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					Platform-Mediated Networks

      Module Overview
      November 8, 2007
                      Notes for Instructors
• These slides are available for download as a file named ―PMN
  Slides.ppt‖ at
• I‘ve provided comments on many of the slides, visible as ―Notes‖
  (from the ―View‖ menu, select ―Notes Page‖).
• Feel free to adapt the slides in any way you see fit. In the spirit of open
  source, if you make changes or additions, please forward a copy to me
  at so I can post them for others. I‘m also happy
  to answer questions about the slides by email.
• The slides present concepts covered in an introductory module on
  platform-mediated networks, designed for use in existing courses on
  strategy, technology management, marketing, entrepreneurship, or
  ecommerce. The module is described in ―Platform-Mediated
  Networks: Module Note for Instructors,‖ HBS #807-067.
• For instructors who wish to delve deeper, the module‘s materials are
  drawn from a case-based MBA elective course, described in
  ―Managing Networked Businesses: Course Overview for Educators‖
  HBS #807-104.

1.   Overview, Definitions, and Core Concepts
2.   Network Mobilization
3.   Platform Control
4.   Platform Envelopment

Our vision for the last 20 years can be summarized
in a succinct way. We saw that exponential
improvements in computer capabilities would make
great software quite valuable… In the next 20 years
the improvement in computer power will be
outpaced by the exponential improvements in
communications networks. The combination of
these elements will have a fundamental impact on
work, learning and play.

                                                     Bill Gates
                            The Internet Tidal Wave, May 1995

•   Netscape IPO
•   Rob Glaser launches RealNetworks
•   VocalTec introduces VoIP
•   First cable modems
•   FCC auctions digital mobile spectrum
•   Palm launches Pilot

• IBM embraces Linux
• XML is created, paving the way for ―web
• 802.11b (Wi-Fi) takes off
• Napster launched
• TiVO launched

    2004: Explosive Growth in…
•   Google‘s valuation
•   Skype
•   RSS, podcasting
•   Blogs
•   Open source software
•   Wikipedia
•   BitTorrent
    Platform-Mediated Networks
• Network users access a common platform that
  facilitates their interactions
• Platforms = subset of components and rules
  employed by users in most of their transactions
   – Components = hardware, software, services
   – Rules = technical standards, protocols for information
     exchange, policies, and contracts that govern
• Users rely on a platform when doing so is more
  efficient than unmediated bilateral dealings


User A
User A                  User B

  Components       Rules
  - Hardware       - Standards
  - Software       - Protocols
  - Services       - Policies
                   - Contracts


                eBay‘s Platform
• Components
  –   Browser and Internet access (from 3rd parties)
  –   Website design
  –   Bid tracking software
  –   Shipping services (from 3rd parties)
  –   Links to PayPal (an eBay-owned platform)
  –   Etc.

• Rules
  –   Registration requirements
  –   Dispute resolution processes
  –   Feedback system
  –   Policies for bidding
  –   Etc.
                      Network Effects
• Definition: Network‘s value to a user depends on the
  number of other network users
   – ―Value‖ = willingness-to-pay for network participation =
     WTP for platform affiliation = cap on platform fees
• Properties
   – Can be negative, e.g., due to congestion
   – WTP tends to increase as ―S‖-shaped (logistic) function of
     network growth
   – Network effects are demand-side economies of scale, i.e.,
     they impact revenues
      • Network effects are not supply-side scale economies, which improve unit margins
        through fixed-cost leverage
      • However, many networked businesses do enjoy strong supply-side economies

 Platform-mediated networks do not
       necessarily encompass:
• Physical networks (e.g., gas utilities)
• Social networks (e.g., your golf buddies)
• Supply networks, aka ―ecosystems,‖
  comprised of large firms and their most
  committed suppliers and customers
  (e.g., Wal-Mart, Toyota)

           Why Study
  Platform-Mediated Networks?
• Large and growing share of global
• Distinctive management challenges

