networks and positive feedback john morgan. important ideas positive feedback network effects...
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Networks and Positive Feedback
John Morgan
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Important Ideas
Positive feedback Network effects Returns to scale
Demand side Supply side
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Positive Feedback
How system adjusts to perturbations Negative feedback: stabilizing Positive feedback: destabilizing
Positive feedback makes a market “tippy” – winner take all Examples: VHS v. Beta, Wintel v. Apple,
56k modems, DVD v DivX “Winner-take-all markets”
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Sources of Positive Feedback
Supply side economies of scale Declining unit cost of supply Marginal cost less than average cost Example: information goods are all fixed cost
Demand side economies of scale Increasing value to users as market share increases A single standard: fax, email, Web Competing standards: VHS v. Beta, Wintel v. Apple,
56k modems, Codec “standards” in Digital Audio
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Color fax machine You have a new technology for color
fax machines License it to many sellers Technology can only be used by
sender if receiver has color fax machine
So there is a strong network effect---value to user of technology depends on number of adopters
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Setup Indicate your adoption of the technology by
standing up The number on your card shows that value v
(to you) of adopting if you are the only adopter In n people (including you) adopt, your value is
nv I will write the price of the fax machine on the
board Adopt when your value (strictly) exceeds the
price.
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Analysis
Standalone values were 10,9,8,…,1
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Analysis vn = p : marginal user wants to adopt n=10-v :everyone with greater value
than marginal user adopts Combine to give demand=supply
condition (10-n)n=p n=1, (10-1)1=9 n=2, (10-2)2=16 n=3, (10-3)3=21… n=9, (10-9)9=9
Takeoff occurs when p=9
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Adoption Dynamics
Number of Users
Time
Launch
Takeoff
Saturation
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Network Effects
Demand side economies of scale often referred to as network effects Real networks – telecom Virtual networks – network of users
Metcalfe’s Law: Value of network of size n proportional to n2
Experiment is an example of this
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Expectations Matter What is the difference between success
and failure in tippy markets? Expectations Matter:
I want to join network that I expect to succeed
Central part of successful marketing is setting appropriate expectations Commitment can help Old economy example: Banks New economy example: Microsoft version
1.0 products
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Virtuous Cycles and Death Spirals: 1-2-3 v Visicalc
“Death spiral”
Virtuous cycle
Value to User
Number of Users
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Direct and indirect Network Effects
Value to me depends directly on number of adopters Fax machine, telephone, email
Value to me depends on adoption of some complementary product DVD player/ DVD disks eBook reader + content Palms and software
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Are All Information Markets “Tippy”?
AOL Dell Google What are the key drivers of
network effects?
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Network Effects–Likelihood of Tipping
Low ScaleEconomies
High ScaleEconomies
Low DemandFor Variety
Unlikely High
High DemandFor Variety
Low Depends
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Chicken & Eggs
Fax and fax machines VCRs and tapes DVDs: A more complicated
problem Online dating
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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
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Compatibility versus Performance
Performance
Compatibility
Evolution
Revolution
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Evolution
Offer a migration path Examples
Microsoft Windows Intel Borland v Lotus
Build new network by links to old one
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Important Considerations
Use creative design for migration Think in terms of whole system
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Compatibility versus Performance
Performance
Compatibility
Evolution
Revolution
Migration “sweet spot”
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Technical Obstacles
Converters and bridge technologies One-way compatibility or two way? Windows for Wordperfect users Importance of UI
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Legal Obstacles
May need IP licensing Example: Sony and Philips had
advantage since they held the patents on CDs DVD players usually play CDs as well
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Revolution
Grove’s law: “10X rule” But depends on switching costs Examples: Nintendo, Iomega Zip,
DVD, CD
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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 technology is
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Openness Full openness
Anybody can make the product Problem: no champion Unix v BSD v Linux
Alliance Only members of alliance can use Problem: holding alliance together Conflicting incentives: China and DVDs
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Control
Control the standard and go it alone
If several try this strategy, may lead to standards wars
iPod/iTunes v MP3 players
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Generic Strategies
Control Open
Compatible ControlledMigration
OpenMigration
Incompatible PerformancePlay
Discontinuity
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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
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Lessons, continued
Fundamental tradeoff: openness and control
Generic strategies Performance play Controlled Migration Open Migration Discontinuity
Lessons of history