Cooperation and Compatibility
Network economics and positive feedback make cooperation more important than ever. Most companies need to cooperate with others to establish standards and create a single network of compatible users. But as soon as the ink is dry on the standards agreement, these same companies shift gears and compete head to head for their share of that network. The term competition captures the tension between cooperation and competition prevalent in network industries. When distinct components have to work together as a system, the paramount strategic questions involve cooperation and coordination: with whom should you cooperate, how broadly, and under what terms?
How standards change game
To figure out who really wants a standard, and who doesn’t, you need to envision how the market is likely to evolve with or without an agreed-upon stan
i) Expanded Network Externalities
First and foremost, standards enhance compatibility, or interoperability, generating greater value for users by making the network larger. These standards fuel beneficial network externalities in two ways. First, and most directly, the standard makes it possible to share information with a larger network (without the need to convert the data from one format to another). Second, and indirectly, the enhanced ability to share data attracts still more consumers using this format, further expanding the available network externalities. This analysis applies equally to real communications networks, like fax machines and ATM networks, and to virtual networks, such as users of compatible computer software or compatible disk drives. Either way, the larger network is a real boon to consumers. If you ever lose sight of this basic tenet of network markets—that is, the fact that compatibility creates substantial consumer benefits.
ii) Reduced Consumer Lock-In
If the standard is truly open, consumers will be less concerned about lock-in. They can count on future competition. This has worked nicely for CDs, where holders of patents essential to the CD standard, including Sony, Philips, and Disco Vision Associates, have charged only modest royalties. Likewise, consumers expected competition on the PC platform, owing to IBM’s open approach. And competition they got— among hardware providers, that is, but not among operating systems, which became dominated by Microsoft. Netscape is now touting the open nature of its product line to convince users that they will not be locked into a proprietary solution.
iii) Reduced Uncertainty
Standards reduce the technology risk faced by consumers. This, too, accelerates acceptance of a new technology. A standard with many backers can go far to bolster (encourage or support) the credibility of the technology, which then becomes self-fulfilling. In contrast, with incompatible products, consumer confusion and fear of stranding may delay adoption. One of the risks in a standards war is that the battle to win market share will undermine consumer confidence that either technology will prevail, resulting in a war with no victor. As each side strives to convince consumers that it will be the winner, consumers may take the easy way out and sit on the sidelines, especially if a serviceable older technology is already available and standardized.
iv ) Competition for the Market vs Competition in the Market
Precisely because standards reduce lock-in, they shift the locus of competition from an early battle for dominance to a later battle for market share. Instead of competing for the market, companies compete within the market, using the common standards. Aggressive penetration pricing is far less likely under a common standard, but so is lock-in. One of the worst outcomes for consumers is to buy into a standard that is widely expected to be open, only to find it “hijacked” later, after they are collectively locked in.
- Competition on Price versus Features
Standards shift competition away from features and toward price, for the simple reason that many features are common across all brands. How many? This depends on how specific the standard is: the more detailed the standard, the harder it is for each producer to differentiate its product and still comply with the standard. So, while a more extensive standard leads to fewer compatibility problems, and
stronger network externalities, it also can reduce the ability of each supplier to differentiate its products, thereby intensifying price competition. For this very reason, consumers tend to seek more extensive standards than do suppliers. It follows that rival manufacturers may all be better off living with some incompatibilities and with a smaller total market in order to deemphasize pricing competition and focus competition more on product features.
Component versus Systems Competition
Standards shift the locus of competition from systems to components. When Nintendo competes against Sega, consumers compare the Nin tendo system of hardware and available software with the Sega system. The firm that can offer the superior total package stands to win. Compare this with audio and video equipment (stereo systems, televisions, and VCRs), where the various components are (by and large) compatible. A company can do well making the best or cheapest television, even if it sells no VCRs. Similarly, a different company can profit by selling stereo speakers, even if it makes no receivers or CD players. The same is true for PCs: HP has a very profitable printer business, even though its computer sales are modest. Sony has done well selling monitors, with essentially no presence in the PC box business, at least in the United States.
WHO WINS AND WHO LOSES FROM STANDARDS
We have seen how standards change the nature of the game; here we examine how they affect the players
Consumers generally welcome standards: They can enjoy the greatest network externalities in a single network or in networks that seamlessly interconnect. They can mix and match components to suit their tastes. And they are far less likely to become locked into a single vendor, unless a strong leader retains control over the technology or wrests control in the future through proprietary extensions or intellectual property rights. Standardization does have some downsides for consumers, however. The main one is a loss of variety: the standard may be poorly suited to some customers’ needs, or it may just turn out to be an inferior technology.
Like consumers, sellers of complements welcome standards, so long as their products comply with the standard. AOL sells Internet access, a complement to modems. AOL benefits from the use of standardized, high-speed modems in that AOL itself does not need to maintain separate banks of modems with different formats. In fact, influential complementors can affect the choice of a standard, just as • can influential consumers. For example, Recording studios and retail music stores are complementors to music CDs and therefore beneficiaries of the CD standard. Phonograph manufacturers, on the other hand, offered a product that was a direct competitor to CD players. The CD was a grave threat to these companies; they had to learn to make CD players, a very different business from making phonographs, or go out of business.
- Product standards for new technologies can pose a grave threat to established incumbents.
- After all, if standards fuel the positive feedback cycle and help launch a new technology, they can easily cannibalize sales from an older technology.
- Incumbents have three choices.