            Large and Growing Share of
                 Global Economy
• Not just digital industries, also:
   – Financial services, e.g., ATMs, credit cards, stock exchanges
   – Transportation, e.g., package delivery, airlines, travel agents,
     reservation systems, fuel cell-powered cars
   – Retail, e.g., shopping centers, bar codes/RFID
   – Energy, e.g., grid + appliances, energy trading
   – Real estate, e.g., home buying
   – Health care, e.g., HMOs
   – Enterprise administration, e.g., recruiting, B2B procurement
• 60 of the world‘s 100 largest companies earn most of
  their revenue from platform-mediated networks
               Distinctive Challenges
• Concepts are new: first academic papers on ―two-
  sided‖ networks published in 2003
• Platform-mediated networks are very complex, but
  oversimplification is common
   – Over- or underestimate strength of network effects
   – Price to network‘s sides as if they were separate markets
• Errors can be fatal
   –   Yahoo, Amazon failed in U.S. auctions
   –   eBay exited Japan and China; failed to dislodge PayPal
   –   NASDAQ collusion = $1 billion fine; ECN entry
   –   IBM spent $1+ billion on OS/2
   –   Apple forfeited Microsoft‘s position
       Distinctive Challenges

• Business Model Design
• Winner-Take-All Dynamics

      Business Model Design
―This is like the Cambrian explosion 550 million years
ago, when multicelled life first appeared on the scene. It
was the greatest speciation ever seen, but it was also —
which people forget — the greatest rate of extinction ever
seen. We‘re going to see all kinds of ideas tried, and the
majority of them are probably going to fail.‖

                            Jeff Bezos, CEO
                                 (Business Week, 9/13/99)

        Designing Business Models
           is Difficult Due To:
• ―Two-sidedness‖ of most networks
• Bifurcation of platform roles
• Rapid growth, precluding trial-and-error

       One- and Two-Sided Networks

• “One-sided” networks: Transaction partners
  alternate roles, e.g., e-mailers send & receive,
  traders buy & sell
• “Two-sided” networks: Users are permanent
  members of one distinct group — a ―side‖ —
  which transacts with a second group, e.g.,
  – Job seekers + recruiters
  – Card holders + merchants

     A two-sided network has
       four network effects
                             • A same-side effect for
                               each side, i.e.,
                               preference regarding
Side 1              Side 2     number of other users
                               on own side
                             • A cross-side effect in
                               each direction, i.e.,
         Platform              preference regarding
                               number of users on
                               other side
                             • Each effect can be
                               positive or negative
  Platform Roles: Sponsors and Providers
• Providers are users‘ primary point of contact
  with platform
• Sponsors do not deal directly with users; rather,
  sponsors hold property rights that determine:
   – Who may change platform technology
   – Who may participate in network as a platform
     provider or network user

       VISA =                              XBOX =

 CARD                   MERCHANTS     GAMER                  DEVELOPER

                                          CONSOLE          SDK
      BANKS            BANKS


       Distinctive Challenges

• Business Model Design
• Winner-Take-All Dynamics

Schumpeterian Competition: Serial WTA Battles

•   VCR  DVD + PVR + VOD
•   LP  CD  download and/or subscription
•   Human market makers  ECNs
•   1G  2G  3G
•   Analog POTS  VoIP
•   Broadcast  cable  IP TV
•   Atari  Nintendo  Playstation  Xbox?
•   Wi-Fi  WiMax?
•   Gasoline-powered cars  Fuel cell-powered cars?
•   Barcodes  RFID?

Blu-Ray vs. HD-DVD

• Network effects  increasing returns 
  winner-take-all, i.e., one platform prevails
• Examples: Windows, eBay, PDF, DVD, fax,
  real estate MLS
• Winner-take-all implies loser takes nothing!
• So, should you share platform with rivals?
• If not, should you race to acquire network

            WTA Implications
• Sharing and racing are ―bet-the-company‖
  decisions, so organizational design is crucial
• Growth opportunities  capital market
• WTA monopoly power  government

          Platform Structure
• Winner-take-all: one platform serves the
  mature networked market
• Mono-homing: most users on a given side
  affiliate with a single platform
• Multi-homing: most users on a given side
  affiliate with multiple platforms

