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© 2006 Institute of Information Management National Chiao Tung University Economics of Information Technology 資訊經濟 Spring 2010 Instructor: Dr. Yung-Ming.

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Presentation on theme: "© 2006 Institute of Information Management National Chiao Tung University Economics of Information Technology 資訊經濟 Spring 2010 Instructor: Dr. Yung-Ming."— Presentation transcript:

1 © 2006 Institute of Information Management National Chiao Tung University Economics of Information Technology 資訊經濟 Spring 2010 Instructor: Dr. Yung-Ming Li 李永銘 博士

2 © 2006 Institute of Information Management National Chiao Tung University Course Information Instructor: Dr. Yung-Ming Li Meeting time: –T Section 0130-0430 TH Section 0630-0930 Meeting room: T Sec MB 312/ Th Sec MB 311 Office hours : Tuesday 1000-1200 or by appointment Email: yml@mail.nctu.edu.twyml@mail.nctu.edu.tw Web: www.nctu.edu.tw/~yml

3 © 2006 Institute of Information Management National Chiao Tung University Instructor’s Information Name: Yung-Ming Li Education –Ph.D., University of Washington (Information Systems) –M.S., University of Southern California (Computer Science) –B.S., National Chiao Tung University (Computer & Information Science) Experiences –A TA/RA (UW Business School) –A start up cofounder (KEYNet/KEYCITI) –A lecturer (KYU) –An engineer (Institute for Information Industry)

4 © 2006 Institute of Information Management National Chiao Tung University Research Interests Electronic Commerce Online Community Digital Media Internet Communications Networks Economics Operations Technologies TopicsProblems/Modeling

5 © 2006 Institute of Information Management National Chiao Tung University IS Methodologies Computer Science Operations Research Economics Optimization (centralized optimal solution for resource allocation) Game theory Algorithm (Heuristic, discrete methodologies) (Equilibrium of distributed Individual decisions)

6 © 2006 Institute of Information Management National Chiao Tung University 智慧科技 (Intelligence Technology) –peer to peer, intelligent agent, data/web mining, information security 資訊經濟 (Information Economics) –digital content, electronic commerce, web social networks, Internet/telecommunication service

7 © 2006 Institute of Information Management National Chiao Tung University CS v.s. Econ - Examples 1. Online Auction (eBay) –Technology issues: networks security, database, AI, etc. –Economics issues: auction rule design (who will win ? Intermediary, bidders, sellers, or society), reputation/trust, etc. 2. P2P Networks (Kazaa) –Technology issues: content search and download protocol and network topology design, etc. –Economics issues: Incentive to sharing (free riding), pricing P2P networks services, etc.

8 © 2006 Institute of Information Management National Chiao Tung University CS v.s. Econ – Examples (Cont’) 3. Knowledge Management –Technology issues: workflow design, data mining, document presentation, etc. –Economics issues: incentive mechanism to induce cooperative sharing behavior, stability and efficiency, etc. 4. Digital Media (content) –Technology issues: multimedia, compression technology, DRM technologies, etc. –Economics problem: versioning content, bundling content, etc.

9 © 2006 Institute of Information Management National Chiao Tung University Course Objectives IT economics becomes one of the IS main stream areas in US (research papers in top journals and courses offered in top business schools) IT changes traditional economic behavior (like Auction, P2P, Intelligent property, etc) Apply economics method to study the emerging Internet/digital economy

10 © 2006 Institute of Information Management National Chiao Tung University Course Objectives (Cont’) Business Modeling IT Profit maximization Business Strategies Information & Networks services Economic (game) modeling Managerial insight

11 © 2006 Institute of Information Management National Chiao Tung University Course Outline Introduction (IT Economics) Game theory Information asymmetry Networks externality Incentive mechanism Competition and cooperation Trust and reputation Mechanism Networks Pricing Digital Content Pricing Emerging Internet applications (P2P, DRM, electronic commerce, online community,.. etc)

12 © 2006 Institute of Information Management National Chiao Tung University Reference books Textbooks –Shapiro,C. and Varian, 1999, Information Rules. Harvard Business School Press. –Vulkan. N. 2003. Economics of E-commerce. Princeton –Gibbons, R, 1993. Game Theory for Applied Economists. Princeton University Press. –Shy,Oz, 2001, The Economics of Network Industries. Cambridge

13 © 2006 Institute of Information Management National Chiao Tung University Reference Materials Magazines –Business Week, Economist, Business 2.0 (start up)

14 © 2006 Institute of Information Management National Chiao Tung University Course Activities Lectures (from the instructor) Homework practices General IT-Business articles and research papers reading, presentation, and discussion Term project

15 © 2006 Institute of Information Management National Chiao Tung University Lecture and Homework The instructor will provide the class notes for each lecture (Powerpoint) Homework will be assigned to help students practice and familiarize the methodologies All students are expected to try the problems by himself. However, you are highly encouraged to discuss the problems

16 © 2006 Institute of Information Management National Chiao Tung University Reading, Presentation, and Discussion Identify and position the research question Evaluate the proposed approach to the question Theoretical modeling issues Suggest a research question that would extend the work

17 © 2006 Institute of Information Management National Chiao Tung University Term Project Select a interesting, timely, and promising topic Emphasize the importance of chosen topic (technology and business opportunities) Utilize discussed methodologies to model the economic behaviors Derive managerial implications based your model

18 © 2006 Institute of Information Management National Chiao Tung University Grading Homework (20%) Exam (20%) Presentation (30%) Term Project (30%)

19 © 2006 Institute of Information Management National Chiao Tung University Lecture Part I-1 The Information Economy Information goods Cost structure of production Characteristics of consumption Networks effect Lock-in Compatibility and System competition

20 © 2006 Institute of Information Management National Chiao Tung University Information goods Anything that can be digitalized –Baseball scores, books, database, magazines, movies, music, stock quotes, Web pages Focus on the value of information to different consumers –People have widely different values for a particular piece of information

21 © 2006 Institute of Information Management National Chiao Tung University Cost characteristics High fixed costs (sunk cost) low marginal costs of production No significant capacity constraints Particular market structures –Monopoly –Cost leadership

22 © 2006 Institute of Information Management National Chiao Tung University Right Management Low reproduction cost is two-edged sword –Cheap for owners –But also cheap for copiers Maximize value of IP (intellectual property), not protection Examples –Video industry –Hollywood now makes more from video sales and rental market, them theater presentation

23 © 2006 Institute of Information Management National Chiao Tung University Consumption Characteristics Experience good –Browsing, always new, reputation and brand A wealth of information creates a poverty of attention –Emergence of search engine, data mining, personalization technologies Internet is a hybrid medium between a broadcast and point-to-point –Allow information vendors to move from the conventional broadcast advertising to one-to-one marketing –Know your customer and provide customized information

