Controversy: do DSIR mean that mediocre technologies win?– Mixed evidence

• QWERTY

• VHS

• DOS/Windows

– Item’s quality must remain high enough to overcome costs of adopting rival item

– Disproportionate success due to tipping

February 11, 2003 John Roberts 6

• Factors swaying adoption• Reputations• Number of existing platforms• Cost of adoption (e.g., software)• Influential buyers (e.g., Safeway with UPCs)• ‘Open’ Standards

– Trade-off with monopoly position

• Availability of complements

February 11, 2003 John Roberts 7

• Strategic Tools in Markets with DSIR• Provide or subsidize complements to ensure

availability (ownership?)• Exaggerated Claims• Advance sign-ups• Give-aways and bargain prices

– Product to get buyers

– Technology to get suppliers and set standard

• Upgrade pricing• “Winks” at pirates

February 11, 2003 John Roberts 8

• Leveraging positional advantage– A firm that controls the prior standard may be

able to steer technological change in a preferred direction.

– Examples from Microsoft:• Using its dominance with MS-DOS to gain acceptance

for Windows and the consequent takeover of the applications layer.

• Various strategies to make web-users use IE and make the latter dependent on the Windows OS (e.g., deal with OEMs, deals with ISPs, melding IE with the OS)