Platform Structure Examples

  Networked Market is More Likely to be
   Served by a Single Platform When:
• The platform is a natural monopoly


• Multi-homing costs are high AND
• Network effects are positive and strong AND
• Demand for differentiated features is weak
  – OR dominant platform can offer such features
    selectively to users willing to pay premium
 Natural monopoly: minimum efficient
scale of production > mature market size

Natural monopolies are rare, but evident in
       some networked businesses
 • Past: local utilities (phone, power,
   cable TV), railways, postal delivery
 • Present
   – Internet content delivery networks (e.g.,
     Akamai, which has 85% market share based on
     huge investment in servers)
   – Failed LEO satellite communications (e.g.,
     Iridium, Teledesic)
     Strength of Network Effects
• Network effects are stronger when:
   – Users demand novelty from repeated transactions (e.g., DVDs)
   – Mobile users require geographic coverage (e.g., ATMs, Wi-Fi,
   – Participants in a matching network have idiosyncratic needs and
     offers (e.g., home buying, executive recruiting)
• Access to network users is not valued equally
   – Some are extremely valuable (e.g., friends, family)
   – Others are worth little/nothing (e.g., strangers in another country)
   – Some have negative value (e.g., telemarketers, stalkers)
• Strong preference for variety yields“long tail”

Measuring Network Effects: Conjoint Analysis

• Interviews elicit reactions to product attributes—
  including network size—usually through paired
   – Hence, CONsidered JOINTly
• Requires consumers to understand attributes, so
  may not be reliable for breakthrough products
• Studies should be designed by market research
  professionals and cost between $50k-$250k

Homing costs: costs/investments incurred by
     user due to platform affiliation

Upfront   •Search and negotiation
          •Account setup, e.g., software configuration
          •Initial hardware & software investment; system integration
Ongoing   •Membership and transaction fees
          •Maintenance costs; customer service hassles
          •Tenure- or volume-based benefits
Exit      •Account termination hassles and costs, e.g., changing email
          address, moving funds between brokerage accounts
          •Contract severance penalties
          •Salvage value of hardware, software

               Switching Costs
• Out-of-pocket expenses and inconveniences incurred by
  network users (or by platform providers on their behalf)
  when users switch from one platform to another
• Network effects may deter or encourage switching,
  depending on the relative sizes of rival platforms.
• However, network effects and switching costs are
  conceptually distinct and should not be confused

    Homing vs. Switching Costs
                      1 SETUP + 1ONGOING

               2 SETUPS + 1 TERMINATION + 1 ONGOING


                     2 SETUPS + 2 ONGOING


      Homing vs. Switching Costs
• Usually they move together, e.g., satellite radio (both high),
  package delivery (both low)
• Sometimes, switching cost is high but multi-homing cost is
   – eBook readers: costly to switch because you must replace entire
     library, but not very costly to multi-home
   – Email account: costly to switch because you must notify all your
     contacts, but not very costly to multi-home

         Homing vs. Switching Costs
• When predicting whether a new networked market
  will be served by a single platform, focus on multi-
  homing costs
• When predicting whether to race to acquire network
  users, focus on switching costs
• When predicting whether an established platform is
  vulnerable to displacement by a new platform, focus
  on both multi-homing costs and switching costs

  Users‘ Preferences for Differentiated
        Platform Functionality
• User segments have different needs
  – DBS picture is sharper than cable‘s
     • Appealing for sports and movie lovers?
  – DBS requires a set-top box for every TV
     • A liability for large families?
• Can functionality be offered selectively to
  users willing to pay a premium?
  – To match DBS picture quality, cable would
    have to convert to all-digital architecture, so
    selectivity is not an option
Homing Logic: Affiliate With Platform
        When ∑VP + I ≥ H
• VP = expected value from ability to interact
  with a potential transaction partner
• I = value from platform, independent of
  platform size
• H = homing cost

                    Multi-Homing Logic
• For platforms A and B, calculate ∑VP + I ≥ H
• Consider incremental value from access to potential transaction
  partners from multi-homing on A and B, compared to mono-
  homing with the best single platform, A
   – B may offer access to some partners not affiliated with A
   – Due to differentiation, B may offer more value for certain transactions
     than A
• Compare incremental value to incremental homing cost

