7 Chapter Prepared by C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University Prepared by C. Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Strategy and Technology Student Version GARETH R. JONES /CHARLES W. L. HILL Theory of Strategic Management 10th ed.

Learning Objective:After reading this chapter you should be able to understand the tendency toward standardization in many high- technology markets. Learning Objective: After reading this chapter you should be able to understand the tendency toward standardization in many high- technology markets. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. TECHNICAL STANDARDS AND FORMAT WARS  A technical standards are a set of technical specifications that producers adhere to when making the product, or a component of it.  A dominant design refers to a common set of features or design characteristics. Most personal computers share a common set of features: RAM, a monitor, keyboard, etc.

7-3 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  A technical standard helps to guarantee compatibility between products and their complements.  Having a standard can reduce confusion in the minds of consumers.  Having standards can reduce production costs.  The emergence of standards can help to reduce the risks associated with supplying complementary products. Benefits of Standards TECHNICAL STANDARDS AND FORMAT WARS

7-4 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Standards emerge in industry in three primary ways: 1)When the benefits of establishing a standard are recognized, companies in an industry might lobby the government to mandate an industry standard. 2)Technical standards are often set by cooperation among businesses. 3)The standard is set by market demand.  When a standard becomes public domain, any company can freely use the technology. Establishment of Standards TECHNICAL STANDARDS AND FORMAT WARS

7-5 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Network Effects, Positive Feedback, and Lockout TECHNICAL STANDARDS AND FORMAT WARS  Network effects arise in industries where the size of the “network” of complementary products is a primary determinant of demand for a product.  General principle: When two or more companies are competing with each other to get technology adopted as a standard in an industry, the company that wins the format war will be the one whose strategy best exploits positive feedback loops.

7-6 Learning Objective:After reading this chapter you should be able to describe the strategies that firms can use to establish their technology as the standard in a market. Learning Objective: After reading this chapter you should be able to describe the strategies that firms can use to establish their technology as the standard in a market. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The various strategies that companies should adopt in order to win format wars are centered upon finding ways to make network effects work in their favor and against their competitors.  Winning a format war requires a company to build the installed base for its standard as rapidly as possible. STRATEGIES FOR WINNING A FORMAT WAR

7-7 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  It is important for the company to make sure that, in addition to the product itself, there is an adequate supply of complements (for example, games for Sony PlayStation 3).  Killer applications are applications or uses of new technology or product that are so compelling that they persuade customers to adopt the new format. The theory is to “kill” demand for competing formats. , chats, and Web browsing gave AOL killer applications that attracted consumers. STRATEGIES FOR WINNING A FORMAT WAR

7-8 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  By pricing the product (for example, a razor) low in order to stimulate demand and increase the installed base, and then trying to make high profits on the sale of complements (for example, razor blades) is called a razor and blade strategy.  Aggressive marketing is a key approach to getting an early lead.  Substantial upfront marketing and point-of-sales promotion techniques are used to attract potential early adopters who will bear the switching cost of a new format. STRATEGIES FOR WINNING A FORMAT WAR

7-9 © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  When two or more competitors are close to simultaneously introducing competing and incompatible technology standards, some firms have chosen to join forces to make and market the product (Sony and Phillips joined forces to make the CD players).  Licensing the format to other enterprises so that those others can produce products based on the format is another strategy often adopted. In addition to producing VCRs at its own factory, Matsushita let a number of other companies produce VHS format players under a license. STRATEGIES FOR WINNING A FORMAT WAR

Learning Objective:After reading this chapter you should be able to explain the cost structure of many high-technology firms, and articulate the strategic implications of this structure. Learning Objective: After reading this chapter you should be able to explain the cost structure of many high-technology firms, and articulate the strategic implications of this structure. COST IN HIGH-TECHNOLOGY INDUSTRIES  In many industries, marginal costs rise as a company tries to expand output (the law of diminishing returns). To produce more of a good, a company must hire more labor and invest in more plants, etc. This law often does not apply in many high-tech settings, such as the production of software. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7-11 COST IN HIGH-TECHNOLOGY INDUSTRIES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Strategic Significance  If a company can shift from a cost structure where it encounters increasing marginal costs to one where fixed costs may be high but marginal costs are much lower, its profitability may increase.  When a high-tech company faces high fixed costs and low marginal costs, its strategy should be to deliberately drive down prices to increase volume.  The strategy of pricing low to drive volume up is central to the business model of Microsoft.

7-12 CAPTURING FIRST-MOVER ADVANTAGES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Some first movers have the ability to capitalize on (and reap) substantial first-mover advantages that lead to an enduring competitive advantage (for example, Intel).  There might be first-mover disadvantages. The first mover has to bear significant pioneering costs that later entrants do not. The first mover must pioneer the technology, develop distribution channels, and educate customers about the nature of the product. The first mover runs the risk of building the wrong resources and capabilities.