24 © 2006 Institute of Information Management National Chiao Tung University Information Technology Information technology –The infrastructure that make it possible to store, search, retrieve, copy, filter, manipulate, view, transmit, and receive information Adds value to information –Static HTML in Web =1.5 million books –If 10% is useful= 1 Borders Bookstore –Value of Web is in ease of access Front end to database et Currency

25 © 2006 Institute of Information Management National Chiao Tung University Network Effects Value depends on number of users –Networks effects lead to demand side economies of scale Positive feedback –E.g. Fax (1843, 1987), Internet/ Email(1969,1989-1995) Indirect network effects –DVD players, Software Expectations management (battle for the standard) –Competitive pre-announcements to be standard –Quattro Pro (Borland),1980s, MS pre -announce Excel Assemble a powerful group of strategic partners –Customers, Complementors, competitors –Ex. Java coalition (from Sun)

26 © 2006 Institute of Information Management National Chiao Tung University Lock-In and Switching Cost Example –Stereos and LP (long-playing phonograph records) –Costly switch to CDs System lock-in: durable complements –Hardware, software –Individual, organizational, and societal

27 © 2006 Institute of Information Management National Chiao Tung University Compatibility Complements –Different manufacturers –Strategy for complementors as well as competitors –Compatibility as strategic choice –Standards and interconnection

28 © 2006 Institute of Information Management National Chiao Tung University Systems Competition Microsoft-Intel: Wintel –Intel Commoditize complementary chips –Microsoft Commoditize PCs Apple –Integrated solution –Worked better, but lack of competition and scale to current problem

29 © 2006 Institute of Information Management National Chiao Tung University Information Policy Antirust law –Mergers and acquisitions –Cooperative standard setting –Monopolization Cases –Microsoft’s Internet Explorer –Peer to peer networks

30 © 2006 Institute of Information Management National Chiao Tung University Agenda (Meeting II) I: Pricing Information goods II: Versioning Information goods III: Right Management

31 © 2006 Institute of Information Management National Chiao Tung University Lecture notes I- 2 Pricing Information Pricing strategies Personalized pricing Group pricing

32 © 2006 Institute of Information Management National Chiao Tung University Example: Britannica v. Encarta Britannica: 200 years, $1,600 for a hardback set Microsoft purchased Funk & Wagnalls to make Encarta (1992) Britannica response –Sales dropped 50% between 1990 and 1996 –Online subscription at $2,000 per year –Online subscription at $120 –CD for $200 –CD $70-$125 since 1996 Problem: Whether it can sell to a large enough market to recover its costs.

33 © 2006 Institute of Information Management National Chiao Tung University Production Costs First-copy costs dominate –Sunk costs (not recoverable) Variable costs small; no capacity constraints –Microsoft has 92% profit margins Significant economies of scale –Marginal cost less than average cost –Declining average cost

34 © 2006 Institute of Information Management National Chiao Tung University Implications for Market Structure Cannot be "perfectly competitive" 2 sustainable structures –Dominant firm/monopoly –Differentiated product Combinations of above

35 © 2006 Institute of Information Management National Chiao Tung University Strategy What to do –Differentiate your product Add value to the raw information to distinguish yourself from the competition –Achieve cost leadership through economies of scale and scope

36 © 2006 Institute of Information Management National Chiao Tung University Commoditized Information CD ROM phonebooks 1986: Nynex charged $10,000 per disk for NY directory ProCD and Digital Directory Assistance Chinese workers at $3.50 daily wage Bertrand competition –Start at $200 each –Price forced to marginal cost

37 © 2006 Institute of Information Management National Chiao Tung University If You are in Commodity Business Cost leadership Sell the same thing over again –Baywatch (TV show), Reuters –Reduces average cost

38 © 2006 Institute of Information Management National Chiao Tung University Differentiated Product Bigbook (maps+ database of phone numbers and address) West Publishing (copyright key number systems) –Copyright and content

39 © 2006 Institute of Information Management National Chiao Tung University Personalize Your Product Personalize product, personalize price – PointCast – Personalized ads Hot words (in cents/view) –Deja News: 2.0 4.0 –Excite: 2.4 4.0 –Infoseek: 1.3 5.0 –Yahoo: 2.0 3.0

40 © 2006 Institute of Information Management National Chiao Tung University Know Your Customer Registration –Required: NY Times –Billing: Wall Street Journal (ZIP code) Know your consumer –Observe Queries –Observe Clickstream

41 © 2006 Institute of Information Management National Chiao Tung University Clickstream Interest and how long you look Problem: Connectionless nature of HTTP Java: a promising solution –Virtual Vineyards –Optimized browsers

42 © 2006 Institute of Information Management National Chiao Tung University Logic of Pricing Quicken example –1 million wtp $60, 2 million wtp $20? –Demand curve (next slide) –Assumes only one price $60 or $20 has same revenue $60 million –Price discrimination Price discrimination gives $100 million –Problems How do you know wtp? How do you prevent arbitrage?

43 © 2006 Institute of Information Management National Chiao Tung University Demand Curve Price (Dollars) Quantity (Millions) $20 $40 $60 123

44 © 2006 Institute of Information Management National Chiao Tung University Forms of Differential Pricing A.C. Pigou (1920) Personalized pricing (first degree pricing) –Sell to each user at a different price Versioning (second degree pricing) –Offer a product line and let users choose Group pricing (third degree pricing) –Based on group membership/identity

45 © 2006 Institute of Information Management National Chiao Tung University Personalized Pricing Vendor charges different prices to different consumer –Market research –Selling via catalog Easy on the Internet –Eg. Online travel agency Deep-sea fishing (high-price package) Snorkeling (budget package)

46 © 2006 Institute of Information Management National Chiao Tung University Personalized Pricing - Internet Example –Virtual Vineyards (trace clickstream) –Amazon.com (recommendation systems) –Auctions –Closeouts, promotions

47 © 2006 Institute of Information Management National Chiao Tung University Personalized Pricing (summary) Personalize your product and personalizing you pricing Know the customer Differentiate your prices when possible Use promotions to measure demands

48 © 2006 Institute of Information Management National Chiao Tung University Group Pricing The prices weren ’ t really perfectly individualized. Instead, people who had certain purchase histories, zip codes, or behavior patterns were offered different prices (based on a group identity) –Price sensitivity –Network effects, standardization –Lock-In –Sharing

49 © 2006 Institute of Information Management National Chiao Tung University Price Sensitivity International pricing – US edition textbook: $70 – Indian edition textbook: $5 Problems raised by Internet – Localization as solution

50 © 2006 Institute of Information Management National Chiao Tung University Network Effects Sellers of software can exploit this desire for standardization and offer the organization quality discount Compatibility –Site licenses –Variety of schemes: per client, per user, per server, etc.