                  WTA Potential?
                          DVD:                   Credit Cards:
                          WTA                    Multi-Homing
Strength of      High for most users on        High for most users on
Network Effect   both sides, i.e., consumers   both sides, i.e., card
                 and studios                   holders and merchants

Multi-Homing     High for both sides           Low for both sides

Demand for       Low due to technical          High: ―revolve‖ vs.
Inimitable       standardization of TV         charge (i.e., pay-in-full
Features                                       with no preset limit)

     Mono-Homing + Multi-homing
   Example: Online Subscription Music
                 Side 1 Mono-Homing:        Side 2 Multi-Homing:
                      Consumers               Music Companies
Strength of      •High: want access to    •High: revenue increases
Network Effect   all music                in direct proportion with
                                          user base

Multi-Homing     •High: monthly fees,     •Low: duplicated legal
Cost             playlist management      work, but zero inventory
                                          and modest incremental
                                          production costs due to
                                          digital distribution
Demand for       •Moderate: differences   •Low: music companies
Inimitable       include quality of       have similar needs for
Features         editorial content, IM    DRM, promotional
                 integration              support, etc.
1.   Overview, Definitions, and Core Concepts
2.   Network Mobilization
3.   Platform Control
4.   Platform Envelopment

      Barriers to Network User Adoption
• Business stealing risk: too many rivals on your side
   – Unlike other risks, does not involve provider/user trust
• Holdup risk: dominant platform extracts too much value (e.g.,
  Microsoft OS for cable set-top box or mobile phones)
• Stranding risk: 1) user backs wrong side in WTA battle; 2)
  platform fails to invest; 3) no backward compatibility
• Integration risk: platform provider integrates into network
  user role (e.g., Microsoft with Office & Halo)
• Favoritism risk: to attract users, extract rent, or serve self-
  interest, platform provider skews terms in one side‘s favor (e.g.,
• Relationship risk: In 2-sided net, who controls access to users
  on other side? (e.g., Xbox vs. EA; Autobytel loans)
Willingness-To-Pay and Network Size
                               •   D1 is traditional demand curve if
                                   customers/prospects expect a network size
WTP                                equal to N1
                               •   If customers/prospects expected a bigger
                                   network, N2, then demand curve would shift
                                   outward to D2
                                    – Bigger network is more useful
                                    – Existing customers will consume more
      D2        D3                  – New prospects will join network

P2                             •   Outward shifts become smaller as expected
                                   network size nears saturation point, Ns, due to
                                    – Later adopters not as valuable as early adopters
                                    – Congestion
      N1   N2        N3   Ns

                 Network Size
         Beware Metcalfe‘s Law
• According to Metcalfe’s Law, the value of a network grows
  with the square of growth in its user base
   – In a mesh network with each of N nodes connected to every other node,
     there are N x (N-1) links, i.e., ~ N2
• But, ∆ Value = ∆ N2 only if:
   – Per capita transaction volumes also increase by ∆ N2
   – Each user‘s WTP per transaction remains constant as her transaction
     volume grows
• In the real world: diminishing returns set in and constraints on
  attention/budget prevail

                Upward Sloping Demand
                 in Network Industries
WTP                                           • ―Fulfilled expectations‖ curve
                                                traces price that would exactly
                                                fulfill demand, for a given
                                                expected network size
           D3                                 • Curve is upward sloping in
                     Fulfilled Expectations
      D2                                        domain where network effects
                     Demand Curve

P2                                              dominate price elasticity
P3                                              effects
      N1   N2        N3

                 Network Size
Multiple Equilibria in Network Industries
                                         • Assume competitive market with
WTP                                        Price = Marginal Cost
                                         • Market has three equilibrium points:
                                           N0, N1, and N2
                                         • N1 is not a stable equilibrium
                                             – If expected network size < N1,
                                               firms cannot make money, so N0
                Fulfilled Expectations         prevails
                Demand Curve
                                             – If expected network size is > N1,
                                               supply will surge to N2
P                        Marginal        • Implication: network markets are
                         Cost              tippy —they can stall, and they can
                                           grow explosively— and
                                           expectations matter!
    N0   N1      N2

