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Information Rules: A Strategic Guide to the Network Economy

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Information Rules: A Strategic Guide to the Network Economy by Carl Shapiro and Hal Varian takes a look at the emerging Internet economy, and argues compellingly that traditional economics still apply in evaluating the Yahoos of our generation. In fact, history provides a pretty good guide for evaluating network-centric businesses. One only has to look at the evolution of the railroad, telephone and television networks. The book reaches some interesting conclusions, summarized here:

1.Information is costly to produce but inexpensive to reproduce (i.e., has a high fixed cost but a low marginal cost). This translates to a lot of latitude, challenges and opportunities in coming up with pricing models and corresponding versions of a product to create both the maximum revenue opportunities and establish the largest number of members of the product's network of users. Also, given the low cost of reproduction, it stands to reason that protecting intellectual property is a key determinant of information good's economic success. 2.Information is an "Experience Good," which is to say that customers must use and experience the product to put value on it. One only has to think about Netscape's initial success giving away the browser to see the value of leveraging the "experience" factor. 3.Products that can achieve "lock-in" will benefit from the "switching costs" that preclude customers from switching-over to competing (even superior) solutions. In other words, products that get a user to commit time, knowledge and/or resources to them are likely to continue to be used even in the face of superior products given the cost of switching to alternative products. An interesting point the book makes is to look at lock-in and switching costs not only in terms of your product, but your collaborators and complementors as well. 4.Fundamental to success is leveraging the power of positive feedback, or network effects. What this means is that the value of your product is a function of the total number of vendors, partners and endusers participating in its "network."

Some specific strategic considerations:

1.Versioning: create different versions of your products tailored to the need of different groups of customers. This allows customers to select the version that best meets their needs and enables you to pick up as wide a base of customers as possible (e.g., Quicken, Quicken Deluxe, QuickBooks). Specific mechanisms for accomplishing same are: delay, user interface, convenience, image resolution, speed of operation, flexibility of use, capability, features and functions, comprehensiveness, annoyance, support. 2.The total cost of switching = cost the customer bears + costs the new supplier bears. Types of lock-in: contractual commitments, durable purchases, brand-specific training, information and databases, specialized suppliers, search costs, loyalty programs. 3.The lock-in cycle: brand selection, product sampling, entrenchment, lock-in. Needless to say, the more successful you are at getting customers more locked-in to your products (e.g., taking advantage of proprietary features), the more successful you will be in keeping customers at peak prices. 4.Leveraging your installed base: focus on selling complimentary products (Micorsoft), selling access to your installed base (Yahoo), setting differential prices to achieve lock-in (Adobe's Photo Deluxe for beginners is a low-end product that is often bundled with scanners and gets users hooked on product. Many ultimately upgrade to full version of product, Adobe Photoshop), exploiting first-mover advantages (Ticketnmaster locks customers into long-term contracts). 5.Market adoption dynamics in positive feedback markets tend to evolve along the lines of an S-curve, with the initial adoption period being flat (while the market winner is in doubt). Once an apparent market winner emerges, the adoption rates takes off dramatically continuing until market saturation. In other words, popularity in positive feedback markets is the ultimate metric of success. Hence, perception becomes reality in these markets. Those expected to win in the market do win because second place or third place is tantamount to last place (i.e., having to bear the switching cost of moving to the winning vendor in the market). This is a zero-sum game, where both vendors must proclaim themselves the ultimate winner, and the success of getting out the message is as important as the technical attributes of the product. 6.Evolution vs. Revolution: there are two paths for unseating an incumbent. One is evolution, which is akin to providing an adapter to a legacy technology. The other is revolution, which disregards legacy in favor of improved design (CDs as a replacement for records). Both paths have technical, creative, systemic, performance and legal considerations. 7.Openness vs. Control: This is a key tightrope in the age of open standards. The more open your solution, the lower the bar to positive feedback. With control comes a hedge against commoditization and low margin pricing. Four key vectors are represented: Controlled Migration (Windows 98), Performance Play (Iomega Zip), Open Migration (fax machines), Discontinuity (records to CDs). 8.How standards change the game: Expanded network effects, reduced uncertainty, reduced consumer lock-in, competition for the market vs. competition in the market, competition on price vs. features, competition to offer proprietary extensions, component vs. systems competition. 9.Tactics in formal standard setting: If you can follow a control strategy, you are better off organizing an alliance outside of the formal standards bodies. Search carefully for blocking patents of competitors in the standard definition. Consider building an installed base pre-emptively. 10.Waging a standards war -The key assets in such a battle are: 1. Control of an installed base, 2. Intellectual property rights, 3. Ability to innovate, 4. First mover advantages, 5. Manufacturing abilities, 6. Presence in complimentary products, and 7. Brand name and reputation. Example: Netscape vs. Explorer: Netscape had a huge first-mover advantage over Microsoft that Microsoft was able to neutralize by preempting new users through a number of strategies, including bundling on OS, signing deals with OEMs, bundling content with the browser and giving links to ISPs for making Explorer the preferred browser supported. Both vendors used penetration pricing to set a low bar to using their products. Both vendors also leveraged the expectations management and alliances trump cards to win their places in the market.

