Leveraging Network Effects and Competing Without DSC340 Mike Pangburn

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

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

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

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

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)?

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 $.

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)? ??

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

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

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

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

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

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

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?

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

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

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.”

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?

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.

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?