              Network Size
The Penguin Problem

           The Penguin Problem
                  (Farrell & Saloner, 1986)

• In new markets, uncertainty is high; individuals have
  different expectations about long-term demand
• If user base is fragmented, users cannot communicate
  expectations or coordinate behavior. Network may
  stall, even with strong network effects!
• No-one moves unless everyone moves, so no-one
  moves, like penguins afraid to be first to dive for food

Two ways to categorize platforms:
• Structure: Proprietary, Shared, Joint
  Venture, Licensor
• Function: Connectivity, Variety, Matching,
  Price Setting

Categorization Based on Platform Function
• Connectivity: platform facilitates point-to-point exchange of information,
  physical goods, or passengers (e.g., fax; Fedex)
    – More points connected  more valuable network  more points  etc.
• Variety: platform elicits supply of a variety of complements from one
  network side and promotes complement consumption by the other side
  (e.g., console + games; credit card + merchant locations)
    – More complements  more demand-side users  more complements  etc.
• Matching network: platform matches transaction partners with
  heterogeneous needs and offers (e.g., real estate; online dating)
    – More buyers  more sellers  improved odds of suitable transaction  more
      buyers  etc.
• Price-setting network: platform facilitates exchange of well-defined
  items valued differently by trading partners (e.g., stock exchange,
  gambling book-maker)
    – More buyers  more sellers  reduced price volatility  more buyers  etc.

Categorization Based on Platform Function

      Key Challenges in Network Mobilization
             Connectivity                                   Price Setting
•Ensure reliability                            •Balance users’ different needs for:
•Optimize reach (infrastructure investment          –Anonymity
to extend network vs. incremental                   –Transparency with respect to most recent
revenue)                                            price and best current offer
                                                    –Transaction speed
                                                    –Flexibility to trade with preferred partners

                  Variety                                      Matching
•Optimize price structure, exclusivity         •Optimize price structure, exclusivity
•Elicit complement supply despite:             •Build user trust
     –Risky platform-specific investments      •Address worries about business stealing
     –Conflict with large users over rent      •Manage concerns about conflicts of
     division, end user relationship control
                                               interest, ownership of data, etc.
     –Concerns about platform provider
     integration into user role                •Avoid disintermediation, off-exchange
•Help end users find complements

          Internalizing Externalities
• Externality = benefit or harm experienced by B due to A‘s
  actions, with no compensating payment
   – Positive externality: I admire your flowers
   – Negative externality: your pig pen is upwind
• Network effects are externalities
• Three approaches for internalizing externalities
   – #1: Side payments between users, e.g., I buy grandma‘s videophone
   – #2: In two-sided network, permanent subsidization of one side
   – #3: Inter-temporal internalization: sponsor ―primes the pump‖ with
     discounts to early adopters; this leads others to revise expectations/WTP
• For #2 and #3, proprietary platform is typically required;
  otherwise, free riders exploit subsidy
   – Exception: sponsors can dictate pricing terms that underwrite subsidies, as
     with credit cards and real estate
  Strategies for Network Mobilization
• Pricing
  – Permanent: should one side be subsidized?
  – Penetration: should platform providers race to
    acquire network users?
• Participation
  – Exclusivity: should platform providers seek
    exclusive relationships with some users?
  – Integration: should platform providers become
    network users to avoid chicken & egg problem?
               Pricing Puzzles
• What explains ―Ladies Night‖?
• Why do similar industries charge different
  – Video games: end user subsidized; developer
  – PCs: end user pays; developer subsidized

Assume monopolist serves markets A and C

Marginal cost = 0

With no network effect between A and C, monopolist prices each product to
maximize P x Q

               Market A                                  Market C

           Case 2: Positive Cross-Side Network Effects

          Compare ((P^A x Q^A) – (P*A x Q*A) – (P*B x Q*B)) to
              ((P^B x Q^B) – (P*B x Q*B) – (P*A x Q*A))