51 © 2006 Institute of Information Management National Chiao Tung University Lock-In If you are selling a good that has big switching costs, then it pays you to offer deep discounts to get customers Example –Wall Street Journal ’ s Newspapers-in- education Microsoft Office –Per seat, concurrent

52 © 2006 Institute of Information Management National Chiao Tung University Sharing Inconvenient for the individual user to manage information Information Intermediaries such as library or system administrators can perform the coordination task Transactions cost of sharing –Videos –Desire for repeat play

53 © 2006 Institute of Information Management National Chiao Tung University Summary Understand cost structure Commodity market: be aggressive, not greedy Differentiate product and price Understand consumer Personalize products and prices Consider selling to groups

54 © 2006 Institute of Information Management National Chiao Tung University Lecture notes I- 3 Versioning Information Product line (menu) pricing Market segmentation Self-selection Quality (Vertical) Differentiation Bundling

55 © 2006 Institute of Information Management National Chiao Tung University Value-Based Pricing Don ’ t need to price by identity Offer product line, and watch choices Design menu of different versions – Target different market segments – Price accordingly (self selection)

56 © 2006 Institute of Information Management National Chiao Tung University Example Quicken example –Quicken for Windows at $20 –Quicken Deluxe at $60 Traditional Information Goods –Hardback/paperback –Movie/video

57 © 2006 Institute of Information Management National Chiao Tung University Dimensions to Use (quality differentiation) Delay (Fed Ex, PAWWS) User Interface (DialogWeb, DataStar) Image Resolution (PhotoDisk) Speed of operation (Mathematica) Format (Lexis/Nexis) Capability (Kurzweil) Features (Quicken, tech support) Comprehensiveness (DialogWeb, DataStar)

58 © 2006 Institute of Information Management National Chiao Tung University Example 40 type As (High type): $100 for speed, $40 for slow 60 type Bs (Low type): $50 for speed, $30 for slow Identity-based pricing: $7000 revenues –100x40+50x60 (both speed) Offer only speedy: $50 is best price, revenues=$5,000 –50x(60+40)>100x40 Offer only slow: not as profitable ($3000) –30x(60+40)>40x40

59 © 2006 Institute of Information Management National Chiao Tung University Versioning Solution Try speedy for $100, slow for $30 –Will this work? Compare benefits and costs –100-100=0, but 40-30=10 > 0 –Discount the fast version: 100-p=40-30 –So, p=90 –Revenues = $5,400 = 90x40 + 30x60

60 © 2006 Institute of Information Management National Chiao Tung University Making Self-Selection Work May need to cut price of high end May need to cut quality at low end Value-subtracted versions –May cost more to produce the low-quality version. In design, make sure you can turn features off!

61 © 2006 Institute of Information Management National Chiao Tung University Pitfalls Make sure users cannot easily turn the low-end version into high-end versions Arbitrage –Windows NT workstation/server

62 © 2006 Institute of Information Management National Chiao Tung University Online and Offline Versions Book: “ The Whole Internet ” –Online free, $24.95 sold in bookstores Software: Netscape Navigator –Download for free, purchased on disk National Academy of Science Press –Both online (browsing format) and offline version (reading) Separate distribution channels –Substitute or complement ? Substitute : fee, advertising, or versioning Complement : promote online as aggressively as possible

63 © 2006 Institute of Information Management National Chiao Tung University How Many Versions? One is too few Ten is (probably) too many Two things to do –Analyze market –Analyze product

64 © 2006 Institute of Information Management National Chiao Tung University Analyze Your Market Does it naturally subdivide into different categories? AND Are their behaviors sufficiently different? Example: Airlines –Tourists v. Business travelers

65 © 2006 Institute of Information Management National Chiao Tung University Analyze Your Product Dimensions to version High and low end for each dimension Design for high end, reduce quality for low end Low end advertises for high end

66 © 2006 Institute of Information Management National Chiao Tung University Goldilocks Pricing Goldilocks: Just right Mass market software (word, spreadsheets) – One or two version (professional, standard) – Network effects – User confusion in identifying appropriate product Default choice: 3 versions Extremeness aversion Small/large v. small/large/jumbo

67 © 2006 Institute of Information Management National Chiao Tung University Microwave Oven Example Bargain basement at $109, midrange at $179 –Midrange chosen 45% of time High-end at $199 added –Mid-range chosen 60% of time Wines –Second-lowest price

68 © 2006 Institute of Information Management National Chiao Tung University Customizing the Browser Java as a versioning technology Collect behavior information (Java) Optimize viewing – B&W page images Can turn it on and off

69 © 2006 Institute of Information Management National Chiao Tung University Bundling Offer a package Example: Microsoft Office – 90% market share Work together Discount one of the products

70 © 2006 Institute of Information Management National Chiao Tung University Reduce Dispersion Example: price separate or together Mark: $120 for WP, $100 for spreadsheet Noah: $100 for WP, $120 for spreadsheet Profits –Without bundling: $400 (100 for WP,100 for spreadsheet) –With bundling: $440 (220 for WP+ spreadsheet)

71 © 2006 Institute of Information Management National Chiao Tung University Reduce Dispersion: Price separate or together? Profits: With Bundling: $440Without: $400

72 © 2006 Institute of Information Management National Chiao Tung University Information Bundles Magazines and newspapers Law of large numbers Customized bundles Nonlinear pricing –Value decreasing –In previous example sell first item for $120 –Sell second item for $100 –Example: MusicMaker

73 © 2006 Institute of Information Management National Chiao Tung University Promotional Pricing Sales, coupons, rebates Only worthwhile if segment market Credible signal of price sensitivity Chanallege: software agents – Example: Bargain Finder,Price Scan

74 © 2006 Institute of Information Management National Chiao Tung University Summary Version your product Version dimensions: Delay, interface, resolution, speed, etc. Add value to online information Use natural segments, otherwise use 3 versions (Goldilocks pricing) Control the browser Bundling may reduce dispersion

75 © 2006 Institute of Information Management National Chiao Tung University Lecture Note I-4 Rights Management Implications of digitalization technology Demand of information good Analytics of right management

76 © 2006 Institute of Information Management National Chiao Tung University Intellectual Property Law “ Intellectual property law cannot be patched, retrofitted, or expanded to contain digitized expression … Information wants to be free. ” John Perry Barlow Is he right? The opportunities offered by digital reproduction far outweigh this problem –Like other reproduction technologies in the past, such as printing press, VCR

77 © 2006 Institute of Information Management National Chiao Tung University Production and Distribution Digital tech lowers production costs Digital tech lowers distribution costs Examples –Tape recorder lowers production, but not distribution costs Distribution cost is the same as original –AM radio broadcast lowers distribution costs, not reproduction costs Quality is reduced –Black and white photocopy of an art book ? Quality is reduced

