Document Sample
					       Strategic Management of
       Technological Innovation
       Melissa Schilling

Chapter 4
  The Rise of Microsoft
• In 1980, Microsoft didn’t even have a personal computer (PC)
  operating system – the dominant operating system was CP/M written
  and sold by Gary Kildall through his company Digital Research
• As the market for personal computers grew and IBM realized they
  were missing out on what might be a significant industry, they rushed
  to get a PC to market.
   – Kildall, for some unclear reason, did not get back to IBM fast
      enough so they turned to Bill Gates who was already writing
      software for IBM.
   – Gates bought an operating system from Seattle Computer Company
      and called it MS DOS. It was a clone of CP/M.
• The success of the IBM PCs (and clones of IBM PCs) resulted in the
  rapid spread of MS DOS, and an even more rapid proliferation of
  software applications designed to run on MS DOS. Microsoft’s
  Windows was later bundled with (and eventually replaced) MS DOS.
• Had Gary Kildall signed with IBM, or had other companies not been
  able to clone the IBM PC, the software industry might look very
  different today!
The Rise of Microsoft

Discussion Questions:
1. What factors led to Microsoft's emergence as the
   dominant personal computer operating system
   provider? Is Microsoft's dominance due to luck, skill, or
   some combination of both?
2. How might the computing industry look different if Gary
   Kildall had signed with IBM?
3. Does having a dominant standard in operating systems
   benefit or hurt consumers? Does it benefit or hurt
   computer hardware producers?

• Many industries experience strong pressure to
  select a single (or few) dominant design(s).
• Once selected, producers and customers focus
  their efforts on improving their efficiency in
  manufacturing, delivering, marketing or deploying
  this dominant design rather than continue to
  develop and consider alternatives
• There are multiple dimensions of value that shape
  which technology rises to the position of the
  dominant design.
  – The strategies of firms can influence several of
    these dimensions, enhancing the likelihood of their
    technologies rising to dominance.
Why Dominant Designs Are Selected
• Increasing returns to adoption
 – When a technology becomes more valuable the more it
   is adopted.
 – The more they are used, the more they are understood
   and thus improved
   • Revenues generated can be used to further develop and refine
     the technology
 – As a technology becomes more widely adopted,
   complementary assets are often developed that are
   specialized to operate with the technology
   • This results in a self-reinforcing mechanism that increases the
     dominance of a technology regardless of its superiority or
     inferiority to competing technologies

  Why Dominant Designs Are Selected
• Two primary sources of increasing returns to adoption are learning effects
  and network externalities.
   – The Learning Curve: As a technology is used, producers learn to
     make it more efficient and effective often with reduced input costs or
     waste rates
      • The cost of producing a unit falls as the number of units produced increases.
      • This pattern has been found to be consistent across a wide range of
        products and services including automobiles, ships, semiconductors, drugs
        and even heart surgery techniques

Why Dominant Designs Are Selected
–Prior Learning and Absorptive Capacity
 • A firm’s prior experience influences its ability to recognize and
   utilize new information.
    – Use of a particular technology builds knowledge base about that
       • Even failures can provide a useful learning experience and build a
         base of knowledge for future use
    – The knowledge base helps firms use and improve the technology
       Suggests that technologies adopted earlier than others are likely to
         become better developed, making it difficult for other technologies
         to catch up.
    – As a technology becomes more widely adopted, complementary assets
      are often developed that are specialized to operate with the technology
       • This results in a self-reinforcing mechanism that increases the
         dominance of a technology regardless of its superiority or inferiority
         to competing technologies

Why Dominant Designs Are Selected
–Network or Positive Consumption
  • In markets with network externalities, the benefit
    from using a good increases with the number of other
    users of the same good.
  • Network externalities are common in industries that
    are physically networked
    – e.g., railroads, telecommunications
  • Network externalities also arise when compatibility or
    complementary goods are important
    – e.g., many people choose to use Windows in order to
      maximize the number of people their files are compatible
      with, and the range of software applications they can use.