7-13 STRATEGIES FOR EXPLOITING FIRST-MOVER ADVANTAGES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  First movers need to build a sustainable long-term competitive advantage and reduce risks.  The three basic strategies for exploiting first- mover advantages are: 1)Develop and market the innovation. 2)Develop and market the innovation jointly with other companies through a strategic alliance or joint venture. 3)License the innovation to others and allow them to develop the market.

7-14 STRATEGIES FOR EXPLOITING FIRST- MOVER ADVANTAGES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Three Questions 1)Does the innovating company have the complementary assets to exploit its innovation and capture first-mover advantages? Complementary assets are the assets required to exploit a new innovation and gain a competitive edge (state-of-the-art manufacturing facilities capable of satisfying demand, marketing know-how). (continued)

7-15 STRATEGIES FOR EXPLOITING FIRST- MOVER ADVANTAGES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Three Questions 2)How difficult is it for imitators to copy the company’s innovation? In other words, what is the height of barriers to imitation? Barriers to imitation give an innovator time to establish a competitive advantage and build more enduring barriers to entry in the newly created market (patents). (continued)

7-16 STRATEGIES FOR EXPLOITING FIRST- MOVER ADVANTAGES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. The Three Questions 3)Are there capable competitors that could rapidly imitate the innovation? Capable competitors are companies that can move quickly to imitate the pioneering company. In general, the greater the number of capable competitors with access to the R&D skills and complementary assets needed to imitate an innovation, the more rapid imitation is likely to be.

7-17 Learning Objective:After reading this chapter you should be able to explain the nature of technological paradigm shifts and their implications for enterprise strategy. Learning Objective: After reading this chapter you should be able to explain the nature of technological paradigm shifts and their implications for enterprise strategy. TECHNOLOGICAL PARADIGM SHIFTS  Technological paradigm shifts occur when: New technologies revolutionize the structure of the industry. It dramatically alters the nature of competition. It requires companies to adopt new strategies to survive. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7-18 PARADIGM SHIFTS AND THE DECLINE OF ESTABLISHED COMPANIES  Paradigm shifts appear to be more likely to occur in an industry when one, or both, of the following conditions are in place. 1)The established technology in the industry is mature and approaching or at its “natural limit,” and 2)A new “disruptive technology” has entered the marketplace and is taking root in niches that are poorly served by incumbent companies using established technology. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

7-19 PARADIGM SHIFTS AND THE DECLINE OF ESTABLISHED COMPANIES The Natural Limit to Technology © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The silicon-based semiconductor chip may be approaching its natural limit because we are approaching the limits to the ability to shrink the width of lines on a chip that allows the manufacturer to add more transistors on a chip.  It is more likely that manufacturers will find another technology to replace silicon-based computing and enable them to continue building smaller, faster, cheaper computers.

7-20 PARADIGM SHIFTS AND THE DECLINE OF ESTABLISHED COMPANIES The Natural Limit to Technology © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Richard Foster noted that initially the contenders for the replacement technology are not as effective as the established technology.  He further noted that established companies and their customers often make the mistake of dismissing the new technology, only to be surprised by its rapid performance improvement.  Foster pointed out that there is not one potential successor technology, but a swarm of them.

7-21 PARADIGM SHIFTS AND THE DECLINE OF ESTABLISHED COMPANIES Disruptive Technology © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Clayton Christensen uses the term disruptive technology to refer to a new technology that gets it start away from the mainstream of a market.  Its functionality improves over time, and invades the main market.  Established companies are often aware of the new technology but do not invest in it because they listen to their customers, who do not want it.

7-22 PARADIGM SHIFTS AND THE DECLINE OF ESTABLISHED COMPANIES Disruptive Technology © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Many established companies decline to invest in new disruptive technologies because initially they serve such small market niches that it seems unlikely there would be an impact on the company’s revenue and profits.  When disruptive technology occurs, a new network of suppliers and distributors typically grow alongside the new entrants.

7-23 STRATEGIC IMPLICTIONS FOR ESTABLISHED COMPANIES © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  Having access to the knowledge about how disruptive technologies can revolutionize market is a valuable strategic asset.  It is important for established enterprises to invest in newly emerging technologies that may ultimately become disruptive technologies (a strategy used by Cisco Systems).  Established companies should separate out the disruptive technology and create an autonomous operating division solely for this new technology.

7-24 STRATEGIC IMPLICTIONS FOR NEW ENTRANTS © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.  The new entrants have several advantages over established enterprises. Pressures to continue the existing out-of-date business model do not hamstring new entrants. They do not have to worry about their established customer base, or about relationships with established suppliers and distributors. New entrants can focus all their energies on the opportunities offered by new disruptive technology. New entrants must choose whether to partner with an established company, or go it alone.