78 © 2006 Institute of Information Management National Chiao Tung University Make Lower Distribution Costs Work for You Information is an experience good Must give away some of your content in order to sell rest Can use product line/versioning –Easy to read, hard to print –National Academy of Sciences Press Online content can increase the sales of the physical version of information good

79 © 2006 Institute of Information Management National Chiao Tung University Demand for Repeat Views Give away all your content, but only once Music, books, video have different use patterns –Radio broadcast of a song is an ad for itself (versioning) Example: Children –Barney: free videos –Disney: sued day care centers

80 © 2006 Institute of Information Management National Chiao Tung University Demand for Similar Views Free samples direct customers back to you McAfee Associates –John MacAfee posted a virus fix on a BBS and asked those who downloaded it and send him whatever they thought it was worth –$5 million in first year –$3.2 billion market value by 1997 –Half of virus protection market Similar, but not identical products –Variation on the same basic theme –E.g. Playboy

81 © 2006 Institute of Information Management National Chiao Tung University Demand for Complementary Products Give away index and sell content –Wall Street Journal, New York Times, Economist give away index Free content, organization/index is what matters –Farcast sells “ current awareness ” to help you search and organize a variety of information sources –Two week subscription free trial, 13$ a month

82 © 2006 Institute of Information Management National Chiao Tung University Illicit Copying Digital piracy can ’ t be eliminated but it can be kept under control Compensating factors –Timely information Sports scores, financial information, and gossip –Negative feedback for bitlegger The bigger you are, the easier to detect

83 © 2006 Institute of Information Management National Chiao Tung University Historical Examples Cheap photocopying has probably increased the demand for printed content –E.g. academic journals Circulating libraries –Books were expensive (a book cost a week ’ s wage) –1800: only 80,000 frequent readers in all of England –1840:1000 libraries –1850: 5 million readers –The publishers served new mass market instead of the elite

84 © 2006 Institute of Information Management National Chiao Tung University Historical Examples (cont ’ ) Video stores –1980: US$1000 for VCR, Video $90 retail, and 60 to video store –Video rental as prelude to purchase “ Lady and the tram ” sold 3.2 million copies at $19.95 (Disney) video purchase price drop by more than 90%

85 © 2006 Institute of Information Management National Chiao Tung University Growing the digital content market Key issue: how to exploit economics of scale –A:1000 consumers pays a dollar a piece to download a piece of software that costs pennies to produce and distribute –B: 100 consumers paying $10 a piece for software that costs $5 to produce and distribute Vastly cheaper distribution may feel like a threat, but it offers great opportunity Maximize the value of intellectual property, not protection Questions: DRM vs P2P

86 © 2006 Institute of Information Management National Chiao Tung University Choosing Terms and Conditions Revenue = price x quantity More liberal terms and conditions (Less protected) –Increases price –Decreases quantity sold

87 © 2006 Institute of Information Management National Chiao Tung University The analytics of Rights Management Price Quantity Revenue Demand Curve Price Quantity Revenue Demand Curve Reduced sales

88 © 2006 Institute of Information Management National Chiao Tung University Simple Model Baseline case: max p(y)y –y = amount sold –p(y) = demand, assume zero cost Make Terms& Conditions more liberal –Y =amount consumed, y=amount sold –Original :Y=y –New demand curve P(Y)= αp(Y) with α>1 –Y= βy with β >1

89 © 2006 Institute of Information Management National Chiao Tung University Analysis New profit maximization problem –Max P(Y) y –Max α/βp(Y)Y Conclusion: –Y*=y* the same (amount consumed) –profits depend on α/β

90 © 2006 Institute of Information Management National Chiao Tung University Transactions Costs Transaction cost –E.g. cost of travel and delay Site license reduce the transaction costs of the seller and the buyer Site license v individual licenses? –Who can distribute more cheaply? Site licenses are often priced at a low multiple of the software ’ s unit purchase price –How effectively can group aggregate value? Redistribute articles within the organization with no liability

91 © 2006 Institute of Information Management National Chiao Tung University Summary Two challenges: cheap production, cheap distribution Cheap distribution: helps advertise by giving away samples Copy protection that imposes costs on users is vulnerable to competitive forces Basic tradeoff in terms and conditions: more liberal terms make product more valuable buy may reduce sales Site licenses and other group pricing schemes are a valuable tool

92 © 2006 Institute of Information Management National Chiao Tung University Summary (cont ’ ) Copy protection that imposes costs on users is vulnerable to competitive forces Basic tradeoff in terms and conditions: more liberal terms make product more valuable buy may reduce sales Site licenses and other group pricing schemes are a valuable tool

93 © 2006 Institute of Information Management National Chiao Tung University Lecture Note I-5 Recognizing Lock-In Measure switching cost Classification of Lock-In Lock-in cycle

94 © 2006 Institute of Information Management National Chiao Tung University Recognizing Lock-In Is Internet economy is friction-free economy ? Cost of switching –Your choices for the future will be hammed in by the selections you made in the pass –Buyers typically must bear costs when they switch from one information systems to another Compare – Ford v. GM (low switching cost) – Mac v. PC (high switching cost)

95 © 2006 Institute of Information Management National Chiao Tung University What ’ s the Difference? Durable investments in complementary assets that are specific to that brand of machine (e.g. hardware, Software) Dynamics: –Supplier wants to lock-in customer –Customer wants to avoid lock-in Basic principle: Look ahead and reason back

96 © 2006 Institute of Information Management National Chiao Tung University Examples Bell Atlantic ’ s digital switch equipment –Competitors: AT&T, Northern Telecom and Siemens –Final Decision : Bell Atlantic invested $3 billion in AT&T ’ s 5ESS digital switch which used proprietary operating system –Large switching costs to change switches Recognize 888 Toll – free $8million Offer voice dialing $10 million 30~40% switch related revenue Computer Associates –Leading supplier of software that work with IBM ’ s MVS and VSE/ESA –The third largest software company (behind MS and Oracle) –Rival :Legent corporation

97 © 2006 Institute of Information Management National Chiao Tung University Small Switching Costs Matter Example –Phone number portability –Email addresses Emergence of new business model: Hotmail –advertising, portability New service: ACM, CalTech –offer e-mail forwarding as a way to avoid address lock-in –Keep in with members and alumni Evaluation: Compare switching costs to revenue on a per customer basis

98 © 2006 Institute of Information Management National Chiao Tung University Valuing an Installed Base Total cost of switching =costs the customer bears +costs the new supplier bears (from the perspective of the new supplier) –Customer C switches from A to "same position" with B –Total switching costs = customer costs + B's costs Example – Switching ISPs costs customer $50 new ISP $25 – New ISP make $100 on customer: induce switch – New ISP makes $70 on customer: don ’ t induce switch