  Why Dominant Designs Are Selected
• A technology with a large installed base attracts developers of
  complementary goods; a technology with a wide range of
  complementary goods attracts users, increasing the installed base. A
  self-reinforcing cycle ensues
   – Example of the cycle: Microsoft’s dominance of the OS market and
     GUI market is due to the early adoption of their product which led to
     a large installed base and the development of complementary
     products. This further increased the installed base and reinforced the

  Theory In Action
      A Standards Battles in Digital Audio Formats
• 1982:Sony and Phillips jointly developed the CD that replaced the vinyl
  LP and split the royalties
• Late 1990s: CD market was saturated, looking for new audio format for
  continued growth of the market and prevent music piracy
• 1996: record companies and electronics companies joined together to
  form the DVD Audio Consortium to create a new high-fidelity audio
• 1999: Sony and Philips unveiled their own high-fidelity audio format,
  Super Audio CD, setting the stage for a standards battle similar to the
  VHS versus Beta battle in video recorders.
• Fearing a format war that would select one standard as dominant (and
  one as failed), many manufacturers decided to bear the extra cost of
  producing “Universal players” that would support both formats.
• Neither format has been extremely successful, and popularity of MP3
  format may further dampen demand.

Why Dominant Designs Are Selected
• Government Regulation
   – Sometimes the consumer welfare benefits of having a
     single dominant design prompts government
     organizations to intervene, imposing a standard.
    • 1953: FCC approved the NTSC color standard in television
      broadcasting to ensure compatibility to monochrome TV sets
      broadcasting in the U.S.
    • 1998: EU adopted a single wireless telephone standard the
      general standard for mobile communications (GSM) to avoid
      proliferation of incompatible standards and facilitate exchnage
      within and between members countries
• The Result: Winner-Take-All Markets
   – Natural monopolies
    • Firms supporting winning technologies earn huge rewards; others
      may be locked out.

Why Dominant Designs Are Selected
 – Increasing returns to adoption indicate that technology trajectories
   are characterized by path dependency:
    • End results depend greatly on the events that took place leading up to
      the outcome.
       – Early technology offerings may become entrenched and block subsequent
         superior technologies from being accepted
       – Aggressive sponsorship by a large and powerful firm may ensure acceptance
         but lock out alternatives
 – A dominant design can have far-reaching influence; it shapes future
   technological inquiry in the area.
    • Firms will tend to use and build on their existing knowledge base rather
      than enter unfamiliar areas
 – Winner-take-all markets can have very different competitive dynamics
   than other markets.
    • Technologically superior products do not always win.
    • Such markets require different firm strategies for success than markets
      with less pressure for a single dominant design.
       – Winners know how to manage the multiple dimensions of value that shape
         design selection

   Multiple Dimensions of Value
• In many increasing returns industries (the rate of return from
  a product or process increases with the size of it’s installed
  base), the value of a technology is strongly influenced by
  – Technology’s Standalone Value
  – Network Externality Value
• A Technology’s Stand-alone Value
  – Includes such factors as:
     • The functions the technology enables customers to perform
     • Its aesthetic qualities
     • Its ease of use, etc.
  – Kim and Mauborgne developed a “Buyer Utility Map” that provides a
    guide for managewrs to consider multiple dimensions of technological
    value and multiple stages of the customer experience
     • The benefits have to be considered with respect to the cost to the customer
       of obtaining or using the technology – the benefits to cost ratio determines
Multiple Dimensions of Value

Multiple Dimensions of Value
– Network Externality Value
  • In industries characterized by network externalities, the value of
    technological innovation to users will be a function not only of its
    stand-alone benefits and cost, but also of the value created by:
     – The size of the technology’s installed base
     – The availability of complementary goods
  • A new technology that has significantly more standalone
    functionality than the incumbent technology may offer less overall
    value because it has a smaller installed base or poor availability of
    complementary goods.
     – Value to customers of Windows OS is due to stand-alone value (makes
       it easy use computer), the installed base (number of users you can
       interact with) and availability of compatible software. This is what
       makes it difficult for OSs that are better than Windows to gain a
       foothold in the market
     – NeXT Computers were extremely advanced technologically, but could
       not compete with the installed base value and complementary good
       value of Windows-based personal computers. They were not
       compatible with Wintel machines which had become the standard.
Multiple Dimensions of Value
– To successfully overthrow an existing dominant
  technology, new technology often must either offer:
  • Dramatic technological improvement (e.g., in videogame consoles,
    it has taken 3X performance of incumbent)
    – Greater stand-alone value is not enough, needs greater overall value
      see Fig 4.4(b)
  • Compatibility with existing installed base and complements see
    – Super Audio CD (SACD) from Sony and Philips is a new audio format
      based on Direct Stream Digital technology.
       • It is much better than standard CD technology but they made it
         backward compatible so that people would not have to throw out
         their existing CDs when they buy the new player and the new disks
         can be played on old CD players as well
       • Thus they maintained compatibility with the existing installed base
         and complementary goods