Demand on each side grows if QMAX is sold on the other side at a zero price.
    Charge the side that most highly values growth in the other side.
                Side A                               Side B

 P*A                                   P*B

         Q*A Q^A
                                             Q*B   Q^B QMAX
                   QMAXA                                   B

    Strategies for Network Mobilization

•   Permanent Subsidies
•   Accelerated Growth Strategies
•   Exclusivity
•   Vertical Integration

            Racing to Acquire Users

• Firms race to acquire customers when they face:
   – Increasing returns to scale
   – High switching costs
• Late mover advantages—e.g., reverse engineering,
  free riding on pioneer‘s missionary marketing—may
  discourage preemptive investment
• Will investors fund racing strategies?

       Racing to Exploit Increasing Returns
• Without increasing returns:
   – Maximize: Profit = Revenue - Cost
   – Implies: Marginal Revenue (MR) - Marginal Cost (MC) = 0
   – MR = MC
• With increasing returns due to network effects:
   – Willingness-to-pay (WTP) = f(Number of other users)
   – So, adding a user boosts every other users’ WTP
   – MR + NPV of extra revenue from other users = MC
   – To maximize profit, you should price lower (reducing MR)
     or invest more in marketing (increasing MC)
   – In other words, you should race to acquire customers!

       High switching costs also encourage firms
             to race to acquire customers
• In an otherwise competitive market, a firm should earn profit
  equal to the sum of switching costs confronting its customers
   – $100 price just covers costs of producing/delivering one unit
   – Assume consumers buy one unit of product in periods 1 and 2
   – If switching costs are $50, then firm A can price at $149.99 to its
     existing customers in period 2.
   – To steal A‘s customers, Firm B must fully compensate customers for
     switching costs
   – However, $150 is the best price B can offer and still recover its cost
• These economics will fuel a race to acquire unaffiliated
  customers in period 1: each firm will price at $50.01

      The Payoff from
Racing to Acquire Customers
           • As investment rises, NPV of a
             new customer eventually
             declines due to:
              – Broadening beyond natural
              – Prematurely soliciting prospects
              – Retaliatory responses
              – Scalability constraints
           • I* corresponds to Lifetime Value
             of Customer = 0 for the last
             customer you acquired
              – Average LVC should be positive
             Lifetime Value of a Customer
• Rule: acquire customers until Lifetime Value of a Customer (LVC) = 0 for
  last customer acquired, i.e., PV of variable contribution margin = customer
  acquisition cost (including incremental capital expenditures)
    – LVC does not allocate fixed costs. If LCV is positive, but you don‘t have
      enough customers to cover the present value of fixed costs, you‘ll never earn a
    – LVC provides a guideline for marketing spending; it is not a substitute for
      detailed cash flow analysis
• Issues with LVC in networked industries
    – Issue #1: LVC should include new customer‘s impact on other customers‘
      willingness to pay
    – Issue #2: Harder to calculate LVC in two-sided networks (e.g.,
    – Issue #3: With some connectivity networks (e.g., Federal Express), variable costs
      depend on user density, so you must project customer base to calculate LVC

What might explain departures from long-
term value maximizing investment levels?
               • Investment < I*
                  – Resource allocation processes
                  – Funding constraints
                  – Antitrust constraints
               • Investment > I*
                  – Inadvertent: Overconfidence
                  – Deliberate: Exploit overvaluation

             Managing through a
          speculative valuation cycle
• Can/should managers exploit overvaluation?
  – Currency for acquisitions (Google)
  – Buffer (Akamai)
• How will different types of investors react to bust?
  – Private vs. public equity (e.g., Fedex vs. UPS)
  – VC vs. strategic investor
  – Family (e.g., Cox)

    Strategies for Network Mobilization

•   Permanent Subsidies
•   Accelerated Growth Strategies
•   Exclusivity
•   Vertical Integration