99 © 2006 Institute of Information Management National Chiao Tung University Analytics of Switching Cost Market structure –Perfectly competitive market with many identical firms parameter: –p: price –c: ISPs’ marginal cost –s: customer’s switching cost (cost to change ISP) –d: discount for switching –r: interest rate (monthly)

100 © 2006 Institute of Information Management National Chiao Tung University Competitive market equilibrium Customer’s decision ISP ‘s decision Not switched switched No difference choice Zero profit

101 © 2006 Institute of Information Management National Chiao Tung University Profits & Switching Costs In General: Profits from a customer = [total switching costs] + [quality/cost advantages] In commodity market like telephony –profit per customer = total switching costs per customer Use of this rule of thumb –How much to invest to get locked-in base –Evaluate a target acquisition (e.g., Hotmail) –Product and design decisions that affect switching costs

102 © 2006 Institute of Information Management National Chiao Tung University Classification of Lock-In Contractual commitments: Compensatory or liquidated damages Durable purchases: replacement, declines with time Brand-specific training: rises with time Information and data: rises with time Specialized suppliers: may rise Search costs: learn about alternatives Loyalty programs: rebuild cumulative usage

103 © 2006 Institute of Information Management National Chiao Tung University Contractual Commitments “ Requirements contract ” : –Purchase supplies from one supplier –Minimum order size commitment –Guarantee (price, quality) Beware of “ evergreen contracts ” –Automatically renew sixty or ninety days before initial ending date

104 © 2006 Institute of Information Management National Chiao Tung University Durable Purchases Aftermarket sales (supplies, maintenance) Depends on (true) depreciation Usually fall with time Watch out for multiple pieces of hardware – Supplier will want to stagger vintages – Contract renewal Technology lock-in v. vendor lock-in

105 © 2006 Institute of Information Management National Chiao Tung University Brand-specific Training How much is transferable? Example: Software Competitors want to lower switching costs –Eg. Help systems Borland Quattro Pro aimed at Lotus 1-2-3 Word aimed WordPerfect Customers desire to standardize all of their equipment by using a single vendor –E.g. Fleet commonality

106 © 2006 Institute of Information Management National Chiao Tung University Information & Databases Information and database grow over time Lock-in to grow stronger with time Vendors ’ strategies : raise or lower consumers ’ switch cost and capitalize on the crucial distinction between proprietary and standardized formats Consumers ’ strategy: keep control of information and databases by using standardized formats and interfaces

107 © 2006 Institute of Information Management National Chiao Tung University Specialized Suppliers With specialized equipment, the switch costs depends on the ability of new suppliers to offer comparable equipment when needed in the future Examples –NASA ’ s suppliers, advertising, legal, accounting firms Purchasers ’ strategy: Dual sourcing –IBM (Intel and AMD)

108 © 2006 Institute of Information Management National Chiao Tung University Search Costs Especially, Mass market Transactions cost in finding new suppliers –Psychological costs, time and effort to find a new supplier, risk cost Also costs borne by the new supplier –Promotion, closing deal, setting up account, credit risks Example: Credit Cards –Costly to attract new accounts –Danger of adverse selection – $100 million in receivables would be worth about $120 million –Market valuation of “ loyalty ”

109 © 2006 Institute of Information Management National Chiao Tung University Loyalty Programs Constructed by firm – Frequent flyer programs – Frequent coffee programs Personalized Pricing – Gold status in airline Affiliation –Amazon Associates Program Referral fee: 5+1/8 % –B&N's Affiliates program Referral fee: 7 % –Add nonlinearity? Cumulative referrals Give playoff only after some milestone

110 © 2006 Institute of Information Management National Chiao Tung University Lock-in cycle Brand Selection (Free) Sampling Lock-In Entrenchment

111 © 2006 Institute of Information Management National Chiao Tung University Summary Switching costs are ubiquitous Customers may be vulnerable Value your installed base Watch for durable purchases Be able to identify 7-types of lock-in

112 © 2006 Institute of Information Management National Chiao Tung University Lecture Note I-6 Managing Lock-In Buyers’ strategies to avoid lock-in Sellers’ strategies to exploit lock-in

113 © 2006 Institute of Information Management National Chiao Tung University Basic Strategy for Buyers Bargain for compensation at beginning –Convey the impression that your benefits from switching are small and costs large –Express your ability to influence other purchasers Limit your vulnerability –Dual sourcing (partial switching) –Demand compensation for each step Watch out for creeping lock-in –Insist having the rights to relationship information with the seller –E.g. doctor switching

114 © 2006 Institute of Information Management National Chiao Tung University Buyers : Watch Out For Vague commitments Revealing too much about vulnerabilities Entrenchment phase strategy –May want to switch in part, just to gain leverage

115 © 2006 Institute of Information Management National Chiao Tung University Basic Strategy for Sellers Invest –Employ tactics to build your installed base at least possible cost –Figure different valuable customers and tailor your offering to match Entrench – Design products and promotions so that customers continue to invest in your product or systems – Lengthen and strengthen cycle Leverage –Maximize the value of installed base –Sell complementary products to these consumers

116 © 2006 Institute of Information Management National Chiao Tung University Basic Tensions (sellers vs buyers) For sellers: claim openness, but don ’ t deliver –Example: simple open interface (RTF), powerful closed interface (DOC) For buyers: say you have large switching costs to get large compensation –But want to minimize lock-in as much as possible

117 © 2006 Institute of Information Management National Chiao Tung University Investing in an Installed Base Looking ahead at the whole look-in cycle –Recognize lock-in customers are valuable assets Fighting for new customers –Revenue from lock-in customers is the return on the investment Structure the life-cycle deal –Be explicit about commitments to openness you make to attract customers High market shares don’t imply high switching costs –Rival often design their products to minimize switching cost (Netscape Navigator v MS Explorer) Attracting buyers with high switching costs –Offer discounts to influential buyers Multiplayer strategies –Look for opportunities to exploit divergent interests –Selling to influence buyers and the others will follow

118 © 2006 Institute of Information Management National Chiao Tung University Encouraging Customer Entrenchment Entrenchment by design –Offer value-added information services to deepen your relationship with your customer Loyalty program and cumulative discount –The reward to past loyalty must be available only to customers who remain loyal

119 © 2006 Institute of Information Management National Chiao Tung University Leveraging Your Installed Base Selling complementary products Selling access to your installed base Setting differential prices to achieve lock-in –Prices aimed at locked-in customers may not appeal to new buyers. Differential pricing is the solution Attempts to raise search costs –Make yourself easy to find and your rivals hard to find Exploiting first-mover advantage –Staggers termination dates on different customer contracts to keep rivals from achieving scale economies Controlling cycle length –Get your customers to extend their contracts before those contracts expire