Multiple Dimensions of Value

     Multiple Dimensions of Value
• When comparing the value of a new technology to an existing one, users are
  weighing a combination of:
  – Objective information; actual benefits, installed base and complementary goods
  – Subjective information: perceived benefits, base and complementary goods
  – Expectations: anticipated benefits, base and complementary goods
• These three may be proportional or not
  – For example, perceived installed base may be greater than actual.
  – How is this accomplished? Marketing, stretching the truth, vaporware
     • When Sega and Sony introduced their 32-bit video game consoles, Nintendo was far from
       having one in production. Instead, Nintendo began promoting the development of a 64-
       bit system in 1994 even though it didn’t appear until 1996. But many customers believed
       Nintendo and held off buying the 32-bit systems.
     • Post mortem: Sony developed the PlayStation2 with more than 2x the processing power
       of the Nintendo 64, made it backward compatible, made sure there was a large supply of
       game titles available at launch, marketed it as if it would the product everyone would by
       and sold it at a very low price. Nintendo never regained market dominance

Multiple Dimensions of Value
Actual, Perceived and Expected Components of Value

  Multiple Dimensions of Value
• When customer requirements for network externality value
 are satiated at lower levels of market share, more than one
 dominant design may thrive.
  – This may be the case in the video game console industry.
    While a larger market share may increase network externalities
    so that customers have more games and more people to play
    against, those benefits can be achieved without attaining a
    majority of the market
     • Sony has a majority share of the US video game market and
       neither Nintendo’s GameCube nor Microsoft’s Xbox has greater
       than a 20% market share
     • Yet, there is still an abundance of game titles for all three
       consoles and a significant pool of people to play games against
     • Such markets may not experience great pressure to select a
       single dominant design; ,multiple platforms may successfully exist

   Are Winner-Take-All Markets Good for
• Economics emphasizes the benefits of competition.
  However, network externalities suggest users sometimes
  get more value when one technology dominates.
• Some would argue that Microsoft has clearly engaged in
  anticompetitive behavior in its quest to dominate the PC
  operating system market, others would counter that it’s
  overwhelming market share has created greater
  compatibility among computers and software applications.
• How can a regulatory board determine if a firm has become
  too dominant?
• One way is to compare the network externality returns to
  market share (value customers reap by more people using
  the same product) with corresponding monopoly costs
  (benefits form gets when their product is dominant)
   Are Winner-Take-All Markets Good for
• Network externality benefits to customers rise with cumulative
  market share
   – Greater availability of complementary goods
   – More compatibility among users
   – More revenues that can be channeled into further developing the
• Monopoly costs to customers also rise with cumulative market
   – Price gouging
   – Restricted product variety
   – Product innovation may be stifled or purposely delayed

      Are Winner-Take-All Markets Good for
• Network externality returns to market share often exhibit an s-shaped
• Monopoly costs to market share are exponentially increasing
• The two costs trade off against each other
   – Where monopoly costs exceed network externality benefits, intervention may
     be warranted. Optimal market share is at point where lines cross.
   – A firm can choose not to charge the highest price the market will bear – some
     say that Microsoft does not charge the maximum price for Windows OS but
     they are able to control the evolution of the market by selectively aiding some
     suppliers or complementors more than others

Discussion Questions
 1. What are some of the sources of increasing returns to adoption?
 2. What are some examples of industries not mentioned in the
    chapter that demonstrate increasing returns to adoption?
 3. What are some of the ways a firm can try to increase the overall
    value of its technology, and its likelihood of becoming the
    dominant design?
 4. What determines whether an industry is likely to have one or a
    few dominant designs?
 5. Are dominant designs good for consumers? Competitors?
    Complementors? Suppliers?