"Information Rules" is a hand book for economic layman to understand emerging Internet economy, to help reader to apply feasible strategies into network business. As author mentioned in the beginning of this book, this book is seeking models, concepts, and analysis, which will provide reader with a deeper understanding of the fundamental principles in today's high-tech industries, and enable reader to craft winning strategies for tomorrow's network economy.

Technology changes, economic laws do not. This is the thesis of this book. Shapiro & Varian do a great job of explaining how the fundamental principles of economics are still relevant, even in the new network economy. On the other hand, the technology increases the pace of economic game and requires greater speed and agility to keep playing. Thus, it's necessary to adopt new strategies based on fundamental economic principles.

Shapiro & Varian develop this thesis into ten chapters: The Information Economy, Pricing Information, Versioning Information, Rights Management, Recognizing Lock-In, Managing Lock-In, Networks and Positive Feedback, Cooperation and Compatibility, Waging a Standards War, and Information Policy. Specific strategies are suggested in each chapter. At the end of each chapter, "lessons" are summarized to for readers to outline the main ideas efficiently.

Following are some feature points and strategies this book has reached to enable myself to the network economy.

Point 1: Information is costly to produce but inexpensive to reproduce.
The competition between Britannica Encyclopedia and Microsoft's Funk & Wagnalls brings reader into this topic. The cost change of information products is coming up with the shifting of pricing models and corresponding versions of a product to create both the maximum revenue opportunities and establish the largest number of members of the product's network of users.
Strategy: Personalize your product and your prices
There are three ways to pricing information: personalized pricing, group pricing and versioning. Let's analogize those strategies to the modern fashion industry, a fashion designer can tailor dresses specifically for the need of one customer (personalized pricing) or a group of customer (group pricing). At the same time, he/she also designs different styles (different versions of your products) which are hanged in the window of shopping center. This allows customers to select the styles (versions) that best meets their needs and enables you to pick up as wide a base of customers as possible. There are variety of dimensions along which you can version your products: delay, user interface, convenience, image resolution, speed of operation, flexibility of use, capability, features and functions, comprehensiveness, annoyance, support.

Point 2: Switching costs and lock-in
The total cost of switching = cost the customer bears + costs the new supplier bears. In companies' stance, products that can achieve "lock-in" will benefit from the "switching costs" that preclude customers from switching-over to competing solutions. The more successful you are at getting customers more locked-in to your products, the more successful you will be in keeping customers at peak prices.
Strategy:
1.Invest to build an installed base. 2.Cultivate influential buyers and buyers with high switching costs. 3.Get your customers to invest in your technology, thereby raising their own switching costs. 4.Sell complementary products and access to your installed base

Point 3: Positive feedback
The value of your product to new users depends on the total number of other users there are (externalities). As the base of users grows, more and more users add in. In information economy, the companies that have been propelled forward by positive feedback will become the biggest winners. So, it is the ultimate metric of success that each company pursues.
Strategy:
There are four generic strategies in network markets for igniting positive feedback, Controlled Migration (Windows 98), Performance Play (Iomega Zip), Open Migration (fax machines), Discontinuity (records to CDs).

