1. IT for Managers Understanding Network Effects John Gallaugher Accompanying reading available online at: http://gallaugher.com/chapters & http://flatworldknowledge.com/pub/gallaugher

2. Issues Covered • Network Effects • Defined • Characteristics of markets & competition when present • Examples • Difficulty of technological leap-frogging • Strategies for competing in network markets

3. Understanding Network Effects (a.k.a. Network Externalities, Metcalfe’s Law) buyers • When present, product or services become more valuable as its installed base expands. • Sources of this value: • Exchange opportunities • Staying power • Complementary benefits • Market characteristics: Early competition, bandwagons, monopolistic tendencies • ‘Best’ products don’t always win. Innovation effect • Lowers competition with established standard • Increases innovation within standard sellers Users (Windows, iPhone) Developers (programs, apps) members

4. Switching Costs & Microsoft “It is this switching cost that has given our customers the patience to stick with Windows through all our mistakes, our buggy drivers, our high TCO [total cost of ownership], our lack of a sexy vision at times, and many other difficulties […] Customers constantly evaluate other desktop platforms, [but] it would be so much work to move over that they hope we just improve Windows rather than force them to move. […] In short, without this exclusive franchise [meaning Windows] we would have been dead a long time ago.” - comments from a Microsoft General Manager in a memo to Bill Gates

5. The iPod Economy

6. Graph It! Value Number of Users

7. Radical innovation may be necessary if an incompatible technology is to overthrow an established standard. The technical benefits of the new innovation must exceed the exchange, staying power, and complementary benefits of the incumbent. Technological Functionality Battling a Leader with Network Effects is tough… Switching Costs (staying power) Complementary Benefits --- VALUE --- Installed base (exchange) Technological Functionality New, incompatible entrant Incumbent product

8. Strategies for Competing in Network Markets • Move early • Subsidize product adoption • Leverage viral promotion • Redefine the market or leverage convergence • Alliances and partnerships • Distribution channels • Seed the market with complements • Encourage the development of complementary goods • Maintain backward compatibility • Rivals: be compatible with larger networks • Incumbents: constantly innovate to create a moving target • Large, well-known followers: preannouncements