1.   Definitions and Core Concepts
2.   Network Mobilization
3.   Platform Control
4.   Platform Envelopment

   Platform Roles: Sponsors and Providers
• Providers are users‘ primary point of contact with
• Sponsors do not deal directly with users; rather,
  sponsors hold property rights that determine:
   – Who may change platform technology
   – Who may participate in network as a platform
     provider or network user
• Each role may be filled by one firm or many;
  sometimes, a single company fills both roles
            Platform Types
              One Provider      Many Providers
                Proprietary           Licensor
One        •Macintosh          •Windows
Sponsor    •        •American Express
           •Playstation        •Scientific-Atlanta
               Joint Venture          Shared
Many       •CareerBuilder      •Linux
Sponsors   •Orbitz             •Visa
           •Covisint           •Real Estate MLS
           Key Design Decision
• Preserve proprietary control of new platform, e.g., eBay,
  Federal Express, Google?


• Share platform with rivals who offer compatible but
  differentiated platform products and services, e.g.,
  barcodes, Wi-Fi, DVD?

               Outcomes Vary
• Proprietary platforms may prevail
   – Akamai vs. Content Bridge
   – eBay vs. FairMarket
• Shared platforms may prevail
   – Citibank vs. Cirrus ATM networks
• Proprietary and shared platforms may coexist
   – Macintosh and Linux
   – American Express (until 2004) and Visa

                 Decision Rules
• Aspiring platform providers with a big edge (e.g., via
  strong patents) should almost always pursue proprietary

• When many evenly matched firms can simultaneously
  launch a new platform:
   – Winner-take-all propensity encourages shared approach
   – Free-rider problems encourage proprietary approach

         If a Proprietary Platform
        Serves the Entire Market…

• Users will worry about hold-up by monopolist

• Prospective providers will worry about losing
  100% of their investment if they are not the

     Free-Rider Problems with
     Big Upfront Investments
User Subsidization   Centralized Infrastructure

                                    WTA Potential?

                           Yes                          No
                    Proprietary Favored        Proprietary Favored
               •Proprietary examples:      •Proprietary examples: video
         Yes   PayPal, Yellow Pages in     games, paid search
               smaller cities              •Coexistence examples:
Free           •Shared examples: WWW,      NYSE/ECNs; credit cards
Rider          real estate MLS
Issue?                Shared Favored           Coexistence Common
               •Shared examples: DVD,      •Coexistence examples:
         No    fax, barcodes, Wi-Fi, SMS   Symbian + Blackberry; Linux
                                           + Mac

Competing on a Shared Platform

        Competing on a Shared Platform
• Pulled together by positive impact on platform adoption and
  each firm‘s survival odds
   –   Fear of “penguin effect”
   –   Fear of WTA outcome (e.g., mobile FeliCa)
   –   Fear of Balkanization (e.g., pre-standard 11n)
   –   Fear of outside threats (e.g., mobile phone OEMs vs. Microsoft)
• Pulled apart by reduction in appropriability of platform rent
   –   Concern about too many rivals
   –   Desire to incorporate own technology in standard (802.11)
   –   Desire to differentiate a standardized product (e.g., J2EE; 802.11)
   –   Friction between IP owners and free riders (e.g., RAND-Z)
   –   Propensity to form coalitions that exclude close rivals (e.g., KDDI +
       JCB vs. DoCoMo + Sumitomo)

          Value Capture Strategies for
           Shared Platform Providers
• Restrict Membership
   – Can backfire if excluded parties sponsor competing platform, e.g., Sun vs.
     IBM/Microsoft in web services
• Profit from IP
   – If too low, IP-rich firms may avoid platform
   – If too high, IP-poor may avoid platform and stalemates may occur as firms
     vie to contribute technology
• Profit from Implementation
   – Freely contribute IP to secure time-to-market advantage or develop
     proprietary extensions to industry standards
   – But, proprietary extensions may splinter a platform, e.g., Unix

                               Key Skills
• Timing: Too soon = ignored; too late = blocked
• IP Management: Avoid ―submarine‖ patents and patent ―thickets‖ via:
    – Standard-setting organization (SSO) disclosure rules
    – Patent pools
    – Patent hoarding to ensure ―mutual assured destruction‖
• Diplomacy: Tactics include appeasement, intelligence gathering,
  logrolling, bluffing, burning bridges, irrational commitment to dogma, etc.
    – SSO delegates require rare mix of technical prowess and diplomacy skills; their
      loyalties are often divided between profession and firm
• Organizational Design: Ad hoc vs. established SSOs; ―forum shopping‖;
  SIGs; etc.

