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5.0 out of 5 stars Prescient rules for winning in the Internet economy, December 21, 1998
This review is from: Information Rules: A Strategic Guide to the Network Economy (Hardcover)
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.
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