Networks and Positive Feedback

John Morgan

Important Ideas

Positive feedback Network effects Returns to scale

Demand side Supply side

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”

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

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

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.

Analysis

Standalone values were 10,9,8,…,1

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

Adoption Dynamics

Number of Users

Time

Launch

Takeoff

Saturation

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

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

Virtuous Cycles and Death Spirals: 1-2-3 v Visicalc

“Death spiral”

Virtuous cycle

Value to User

Number of Users

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

Are All Information Markets “Tippy”?

AOL Dell Google What are the key drivers of

network effects?

Network Effects–Likelihood of Tipping

Low ScaleEconomies

High ScaleEconomies

Low DemandFor Variety

Unlikely High

High DemandFor Variety

Low Depends

Chicken & Eggs

Fax and fax machines VCRs and tapes DVDs: A more complicated

problem Online dating

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

Compatibility versus Performance

Performance

Compatibility

Evolution

Revolution

Evolution

Offer a migration path Examples

Microsoft Windows Intel Borland v Lotus

Build new network by links to old one

Important Considerations

Use creative design for migration Think in terms of whole system

Compatibility versus Performance

Performance

Compatibility

Evolution

Revolution

Migration “sweet spot”

Technical Obstacles

Converters and bridge technologies One-way compatibility or two way? Windows for Wordperfect users Importance of UI

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

Revolution

Grove’s law: “10X rule” But depends on switching costs Examples: Nintendo, Iomega Zip,

DVD, CD

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

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

Control

Control the standard and go it alone

If several try this strategy, may lead to standards wars

iPod/iTunes v MP3 players

Generic Strategies

Control Open

Compatible ControlledMigration

OpenMigration

Incompatible PerformancePlay

Discontinuity

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

Lessons, continued

Fundamental tradeoff: openness and control

Generic strategies Performance play Controlled Migration Open Migration Discontinuity

Lessons of history