120 © 2006 Institute of Information Management National Chiao Tung University Summary Buyers –Bargain hard –Use second-sourcing and open systems –Improve bargaining position at choice stage Sellers –Invest in your installed base –Cultivate influential buyers –Design product and pricing to get customers to invest in your technology –Sell your customers complementary products –Sell access to your installed base

121 © 2006 Institute of Information Management National Chiao Tung University Lecture Note I-7 Networks and Positive Feedback Positive feedback Network Externality Evolution VS Revolution Openness VS Control

122 © 2006 Institute of Information Management National Chiao Tung University Positive Feedback Positive feedback –The stronger get stronger, the weaker get weaker –market dominated by a single firm or technology Negative feedback –The stronger get weaker, the weaker get stronger –Market in oligopoly –Stabilizing (competitive and balanced equilibrium) Positive feedback market –Makes a market “ tippy ” : “ Winner take all markets ” –Examples: VHS v. Beta (1980), Wintel v. Apple (1990) –A more potent force in the network economy or market for information infrastructure

123 © 2006 Institute of Information Management National Chiao Tung University Positive Feedback Battle zone Winner Loser Time Market Share 100% 50% 0%

124 © 2006 Institute of Information Management National Chiao Tung University Adoption Dynamics Time Number of Users 100% 50% 0% Takeoff Launch Saturation Adoption of new technologies: S-shape curve (CD, color TV, video game machine, email, Internet, etc.)

125 © 2006 Institute of Information Management National Chiao Tung University Sources of Positive Feedback Supply side economies of scale –Declining average cost –Marginal cost less than average cost –Example: information goods Demand side economies of scale –Network effects –In general: fax, email, Web –In particular: Sony v. Beta, Wintel v. Apple

126 © 2006 Institute of Information Management National Chiao Tung University Demand Side Economies of Scale Number of Compatible Users Value to User 100% 50% 0% Virtuous cycle Vicious cycle Implication: success and failure are driven by the consumer expectation and the underlying value of product e.g. Lotus 1-2-3 e.g. VisiCalc

127 © 2006 Institute of Information Management National Chiao Tung University Demand Side Economies of Scale Demand Willingness to pay Network size Critical mass Stable equilibrium (2) Stable equilibrium (1)

128 © 2006 Institute of Information Management National Chiao Tung University Critical Mass

129 © 2006 Institute of Information Management National Chiao Tung University Example: Fax

130 © 2006 Institute of Information Management National Chiao Tung University Network Externalities Networks –Real networks Communications, transportation –Virtual networks Like “ Mac network ” Externality –Externality arise when one market participant affects others without compensation being paid Value of Network –Metcalfe ’ s Law: Value of network of size n proportional to n 2

131 © 2006 Institute of Information Management National Chiao Tung University Laws of growth Sarnoff’s Law - content –Radio and television networks –The value pf broadcast networks is proportionate to the number of views Morre’s Law (microprocessor investor)-innovation –Hyper-evolution of electronics, computers, and networks –The number of elements that could be packed into the same amount of space on microchip double very year Metcalfe’s Law (Ethernet inventor)- communication –Growth of value in networks –The total value of a network where each node can reach every other node grows with the square of the number of the nodes Reed’s Law - community –Links between computer networks and social networks –Email, BBS –The value of online social networks grows proportionately to users exponentially

132 © 2006 Institute of Information Management National Chiao Tung University Lock-In and Switching Costs Network effects lead to substantial collective switching costs –The combined costs of all users –Nonlinear –Even worse than individual lock-in –Due to coordination costs Example: – QWERTY (1870) vs AOEUIDHTNS (1932)

133 © 2006 Institute of Information Management National Chiao Tung University Igniting Positive Feedback Evolution (compatibility) –Give up some performance to ensure compatibility, thus easing consumer adoption Revolution (performance) –Wipe the slate clean and come up with the best product possible

134 © 2006 Institute of Information Management National Chiao Tung University Tradeoff of Compatibility and Performance Performance Compatibility Evolution Revolution Improved design or adapters

135 © 2006 Institute of Information Management National Chiao Tung University Evolution Offer migration paths to new technologies Examples –Microsoft, Intel Build new network by links to old one –One way compatibility Problems: technical and legal

136 © 2006 Institute of Information Management National Chiao Tung University Strategies of Evolution Technical obstacles –Use creative design –Think in terms of system –Converters and bridge technologies Legal obstacles –Need IP licensing –Example: Sony and Philips CDs (pay patent license fee)

137 © 2006 Institute of Information Management National Chiao Tung University Revolution Performance: Groves ’ s law: “ 10X rule ” Success –depend on switching costs, critical mass –Market is growing rapidly, lock-in is mild, performance loom larger than backward compatibility Example: Game video –Lower switch cost for ten-year-boys –Sega vs Nintendo

138 © 2006 Institute of Information Management National Chiao Tung University Openness v. Control Your reward = [Total value added to industry] x [Your share] –Total value added to industry Depends on product and Size of network –Your share Depends on how open

139 © 2006 Institute of Information Management National Chiao Tung University Tradeoff of Openness and Control Total Value Added to Industry Your Share of Industry Value Propriety Open Optimum

140 © 2006 Institute of Information Management National Chiao Tung University Openness vs. Control Openness –Full openness Anybody can make the product –Alliance Only members of alliance can use Control –Control standard and go it alone If several try this strategy, may lead to standards wars

141 © 2006 Institute of Information Management National Chiao Tung University Generic Strategies Compatibility Performance Company’s market shareTotal industry’s value 2 1 3 4

142 © 2006 Institute of Information Management National Chiao Tung University Generic Strategies (cont ’ ) (1)Performance Play –Introduce new, incompatible technology –Examples: Palm Pilot, Iomega Zip (2)Controlled Migration –Compatible, but proprietary –Examples: Windows 98, Pentium (3)Open Migration –Many vendors, compatible technology –Examples: Fax machines, some modems (4)Discontinuity –Many vendors, new technology –Examples: CD audio, 3 1/2 ” disks

143 © 2006 Institute of Information Management National Chiao Tung University Historical Examples of Positive Feedback Railroad Gauges …. Battle of the Systems: AC v. DC …. Telephone networks and Interconnection …. Color Television …. High-Definition Television (HDTV) ….

