Chapter 8: platforms, network effects, and competing in a world
Network effects (metcalfe’s kaw or network externalities) – implies that the value of a product
increases as its number of users expands, so more users means more value. These effects are
strategic resources and can be created through technology innovation. This is possible through
platforms – they create an ecosystem of networks
Where does the value come from?
The value derived from network effect comes from three sources
1. Exchange (new user comes online and network becomes more valuable)
2. Staying power
3. Complementary benefits
Staying power – long-term viability of a product or service. It is important for customers since
users invest in learning how to use a system, installs software, etc. This concept is connected to
switching costs which can strengthen the value of network. The higher the value of investment,
the more likely the consumer is to consider the staying power before choosing to adopt is, and
higher the investment, less likely to leave the product.
Complementary benefit – refer to products that add additional value to the primary product
that makes up a network.
Platforms – products and services that allow for development and integration of software
products and encourage others to offer complementary goods. For example, application
programming interfaces (APIs), allowing third parties to integrate.
Understanding network structure
One-sided market – derives its value from single class users e.g. instant messaging
The network effects obtained from IM users attracting more IM users, this is called “same-side
exchange benefits” (interaction between single class users)
Two-sided market – includes two distinct categories of users, both are needed to deliver value
for the network to work. When the rise of one user of the market causes a rise in the second
user of the market, this is called as “cross-side exchange benefit”.
Network markets experience early and fierce competition, caused by positive feedback loop.
(winners take all or winner take most)
Firms become aggressive during the early stages of competition because new adopters begin to
favor the leading product over rivals, tipping the market in favor of one dominant firm. (they
can enjoy bargaining power)
, The incumbent must not be able to copy any of the newcomers’ valuable innovations. Because
of this “technological leapfrogging” can be very hard.
Technological leapfrogging – competing by offering a new technology that is so superior that
the value overcomes the total resistance that older technologies might enjoy
Network effect limits competition against the dominant standard, however, innovation within
a standard may blossom.
Different strategies exist for competing
1. Move early – starting your network in your direction
2. Subsidize adoption – firms offer subsidize initial adopters in hopes that network effects
will kick in shortly after.
3. Leverage viral promotion – it is possible to use firms’ customers to promote product
through word of mouth or sharing. Viral promotions are often linked to subsidies, but
they can also provide the additional benefit of leveraging a trusted friend to overcome
disinterest. These incentives are called as “social proof”.
4. Expanding by redefining the market – e.g. blue ocean strategy where firms seek to
create a compete in uncontested “blue ocean” market spaces.
Two or more markets that were previously considered separate beginning to
offer similar features and capabilities, this is referred as “convergence”.
Envelopment – one market attempting to conquer (ele geçirmek) a new market
by making it a subset, component, or feature of its primary offering.
5. Alliances and partnerships – firms use this to increase market share for a network.
6. Leverage distribution channels – when you do not have distribution channels, it is
important to create them.
7. Seed the market – in two-sided markets, firms can charge the ones who are willing to
pay.
8. Encourage the development of complementary goods – either develop a subsidy or
other free or discounted service
9. Leverage backward compatibility – firms that control a standard should also ensure
that new products are backward compatible which refers to the ability to take
advantage of complementary products developed for a prior generation of
technology. If they do not have backward compatibility, it re-enters a market at zero
and gives up a major advantage which is a switching cost build by prior customers.
Rivals: be compatible with the leading network
- Making new products compatible with the leading standard
Incumbents (dominant player): close off rival access and constantly innovate
- Dominant networks/Firms that constantly innovate make compatibility difficult for rivals
who connect with their systems
Network effects (metcalfe’s kaw or network externalities) – implies that the value of a product
increases as its number of users expands, so more users means more value. These effects are
strategic resources and can be created through technology innovation. This is possible through
platforms – they create an ecosystem of networks
Where does the value come from?
The value derived from network effect comes from three sources
1. Exchange (new user comes online and network becomes more valuable)
2. Staying power
3. Complementary benefits
Staying power – long-term viability of a product or service. It is important for customers since
users invest in learning how to use a system, installs software, etc. This concept is connected to
switching costs which can strengthen the value of network. The higher the value of investment,
the more likely the consumer is to consider the staying power before choosing to adopt is, and
higher the investment, less likely to leave the product.
Complementary benefit – refer to products that add additional value to the primary product
that makes up a network.
Platforms – products and services that allow for development and integration of software
products and encourage others to offer complementary goods. For example, application
programming interfaces (APIs), allowing third parties to integrate.
Understanding network structure
One-sided market – derives its value from single class users e.g. instant messaging
The network effects obtained from IM users attracting more IM users, this is called “same-side
exchange benefits” (interaction between single class users)
Two-sided market – includes two distinct categories of users, both are needed to deliver value
for the network to work. When the rise of one user of the market causes a rise in the second
user of the market, this is called as “cross-side exchange benefit”.
Network markets experience early and fierce competition, caused by positive feedback loop.
(winners take all or winner take most)
Firms become aggressive during the early stages of competition because new adopters begin to
favor the leading product over rivals, tipping the market in favor of one dominant firm. (they
can enjoy bargaining power)
, The incumbent must not be able to copy any of the newcomers’ valuable innovations. Because
of this “technological leapfrogging” can be very hard.
Technological leapfrogging – competing by offering a new technology that is so superior that
the value overcomes the total resistance that older technologies might enjoy
Network effect limits competition against the dominant standard, however, innovation within
a standard may blossom.
Different strategies exist for competing
1. Move early – starting your network in your direction
2. Subsidize adoption – firms offer subsidize initial adopters in hopes that network effects
will kick in shortly after.
3. Leverage viral promotion – it is possible to use firms’ customers to promote product
through word of mouth or sharing. Viral promotions are often linked to subsidies, but
they can also provide the additional benefit of leveraging a trusted friend to overcome
disinterest. These incentives are called as “social proof”.
4. Expanding by redefining the market – e.g. blue ocean strategy where firms seek to
create a compete in uncontested “blue ocean” market spaces.
Two or more markets that were previously considered separate beginning to
offer similar features and capabilities, this is referred as “convergence”.
Envelopment – one market attempting to conquer (ele geçirmek) a new market
by making it a subset, component, or feature of its primary offering.
5. Alliances and partnerships – firms use this to increase market share for a network.
6. Leverage distribution channels – when you do not have distribution channels, it is
important to create them.
7. Seed the market – in two-sided markets, firms can charge the ones who are willing to
pay.
8. Encourage the development of complementary goods – either develop a subsidy or
other free or discounted service
9. Leverage backward compatibility – firms that control a standard should also ensure
that new products are backward compatible which refers to the ability to take
advantage of complementary products developed for a prior generation of
technology. If they do not have backward compatibility, it re-enters a market at zero
and gives up a major advantage which is a switching cost build by prior customers.
Rivals: be compatible with the leading network
- Making new products compatible with the leading standard
Incumbents (dominant player): close off rival access and constantly innovate
- Dominant networks/Firms that constantly innovate make compatibility difficult for rivals
who connect with their systems