1.   Definitions and Core Concepts
2.   Network Mobilization
3.   Platform Control
4.   Platform Envelopment

               Platform Envelopment
• Platform Envelopment: Entry by one platform provider
  into another‘s market, combining its own functionality with
  the target‘s in a multi-platform bundle that leverages
  common components and/or shared user relationships
• Envelopment is a powerful force shaping the evolution of
  platform-mediated networks
   – Path to platform leadership change that does not require
     Schumpeterian creative destruction
   – Driver of industry convergence
   – Strategy for cross-layer competition

               Platform Entrenchment
• Single platform often dominates due to demand- and supply-side
  scale economies, e.g., Windows, eBay, PDF
• Dominant platforms often difficult to displace due to network
  effects and switching costs To succeed, entrants generally must
  offer revolutionary products, e.g., ECNs, fuel-cell cars, IPTV,
  VoIP, WiMax
• Hence, platform leadership change often entails serial winner-
  take-all battles, with superior new platforms displacing old ones
• Platform envelopment is a second path to platform leadership
  change that does not require Schumpeterian creative

Platform providers serving separate markets may
          share users and components
       Users                     Users

       Platform                 Platform
           A                        A
       Platform                     B

 Platform Envelopment
           • B enters A‘s market
             with a multi-platform
           • A is vulnerable if it
    A        cannot match an
Platform     appealing bundle

Envelopment in Subscription Music
                             •   Prior to 1999, RealPlayer dominates
                                 streaming media
         AT&T                •   Microsoft’s WMP envelops RealPlayer,
                                 bundling streaming server into NT at no
         Apple                   extra cost
                             •   Real launches subscription music service
         Yahoo                   Rhapsody
                             •   Yahoo discounts subscription music, cross-
         Rhapsody                selling via portal
                             •   Apple could bundle subscription service
                                 into iTunes, leveraging iPod
Labels           Consumers   •   AT&T Wireless bundles Yahoo
                                 subscription music with cell phone service


Convergence  Envelopment

Xbox 360 vs. PS3

Cable vs. Telco

Cross-Layer Competition  Envelopment

  Operating Systems
                       Operating Systems

Telephone and Telegraph
             ―One newspaper account
             described AT&T, in its
             slow but steady
             envelopment of the
             telegraph industry, as a
             ‗quiet octopus.‘‖

              Business History Review,

                 Mechanism: Bundling
• Efficiency Gains: Transaction and production cost savings; improved user
• Price Discrimination: Reduces heterogeneity in consumers‘ aggregate
• Strategic Advantages: Extend market power into complement market;
  protect core market by foreclosing rivals‘ access to key complement

                    Foreclosure          Conglomeration                Intermodal
                    (Cross Layer)         (Convergence)

Relationship     Complements            Functionally             Weak substitutes
Examples         •Microsoft vs. Real    •Cable vs. Telco         •Monster vs. LinkedIn
                 •eBay vs. PayPal       •DoCoMo vs. JCB          •UPS vs. Federal Express
                 •Microsoft vs. Adobe   •iPhone vs. Blackberry   •Blockbuster vs. Netflix

Efficiency       •Economies in          •Only viable with        •Production cost
                 marketing              strong production        synergies
                 •Avoid double          cost synergies           •Some economies in
                 marginalization                                 marketing

Price            Limited                Moderate to strong Limited

Strategic        Extend market      Limited                      Neutralize emerging
                 power, defend core                              threat
       Defending Against Envelopment

• Match bundle, but bundle vs. bundle competition can be fierce
• Find a “big brother” via merger (e.g., Scientific-Atlanta + Cisco;
  Lotus + IBM) or alliance (e.g., RealNetworks + Comcast, Cingular)
• Cede and redeploy, e.g., RealNetworks shifts from streaming to
  subscription media
• Sue, e.g., Novell, RealNetworks, Netscape, Sun vs. Microsoft


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