144 © 2006 Institute of Information Management National Chiao Tung University Summary Positive feedback means strong get stronger and weak get weaker Consumers value size of network Adoption dynamics follows an S-shape growth path Positive feedback works for large networks, against small ones Consumer expectations are critical Fundamental tradeoffs: (performance and compatibility), (openness and control) Generic strategies –Performance play, Controlled Migration, Open Migration, Discontinuity

145 © 2006 Institute of Information Management National Chiao Tung University Agenda Cooperation & Compatibility Standard War Information Policy

146 © 2006 Institute of Information Management National Chiao Tung University Lecture Note I-8 Cooperation and Compatibility Standard and competition game Standard setting tactics

147 © 2006 Institute of Information Management National Chiao Tung University How Standards Change the Game Expanded network externalities –Make network larger, increase value Reduced uncertainty –No need to wait Reduced consumer lock-in –Netscape ’ s “ Open Standards Guarantee ” ; MS ‘ s XML Competition for the market v. competition within the market –Shift from an early battle for dominance to later for market share

148 © 2006 Institute of Information Management National Chiao Tung University How Standards Change the Game (cont ’ ) Competition on price v features –Reduce product differentiation, commoditized products Competition to offer proprietary extensions –Strong incentives for suppliers to differentiate by developing proprietary extensions (standard extension) Component v systems competition –With interconnection, can compete on components

149 © 2006 Institute of Information Management National Chiao Tung University Who Wins and Who Loses? Consumers –Generally better off –But variety may decrease Complementors –Generally better off –May sever brokering role Example: Impacts of DVD standard on distributor Blockbuster Gain from sells a complement to DVD Threaten from new channel of distributions

150 © 2006 Institute of Information Management National Chiao Tung University Who Wins and Who Loses? (cont ’ ) Incumbents –May be a threat –Strategies Deny backward compatibility Introduce its own standard Ally itself with new technology (e.g. Sony and Philips on DVD) Innovators –Technology innovators collectively welcome standards –If the group benefits, there should be some way to make members benefit –Small players may especially welcome a standard

151 © 2006 Institute of Information Management National Chiao Tung University Formal Standard Setting Fundamental principle –Essential patents must be licensed on “ fair, reasonable and non-discriminatory ” terms ITU (International Telecommunications Union) –1865, now UN agency –Notoriously slow Organization –Independent professional body: IEEE (Institute of Electric and Electronic Engineers –Government body: NIST (National Institute of Standards and Technology) –Unofficial groups ACM- SIGART (artificial intelligence), SIGCOMM (data communication), SIGGRAPH (computer graphics), SIGIR (information retrieval)

152 © 2006 Institute of Information Management National Chiao Tung University Tactics in Formal Standard Setting What is your goal? –National or international? –Protecting your interests? What are others goals? –Do they really want a standard?

153 © 2006 Institute of Information Management National Chiao Tung University Tactics in Formal Standard Setting (cont ’ ) Don ’ t automatically participate –If you do, you have to license Keep up momentum –Continue R&D while negotiating Look for logrolling –Trading technologies and votes Be creative about deals –Second sourcing, licensing, hybrids, etc.

154 © 2006 Institute of Information Management National Chiao Tung University Tactics in Formal Standard Setting (cont ’ ) Beware of vague promises –“ reasonable ” royalty commitment from holders of key patents Search carefully for blocking patents –Patents held by non-participants Preemptively build installed base –Achieve stronger negotiating position

155 © 2006 Institute of Information Management National Chiao Tung University Building Alliance Assembling Allies Interconnection among Allies Negotiating a Truce Alliances in Action

156 © 2006 Institute of Information Management National Chiao Tung University Assembling allies Partners of Allies –Customers, suppliers, rivals, and complementor Assembling allies –Pivotal customers should get special deals MS give IE users free access to Wall Street Journal –But don ’ t give your first customers too big an advantage Offer temporary price break Who bears risk of failure? –Usually ends up with large firms –But bankruptcy favors small firms –Government is even better! Smart cards in Europe (mandated for pay phone)

157 © 2006 Institute of Information Management National Chiao Tung University Interconnection among Allies Presence of strong network externality Become more strategic once networks began to compete against each other over the same routes :side by side networks rather than end to end networks In you control a key interface or bottleneck, you should open it up but on you own terms and conditions –Reduce the risk to lost control over the network over time –Eg. Sun’s Java (Microsoft “improve” Java working only on windows)

158 © 2006 Institute of Information Management National Chiao Tung University The standards game Player A Player B

159 © 2006 Institute of Information Management National Chiao Tung University Negotiating a truce Maximizing Return –Do the benefit-cost calculation –How to divide a larger pie? –Your reward = Total value added x your share Cooperation between Netscape and Microsoft –Open Profiling Standard –VRML –SET

160 © 2006 Institute of Information Management National Chiao Tung University Alliances in Action Alliance Examples –Xerox - Ethernet (Metcalfe). DIX Coalition Ethernet beat IBM token ring and becomes LAN standard –Adobe - PostScript (Warnock) and PDF (portable document format) –Microsoft - Active X

161 © 2006 Institute of Information Management National Chiao Tung University Managing Open Standards Standard is in danger if it lacks a sponsor –Example: Unix AT&T invention by accident Gave away source code to EDU 1993 Coalition: Novell purchased rights for $320 million and gave name to X/Open Open standards can be hijacked by companies seeking to extend them in proprietary directions –Example: SGML and XML –Multiple dialects being promulgated

162 © 2006 Institute of Information Management National Chiao Tung University Summary Competition requires allies Standard affects competition in several predictable ways Standards benefit consumers and suppliers, at expense of incumbents and sellers Formal standard setting adds credibility Find natural allies Before a battle, try to negotiate a truce Try to retain control over technology, even when establishing an open standard

163 © 2006 Institute of Information Management National Chiao Tung University Lecture Note I- 9 Standards Wars Classification of standards wars Tactics for standards wars

164 © 2006 Institute of Information Management National Chiao Tung University Standard Wars Two new incompatible technologies struggle to become a de facto standard Examples –North v. South (in railroad gauges) –Edison v. Westinghouse (in electricity) –NBC v. CBS (in color TV ) –3Com v. Rockwell/Lucent (in modem) –United States v. Japan (in HDTV) Wars can end –A truce (as with modems) –A duopoly ( as in video games) : Nintendo v Sony –A fight to the death (as with VCRs)

165 © 2006 Institute of Information Management National Chiao Tung University Recent Standards Wars AM stereo –mutually destructive –Auto industry invested, radio didn ’ t Digital wireless phones –two incompatible technologies Europe: GSM Global system for Mobile Communication), 108 countries adopt US: GSM, TDMA (cousin of GSM), CDMA compete –TDMA: 5 million –CDMA: 2.5 million –GSM: 1 million 56 k Modems –resolved through a standard agreement US Robotics x2 attempted preemption Rockwell/Lucent K56 Flex Compromise standard ITU V.90

166 © 2006 Institute of Information Management National Chiao Tung University Classification of Wars

