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Chapter 8

MGCR 331 Chapter 8: Chapter 8

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McGill University
Management Core
MGCR 331
Richard Donovan

1. Information systems – Chapter 8: Understanding Network Effects: Strategies for competing in a platform-centric, winner-take-all world 8.1 Introduction - Network effects = “Metcalfe’s Law” = “Network externalities” - When network effects are present, the value of a product or service increases as the number of users grow 8.2 Where does all that value come from - Exchange, power, and complementary benefits Exchange - Every product or service subject to network effects fosters some kind of exchange - Firms leveraging technology  ones and zeros of digital storage Staying power - Power is particularly important for consumers of technology products  A lot of investment (in learning how to use the system, buying and installing software, entering preferences or other data, creating files) - The concept of staying power (and the fear of being stranded in an unsupported product or service) is directly related to switching costs - Switching cots can strengthen the value of network effects as a strategic asset - Sticky, creating fiction, barnacles, not butterflies Complementary benefits - Those products or services that add additional value to the network  “How-to” books  Software  Feature add-ons  Labor - Platforms: Products and services that encourage others to offer complementary goods  Providing APIs that allow third parties to integrate with their products and services (other companies spend THEIR time and money to help your firm) - When users exchanging information attract more users, they can also attract firms offering complementary products - When developers of complementary products invest time writing software – and users install, learn, and customize these products – switching costs are created that enhance the staying power of a given network 8.3 One-sided or two-sided markets Understanding network structure - IM (instant messaging) = One-sided market = Market that derives most of its value from a single class of users, same-side exchange benefits (benefits derived by interaction among members of a single class of participant) - Softwares, video games = Two-sided market = Network markets comprised of two distinct categories of participant, both of which that are needed to deliver value for the network to work = Cross-side exchange benefit (when an increase in the number of users on one side of the market creates a rise in the other side) The positive feedback loop of network effects: One-side, two-sided, and sometimes a bit of both - In IM, the value-creating, positive-feedback loop of network effects comes mostly from same-side benefits from a single group - Mobile payment efforts = two-sided markets - Possible that a network may have both same-side and cross-side effects 8.4 How are these markets different? - Network markets experience early, fierce competition  Caused by positive-feedback loop inherent in network effects – where the biggest networks become even biger - Markets are also often winner-take-all or winner-take-most, exhibiting monopolistic tendencies where one firm dominates all rivals - The natural state of markets where strong network effects are present is for there to be one major player - Firms with a commanding network effects advantage may also enjoy substantial bargaining power over partners - - Winning customers away from a dominant player in a network industry isn’t as easy as offering a product or service that is better  Any product that is incompatible with the dominant network has to exceed the value of the technical features of the leading player plus the value of the incumbent’s exchange, switching cots, and complementary product benefit  The incumbent must not be able to easily copy any of the newcomer’s valuable new innovations Is this good for innovation? - Network effects limit competition against the dominant standard, innovation within a standard may actually blossom - Need of standards otherwise it’s chaos 8.5 Competing when network effects matter Strategies for Competing in Markets with Network Effects (Examples in Parentheses) Move early (Yahoo! Auctions in Japan) - Allows the firm to start the network effects snowball rolling in your direction - Exchange depends on the ability to communicate Subsidize product adoption (PayPal). - Firms may offer to subsidize initial adoption in hopes that network effects might kick in shortly after  Price reduction
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