1. Leveraging Network Effects and Competing Without
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Mike Pangburn

2. Agenda
Understand meaning of network effects (“positive network externalities”)
1-sided and 2-sided examples
Implications for competition
Discuss competing without network-effects advantage
Need for superior operations, not superior technology
Need for superior use of information
Consider case of Zara

3. Network Effects Network effects
When network effects are present, the value of a product or service increases as the number of users grows
Most products aren’t subject to network effects
“you probably don’t care if someone wears the same socks, uses the same pancake syrup, or buys the same trash bags as you” -- J. Gallaugher
As a manager, it’s critically important to recognize when a product does exhibit network effects

4. More users = More value Where does that value come from? Exchange
Interact with others. The value isn’t typically $.
Switching costs
Save ($ or time) by sticking with initial choice
Are your customers “barnacles” or “butterflies?”
Complementary products
Associated products that develop

5. “Exchange” examples? Telephone / Skype / fax
Local “exchange value” example(s)?

6. Switching costs example
“It is this switching cost that has given our customers the patience to stick with Windows through all our mistakes, our buggy drivers, our high TCO, our lack of a sexy vision at times, and many other difficulties…. it would be so much work to move over that they hope we just improve Windows rather than force them to move…. without this … we would have been dead a long time ago.”
Comments from a Microsoft General Manager in a memo to Bill Gates
Local “switching cost” example(s)?

7. Switching costs recap
The core “switching cost” idea isn’t that customers have already invested $ in some past product/service
A past/irrecoverable investment is sometimes referred to as a sunk cost, which we should, as rational decision makers, ignore
The core switching cost idea is that moving to the new product or service will imply some new investment in time or $.

8. Complementary products
Example: iPod related products
90 brands selling some 280 models of iPod speakers systems
34 auto manufacturers now trumpet their cars as being iPod-ready
Each enhances the value of choosing an iPod over a rival like the Microsoft Zune.
Local (UofO / Eugene) “complementary products” example(s)? ??

9. How do network effects change competition?
Network markets experience early, fierce competition.
Often winner-take-all environments.
Examples:
Apple -- controls over 75% of digital music sales.
Football?
Best product or service doesn’t win.
Example: Xbox 360 was earlier than Playstation 3, gained early success due to inferior specs

10. Want to compete against an incumbent firm? …High hurdle to clear!

11. Facing an incumbent enjoying networking effects
Subsidize new adoptions
Example: PayPal gave $15 off $30 to each new customer to promote its service. eBay was less generous but then ended up later buying PayPal for $15 * 100,000,000
Counterexample: Bing!
Move early
If you don’t? Consider that eBay waited 5 months after Yahoo! to start auctions in Japan… never recovered in that market
Redefine the market
Look for “blue ocean” (W. Chan Kim and Renée Mauborgne)
Example: Nintendo’s Wii strategy
Encourage complementary products
Example: Facebook’s fbFund: up to $250,000 funding per firm writing apps

12. Network effects and IT
Savvy managers look for ways to design-in network effects
E.g., Facebook
Exchange value, Switching cost, Complementary products
Thus, Information Technology can establish competitive advantage via network effects with your firm’s product
The strategic role of IT is not limited to tech products with network effects
IT as product versus IT as enabler
The latter applies even for non-tech products
Zara provides a powerful example of leveraging IT as strategic enabler

13. Agenda
Understand meaning of network effects (“positive network externalities”)
1-sided and 2-sided examples
Implications for competition
Discuss competing without network-effects advantage
Need for superior operations, not superior technology
Need for superior use of information
Consider case of Zara

14. Consider Zara What? Where? Who?
Most successful apparel company on the planet
Where?
Based in the ship-building town of La Coruña, Spain
Who?
Founded by Amancio Ortega, the world's 3rd richest man with assets worth more than $50 billion
Not much of a marketeer, has more a product/process focus

15. Network effects and Zara
For the type of products that Zara sells, why might network effects not be very strong?
Generally speaking, network effects (“network externalities”) can be either positive or negative
When a product exhibits negative network externalities, the resulting challenge for a firm a severe
What product-line management strategy would you recommend to a manager facing that challenge?

16. Core aspect of Zara’s strategy
“If you see something and don’t buy it, you can forget about coming back for it because it will be gone.”
-- 20-something Zara shopper

17. Consider this tension (challenge)
Accounting rule
Inventory = an asset
Retailing adage “Inventory equals death”

18. Use of technology
As a manager, your focus should not be on having better technology
Focus on having better information and processes, with minimal technology costs
Zara is information/process focused, not tech focused
“Whether measured by IT workers as a percentage of total employees or total spending as a percentage of sales, Zara’s IT expenditure is less than one-fourth the fashion industry average.”

19. Technology ≠ Effective Processes Just Ask Prada
Contrast with Prada’s “Manhattan project” to create the ultimate fashion store
PDAs would let staff check inventory immediately
glass dressing room foot pedals would allow customers to turn walls opaque, into a combination mirror and heads- up display
dressing room computer would recommend matching accessories
How did it turn out?

20. Technology ≠ Effective Processes
An information system (IS) is much more than just hardware and software.
An IS also includes data used or created by the system, as well as the procedures and the people who interact with the system
Successful information systems (IS) must integrate these 5 critically-important components: hardware, software, data, procedures, and people.

21. Zara, the new Dell?
Dell was the low-inventory, short lead-time, high product variety competition-killer of the 90’s
Dell is facing more heat now from its competitors.
Is Zara “the new Dell”?
How do they differ?