1. Economics of Standards http://www.vernetzung.de Economics of Standards http://www.vernetzung.de/eng/b3/ The Standardization Problem - An Economic Analysis of Standards in Information Systems - Peter Buxmann, Tim Weitzel, Falk v. Westarp, Wolfgang König Research Program 403 “Competitive Advantage by Networking" Research Project B3 “Economics of Standards” Institute of Information Systems J. W. Goethe-University Frankfurt am Main, Germany

2. Economics of Standards in Information Networks Communications standards can be generally defined as rules which provide the basis for interaction between actors (man, as well as machine). We developed models for centralized and decentralized networks illustrating the advantages and disadvantages of using standards. Economic parameters are based on empirical research. Approaching a general framework for analyzing the standardization problem, we combine three different research approaches: Formal analysis, a simulative approach and empirical studies (questionnaire, case studies). The framework is being developed as part of a general network theory within the interdisciplinary research program "Competitive Advantage by Networking" at Frankfurt University

3. Economics of Standards The standardization problem: A basic model The nodes represent the costs of standardization (K i ) for the respective network actors i The edges show the costs of their communications relations (c ij ) with their respective partners. These costs include costs of information exchange, as well as opportunity costs of sub-optimal decisions Cost reductions can be realized only when both communicating nodes i and j have introduced the same or a compatible standard

4. Network (n=2) Economics of Standards in Information Networks

5. Economics of Standards Centralized coordination Centralized coordination: A central decision making unit (e.g. the state or a parent firm) is credited with the aggregate results

6. Economics of Standards Centralized coordination Centralized coordination determines a first-best solution, but...  Data problem: Given asymmetric information distribution and opportunistic behavior, complete information cannot be retrieved from all nodes at acceptable costs considering that the nodes' reporting induces resource allocation  Complexity problem: The centralized standardization problem is a combinatorial problem. Even solutions to simple centralized coordination problems are difficult because of their integer structure  Implementation problem: Systems of control and incentives guaranteeing that a given, preordained solution will be implemented by all actors also involve costs

7. Network (n=2) Economics of Standards in Information Networks

8. Economics of Standards Decentralized coordination Decentralized coordination: Autonomous actors make individual standardization decisions If E [U (i)] > 0, then i standardizes

9. Economics of Standards Decentralized coordination Using all assumed data, node i can estimate p ij as the probability of standardization in node j by attempting to imitate j's decision behavior:

10. Economics of StandardsNumerical simulations A simulation model shows the problem of decentralized coordination: The Standardization Gap 20 nodes information costs are randomly generated (approx. normally distributed) with a standard deviation of  =200 standardization costs (normally distributed) with µ=10,000 and  =1,000

11. Economics of StandardsThe standardization gap Quality of decisions in a decentralized model based upon ex post network-wide savings on information costs for alternative E[c ij ]

12. Economics of Standards Comparison of centralized and decentralized coordination Generally, the frequency of standardization ceteris paribus increases with c ij or a growing installed base and decreases with K i The risk of incorrect decisions under decentralized coordination leads to less willingness to standardize within the moderate range of values. Network-wide savings attainable through centralized coordination determine the critical value for the costs of coordination above which a centralized solution is no longer advantageous. This value corresponds to the perpendicular distance between the curves.

13. Interdisciplinary Research Program SFB 403 of the J. W. Goethe-University, Frankfurt am Main, Germany Competitive Advantage by Networking - the Development of the Frankfurt and Rhine-Main Region http://www.vernetzung.de/eng/