- First, deny backward compatibility to would-be entrants with new technology in the hope of blockading entry altogether, thereby extending the life of its own technology.
- Second,An incumbent can rush to introduce its own new generation of equipment, perhaps with the unique advantage of backward compatibility, to win a standards war.
- Third : Alliance An incumbent can ally( join with other organization or person) itself with the new technology, hoping to benefit from its established brand name, an expanded market, and perhaps from royalty and technology licensing income
Companies developing new technology collectively tend to welcome standards, because standards typically expand the total size of the market and may even be vital for the emergence of the market in the first place. Whenever a group of innovators collectively benefit from a standard, there is always some way for them to structure an agreement in support of that standard. For precisely this reason, we see literally hundreds of standards introduced each year. Smart cards offer a good example
TACTICS IN FORMAL STANDARD SETTING
The term formal standard refers to a specification that has been approved by a standard setting organization. The term de jure standard refers to a standard mandated by legal requirements or refers generally to any formal standard. Most
Formal Standard–Set by a recognized body , like IEEE, ITU, etc.
Once we have assessed the strengths and objectives of the other players, we should apply the following principles of strategic standard setting:
Don’t automatically participate. If we can follow a control strategy
If you can follow a control strategy or organize an alliance outside the formal standard-setting process, you may be far better off: you can move more quickly, you can retain more control over the technology and the process, you will not be bound by any formal consensus process, and you need not commit to openly licensing any controlling patents. For example, Motorola did not participate in the ITU T.30 recommendation for facsimile equipment and later sought royalties from manufacturers of that equipment. This generated some ill will, since Motorola had previously agreed to license this same technology on reasonable terms for modems as part of the V.29 modem standard-setting process, but nonparticipation also generated significant royalty income for Motorola.
Keep up our momentum.
Don’t freeze your activities during the slow standardsetting process. Actively prosecute any patent applications you have pending, keep up your R&D efforts, and prepare to start manufacturing.
Be creative about cutting deals
Figure out what key assets you bring to the table, and use those to assemble a coalition or to extract favorable terms when you pick sides. Consider low-cost licensing, second sourcing, hybrid standards, grantbacks of improvement patents, and commitments to participate in future joint development efforts. Whatever cards you have in your hand, play them when you are most likely to make a pivotal difference. Don’t confine your deal making to the technology or product in question; think broadly of ways to structure deals that are mutually beneficial
Beware of vague promises
The formal standard-setting process has a great deal of momentum. Don’t count on vague promises of openness made early on; these may evaporate once a standard is effectively locked in. In the ITU, for example, individual companies are expected to support whatever position the State Department takes on behalf of the United States, since the department consults first with the industry. As a result, companies lose the ability to stop or steer the process once national positions are set; to do so would be regarded as treason. For just this reason, make sure early on that holders of key patents are explicit about their commitment to license for “reasonable” royalties.
Search carefully for blocking patents.
Beware of picking a standard that will require using a patent held by a company not participating in the standard-setting process. Suppose a standard is selected, production begun, and positive feedback is achieved. Then a company that did not participate in the standard-setting process suddenly appears and asserts that everyone complying with the standard is infringing on a patent held by that company. Remember, a nonparticipating patent holder is not required to license its patents on fair and reasonable terms. This is the nightmare of every participant, since the interloper can potentially control the entire market the participants have built
Consider building an installed base preemptively.
This is risky, and not always possible, but it can strengthen your bargaining position. Establishing manufacturing sources and building an installed base are akin to moving your troops into a stronger position while negotiating for peace.
Any company participating in an alliance in support of a compatibility standard:
To compete effectively in network markets, you need allies.
Choosing and attracting allies is a critical aspect of strategy in the network economy. Competition thus becomes a mixture of politics and economics. You must assemble allies to promote a standard and then compete against these same companies once the standard is established
To find your natural allies, you must determine how a proposed standard will affect competition. Standards alter competition in several predictable ways.
Standards expand network externalities, reduce uncertainty, and reduce consumer lock-in. Standards also shift competition from a winner-take-all battle to a more conventional struggle for market share, from the present into the future, from features to prices, and from systems to components.
Standards tend to benefit consumers and suppliers of complements at the expense of incumbents and sellers of substitutes. Look for your allies among the groups that will benefit from a standard. Then be creative in finding ways to split the enlarged pie that results from a successful standard.
• Formal standard setting is now being used to develop more standards than ever before. Formal standard setting is slow, but it can give a new technology enormous credibility. Several keytactics will make you more effective in the formal standard-setting process. Don’t slow down your competitive efforts just because you are engaged in formal standard setting. Look for opportunities to build alliances by cutting creative deals, such as licensing arrangements, with selected participants of the standard-setting effort. Beware of companies that hold key patents and are not participating in the process.
• Find your natural allies and negotiate to gain their support for your technology.
Allies can include customers, complementers, suppliers, and competitors. Be prepared to offer special deals to early supporters; with positive feedback, a few visible early supporters can be enough to tip expectations in your favor, making it easier to attract more allies over time.
• Before you engage in a standards battle, try to negotiate a truce and form an alliance with your would-be rival.
An agreed-upon standard may lead to a far bigger overall market, making for a larger pie that you can split with your partners. Don’t be proud; be prepared to cut a deal even with your most bitter enemy.
• Try to retain limited control over your technology even when establishing an open standard.
Without a champion, open standards can stagnate or splinter into incompatible pieces. Allies may be happy to let you guide the future evolution of the standard, so long as you have a lasting commitment to openness.