167 © 2006 Institute of Information Management National Chiao Tung University Examples Rival evolution – DVD v. Divx, 56k modem, various flavors of Unix Rival revolutions – Nintendo 64 v. Sony PlayStation Evolution v. Revolution – Spreadsheet (Lotus 1-2-3 v Excel), database (dBase IV v Paradox)

168 © 2006 Institute of Information Management National Chiao Tung University Key Assets in Network Markets Control over an installed base Intellectual property rights Ability to innovate First-mover advantages Manufacturing Strength in complements Reputation and brand name

169 © 2006 Institute of Information Management National Chiao Tung University Two Basic Tactics Preemption –Build installed base early for positive feedback –But watch out for rapid technological progress Imperfect Quality Expectations management –Manage expectations –But watch out for vaporware Announce an upcoming product so as to freeze your rival ’ s sales

170 © 2006 Institute of Information Management National Chiao Tung University Once You ’ ve Won Staying on your guard –Offer a migration path fend off challenges from upstarts –French ’ s Minitel system (1980, online transaction system) Commoditize complementary products –Retain franchise as the market leader but encourage a competitive market for complements Competing against your own installed base –Durable goods monopoly (Intel again)

171 © 2006 Institute of Information Management National Chiao Tung University Once You ’ ve Won (cont ’ ) Protect your position –Attract important complementors Leverage installed base –Expand network geographically Stay a leader –Develop proprietary extensions

172 © 2006 Institute of Information Management National Chiao Tung University What if You Fall Behind? Adapters and interconnection –Target a market niche or interconnect with the larger networks Survival pricing –Hard to pull off –Different from penetration pricing Legal approaches –Renege the openness promise

173 © 2006 Institute of Information Management National Chiao Tung University Battle of the Browsers: Microsoft v. Netscape Characteristics –Rival evolutions –Low switching costs –Small network externality Strategies –Preemption in distribution –Penetration pricing –Expectations management –Alliances

174 © 2006 Institute of Information Management National Chiao Tung University Summary Understand the type of war –Rival evolution –Rival revolution –Revolution v Evolution Strength depends on 7 critical assets Preemption is a critical tactic Expectations management is critical When you ’ ve won the war, don ’ t rest easy If you fall behind, avoid survival pricing

175 © 2006 Institute of Information Management National Chiao Tung University Lecture Note I-10 Information Policy Competition policy Government’s role

176 © 2006 Institute of Information Management National Chiao Tung University Public policy “ Cooperate centric view ” v. “ policy centric view ” – profitability v. net social benefits Adam Smith: competitive pressures between producers will often induce them to make choice that maximize the general welfare Jim Barksdale (CEO of Netscape) : “… working with the government is far more productive than trying to ignore it. ”

177 © 2006 Institute of Information Management National Chiao Tung University Themes of Information Policy Differentiation of products and prices –High first-copy costs of information and information technology –Problem: charge different users different prices for essentially the same product Lock-in –Information products works together in systems, switching any single product can be very costly to users –Problem: Aftermarket monopolist Positive feedback –Network externality is ubiquitous in the information industry –Problem: Standard (Cartels and Collusion)

178 © 2006 Institute of Information Management National Chiao Tung University Competition Policy Principles of Competition Policy –Ensure a fair fight, not to punish winners or protect losers Sherman Act (1890) –Monopoly isn ’ t illegal, but attempt to monopolize is Clayton Act (1914) –Protects competition as a process

179 © 2006 Institute of Information Management National Chiao Tung University Price Differentiation Price and product differentiation –Mass customization, differential pricing, personalized content, versioning Robinson-Patman Act (1936) – Price discrimination is illegal if it “ effectively lessens competition ” Legal arguments that work –Can set lower prices resulting from lower costs –Set differential prices to meet competition –Pricing only questionable if it “ lessens competition ”

180 © 2006 Institute of Information Management National Chiao Tung University Example 1: Differential Pricing Can Hurt Consumers 100 people wtp $20, 1000 people wtp $6 (No delay) Optimal flat price = $6 –Revenue=$6600 ( 6X(100+1000) ) 100 people wtp $20 for early edition, $5 for later, 1000 people wtp $5 for later Versioning: Optimal to sell at (early, $20) and (later, $5) –Revenue=$7000 (20X100+5X1000) Consumers now are worse off –Inefficient: social loss $1*1000 (due to delay)

181 © 2006 Institute of Information Management National Chiao Tung University Example 2 : Differential Pricing Can Benefit Consumers 1000 consumers wtp $20, 100 people wtp $6 for early, $5 for later Optimal flat price = $20 –Revenue=$20000 (20x1000) Versioning: sell for (early, $20) and (later, $5) –Revenue=$20500 (20x1000+5x100) Key: will versioning increase size of market? social gain $5*100 (due to new customers)

182 © 2006 Institute of Information Management National Chiao Tung University Government Choices Do nothing Act on basis that monopoly was illegally obtained –Break up –Prohibit suspect practices Regulate the monopolist –Control genuine monopoly power where it exists

183 © 2006 Institute of Information Management National Chiao Tung University Implications for Strategy Monopoly may be inhibited from using strategies that are legal for other firms – Even small firms may be accused of antitrust violations E.g. Iomega Zip drive (product design, distribution, IP enforcement) Mergers and acquisitions, cooperation with rivals to set standards, and market dominance can antitrust scrutiny Cooperative standard setting can be investigated if there are pricing, collusion, cartels

184 © 2006 Institute of Information Management National Chiao Tung University Cooperative Standards Setting Cooperation or collusion ? Standards setting or cartel? Watch out for prices and terms agreements Performance standards as barrier to entry Patent cross licenses Interconnection agreements

185 © 2006 Institute of Information Management National Chiao Tung University Single Firm Conduct Exclusive dealing provision – Insists its customers not deal with its competitors Tying (bundling) –Insists its customers take another product if they want the monopolized item –Internet Explorer is separate product or merely part of an integrated operating system ?

186 © 2006 Institute of Information Management National Chiao Tung University Government Role ’ s in Achieving Critical Mass Private sector can be creative about network externalities Important basic technology needs to be proven or demonstrated –E.g. Internet –The government can provide critical mass to ignite positive feedback, but it should be cautious about picking winner

187 © 2006 Institute of Information Management National Chiao Tung University Summary Don ’ t expect government ’ s role to diminish Every company needs to know the rules You can usually use differential pricing Policy should ensure fair fight, not punish winners or protect losers Mergers are subject to review by Justice Department and Federal Trade Commission Cooperate to set standards and develop new technologies, so long as efforts benefit consumers If you gain a leading share of market, conduct audit of your practices Don ’ t expect government regulation of telecom to diminish any time soon


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