Point 4: Standardization
The key assets in winning standards battle are: 1. Control of an installed base, 2. Intellectual property rights, 3. Ability to innovate, 4. First mover advantages, 5. Manufacturing abilities, 6. Presence in complimentary products, and 7. Brand name and reputation. Preemption and expectations management are two basic marketplace tactics that companies will need to employ.

Point 5: Intellectual property
Given the low cost of reproduction and quick, cheap and invisible distribution, protecting and managing intellectual property are more difficult. Although authors believe that the technological advance offer new opportunities which are far outweigh this rights problem, the solutions recommended here are relatively weak and difficult to carry out.
Strategy:
Take advantage of the lower distribution costs by promoting your products more effectively. Such as giving away free samples to sell the content, selling complementary products, choosing the terms and conditions that maximize the value of your property.

Besides those core points and strategies the book reaches, examples which integrate those points make whole book more readable. Authors use examples not only happened recently, but also 100 years ago. Such as interconnection battles were already existed in 1900 when local telephone companies were interconnected with Bell to provide long-distance service. 100 years later, browsers are interconnected with operating systems. History provided a pretty good guide for evaluating network-centric business.
However, almost all of these cases involve the very large firms: e.g. Microsoft, IBM, AT&T, which have strategic planning, high capitalization, and access to best consultants. But the very essence of the new information economy today is entrepreneurship, like Napster, Visi-calc, etc, with good ideas and lucky chance.
The most contradictive part in this book is chapter 6. Authors offer both sellers and buyers alternative strategies on how to manage Lock-in. No matter how effective those strategies are, the dilemma here is that if both sellers and buyers adopt the alternative strategies this book recommends, who will be the winners ultimately?
This book was published four years ago. The network economy has changed a lot since then. From the beginning of 2001, most Internet companies experienced the toughest time. As a reader of this book, a question comes to my mind constantly: are those information rules still applicable in today's network economy? According the thesis of this book, the answer should be yes. It's time to test the models of this book.

I used this book in an undergraduate business school course and all forty-five of us (me and my students) LOVED it. This book is one of those business classics that comes along once every five years. Unlike hyped marketers with ideas but no evidence, this book is grounded in solid research. If you read this one, make sure you also read the authors' article in the November 1998 Harvard Business Review. The book is highly original, fresh, and very very readable. In conclusion, this book is worth *every* penny.

You will have to come back to it many times to improve continually your understanding and practices in the network economy... Invest money and time in "Information Economy, a Strategic guide to the Network Economy" is a real good investment as it gives you guide lines to understand deeply the emerging Network Economy but also how to deal strategically with the main encountered issues: pricing, versioning, rights management, lock-in approaches, and information policy.

Even if Carl Shapiro and Hal R Varian are saying that: "Technology changes, Economics laws do not" their careful analysis on networks and positive feedback is conducting them to write "Strategy in network markets is distinct from strategy in markets for information content, not to mention traditional industrial markets". In network markets positive feedback based on Metcalfe's Law - the value of a network goes up as the square of the number of users - makes the strong grow stronger ... and the weak grow weaker.

To maximize your return you need to find the balance between openness and control, compatibility and performance and to be ready to build alliances, to battle for standardization on your own or with partners... "It is not enough to have the best product, you have to convince customers that you will win" is a crucial idea to apply in the network economy to ignite a positive feedback and reach the critical mass necessary to fuel explosive growth.

The authors are presenting, through real-life examples including the Microsoft Netscape browser battle , a complete battlefield with maps of strategies and tactics to win and stay in the network economy. Keep this guide close to your hand, as it will become your better source of knowledge to be at the forefront of the New Economy. Personally I plan to re-read this book on regular basis to make sure to extract all the richness the authors have put in.

There is a lot of confusion these days in terms of trying to define the rules of success in the new economy. One thing for sure is that the pace of change we are experiencing today is unprecedented and can be ignored at our own peril. But amazingly, the rules of the game have not changed - as argued so powerfully in this book; the pace of the game has increased and it requires greater speed and agility to keep playing.

But if the rules are the same and the pace has increased what about the playing field? Well, it is turning bigger and a player who wants to be in the game should know every inch of it.

