Networks and Positive Feedback Presentation for MGT 523 By Jay Gorman

Morpheus Usage How many of you currently use Morpheus? How many of you would use Morpheus if it had only 10,000 regular users? How many of you would use Morpheus if it had over 10 MM regular users?

Economies of Scale vs. Economies of Networks Economies of Scale –Unit costs decrease as production levels increase. –Typically economic benefits exhausted before demand –Tends to create oligopolies. –Examples: Auto Industry, Steel Industry, Airlines, Etc. Economies of Networks –Value of goods increase with market penetration –Economic benefits continue with increased penetration –Can create monopolies or monopolistic standards –Examples: Microsoft, VHS, Compact Discs.

Supply vs Demand Side Economies of Scale Supply Side Economies of Scale – As production increases, development and fixed costs can be spread over more units, thus making each unit cheaper. –Highly important in establishing information economies. –Examples: Software development, movie production etc. Demand Side Economies of Scale – As more and more users accept a product its value increases as switching costs increase. –Even more important in establishing information economies. –Examples: Word, Excel, AOL IM, Sony Playstation

Creating Economies of Networks Positive Feedback – Feedback that results in amplification or growth in the output signal –Essentially a positive public response to a product which increases acceptance, and thus economies of networks. Negative Feedback – Feedback that reduces the output of a system, such as the action of heat on a thermostat to limit the output of a furnace or the accumulation of toxic waste products by a growing population of bacteria. –Essentially a negative public reaction which causes a reduction in the usage of a product or technology, which ultimately reduces value for remaining users.

Network Externalities Network Externalities – As ownership of a product increases the value of the network to other users is increased, thus creating a positive externality Metcalf s Law: Value of a network is n ² -n. A tenfold increase in a networks size leads to a hundredfold increase in its value. Is this measurable? Are there areas or products with which this logic fails? –Handguns –Collectible Items

Tippy Markets If a market dominated by two major participants and is extremely sensitive to positive feedback then there is a possibility that one will force the other out of business. This is known a as a Tippy Market Likelihood of Market Tipping Low Economies of Scale High Economies of Scale Low Demand for Variety UnlikelyHigh High Demand for Variety LowDepends

Tipping Diagram Introduction Acceptance Positive Feedback Negative Feedback Introduction Rejection Product A Product B

Effects of Tippy Markets? What are the ultimate effects of tipping? Is this truly good for consumers? Are there possible anti-trust ramifications? What are possible solutions to avoid these issues?

Strategies for Promoting New Technology Evolution – Slowly integrating new technology into the market place –Examples: Playstation 2, Windows XP, Color TV –Ideal for technological advances, not new technology –Offers an easy transition to new products for consumers –Often technology is backwards compatible –Strategy is inherently less risky –Is this an ideal strategy for profit maximization? –What should producers do to ensure acceptance?

Strategies for Promoting New Technology Revolution – Introduce superior technology that replaces existing technology. –Examples: CD players, DVD s, HDTV –Ideal for completely new and superior technology –Requires consumers reject old technology and accept the new. –Strategy is extremely risky –How feasible is this strategy for most new products?

Conclusion Network Economies rely on positive feedback rather than economies of scale to prosper. The Network effect creates positive externalities for most existing users, except in in some cases Markets with little need for variety and great economies of scale are likely to be tippy Products that offer small advances in technology should be promoted through an evolution strategy Products which offer a technological breakthrough should be promoted with a revolution strategy

Questions?