The main theme of the book centers on the concept that while we may adopt new strategies in the information economy the fundamental economic principles still apply. The goods that we are dealing with are information goods that are costly to produce and cheap to reproduce. In such a scenario, what are the cost characteristics, pricing strategies and market structures? Similarly the concepts of Versioning, Rights management, Lock-in, Networks & positive feedback are analyzed in great detail with appropriate illustrations and cases.

Highly recommended.

Information rules is a brilliant books that gives a framework to think about software and other information goods. Before reading this book, if I were given a software and asked if it will be successful, I would have evaluated its features, compared them to competitors, checked where it added value etc. Now I ask myself, can this product get customer lock-in ? how will it break the lock-in existing products have ? what is the cost of switching from this product to another? are there network effects?

Shapiro and Varian point out that since the marginal cost of producing information goods is zero, manufacturers of these products will not make any economic profit, unless they can lock-in their customer through network effects or very high switching costs. They then give several case studies to explain this concepts, as well as the strategies that customers and manufacturers should employ in the network economy. There is also an excellent discussion of the standard setting process and the strategies different players must employ based on their place in the industry.

I strongly recommend this book for everyone who plans to work in the information economy. It is a totally excellent book, an eye-opener.

Some of these concepts in the book are like common sense that we know them but fail to explain them well, but the authors manage to describe them in words and with examples. I especially like chapter 5, 6 and 7, which address the lock-in, switching cost, network effects and positive feedback. They also show us how to deal with lock-in issues from both sides, as the suppliers and as the customers. If anyone ever wonders how to explain why Microsoft could be so successful, please ask him/her to read those 3 chapters.

Here are some excerpts of a review I wrote based on aprepublication copy.

Varian and Shapiro (henceforth VS) argue that economics is applicable to the Information Age, even though information has characteristics that differ from those of ordinary goods. As they put it,

"Even though technology advances breathlessly, the economic principles we rely on are durable. The examples may change, but the ideas will not go out of date." (preface, p. viii)

"markets for information will not, and cannot, look like textbook-perfect competitive markets..." (p. 22-23)

In other words, the asylum of economic analysis is still sturdy, even though it may resemble the movie "King of Hearts," in which the inmates are in charge. In this case, the inmates are phenomena that formerly were regarded as theoretical curiosities: zero marginal cost, significant complementarity, etc.

Mass-market business books instead tend to focus on providing affirmation, not information. ("You can be great, too! Here is the recipe for success!"). Many authors use jargon and metaphors to try to make their ideas sound more radical and important than they really are. VS offer neither chicken soup nor cyberbabble. They provide business executives with advice that is unconventional from a traditional vantage point and yet is well-grounded in economic reasoning.

As someone who finds pure intellectual curiosity sufficient motivation to read about this subject, I found "Information Rules" to be very worthwhile. The book is rich with substance, which can be conveyed only superficially in a brief review. It gave me fresh insights that helped to clarify my thinking.

It seems everyone with a modicum of business acumen has written (or is writing) a book analyzing the Information Age. Shapiro and Varian write theirs in the context of classic economic principles, not surprising given they are both economists. They pick out the small set of economic theories that easily translate to current business trends. As a result, this book is interesting to two groups of people: former econ majors and New Economy professionals. If you are both, great. (I'm both.) If you are neither, this book may be fairly dry, and not nearly as approachable as lifestyle books like "The New New Thing" or "Nudist on the Late Shift". Just so you know, this book is rapidly becoming a staple on undergrad econ reading lists.

If you are really, truly into the Information Economy, you will find their spin on our overanalyzed market segment is worth reading. Otherwise, your eyes will glaze over around chapter 3. Econ students, start making coffee in the middle of chapter 2.

This book is a very timely and well-written. The authors are dead-on in their analysis of the current state of the Internet and "Information" markets in general. The authors apply the concepts of economics to the Net and give the reader a clear framework to understanding the future trends of these markets. The authors, however,could have made the book 100 pages shorter by eliminating some of the redundant examples and cutting down some repetitive material. Overall, I would recommend the book but given a choice I would read Webonomics by Evan Shwartz first.