STANDARDS BATTLES
AND DESIGN DOMINANCE
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The Rise of Microsoft
Paul Allen & Bill Gates, Oct 19 1981
after failed negotiations with another
company, IBM gave Microsoft a contract
to develop the OS for the new line of PCs
CP/M (Control Program/Monitor)
In 1980, Microsoft didn’t even have a PC OS.
The dominant OS was CP/M by Gary Kildall (DRI)
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The Rise of Microsoft
• As the market for personal computers grew and IBM realized they were
missing out on what might be a significant industry, they rushed to get a PC
to market.
– Kildall, for some unclear reason, did not get back to IBM fast enough so
they turned to Bill Gates who was already writing software for IBM.
– Gates bought an operating system from Seattle Computer Company and
called it MS DOS. It was a clone of CP/M.
86-DOS was created because sales of the Seattle Computer
Products (SCP) 8086computer kit, were poor due to the
absence of an operating system.
86-DOS had a command structure and application
programming interface that imitated that of CP/M.
The all rights license of 86-DOS system was purchased
by Microsoft in 1981 at $50,000 and developed further
as PC-DOS and MS-DOS.
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The Rise of Microsoft
• The success of the IBM PCs (and clones of IBM PCs) resulted in the rapid
spread of MS DOS, and an even more rapid proliferation of software
applications designed to run on MS DOS. Microsoft’s Windows was later
bundled with (and eventually replaced) MS DOS.
• Had Gary Kildall signed with IBM, or had other companies not been able to
clone the IBM PC, the software industry might look very different today!
CP/M-86 (and CP/M) copied file SOURCE to TARGET using
PIP (Peripheral Interchange Program) : PIP TARGET=SOURCE
while MS-DOS used COPY SOURCE TARGET
Controversy has continued to surround the similarity between the two systems.
The most sensational claim comes from Jerry Pournelle, who claims that Kildall
personally demonstrated to him that DOS contained CP/M code by entering a
command in DOS that displayed Kildall's name. A 2004 book about Kildall says that
he used such an encrypted message to demonstrate that other manufacturers had
copied CP/M.
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Overview
• Many industries experience strong pressure to select a
single (or few) dominant design(s).
• Once selected, producers and customers focus their efforts
on improving their efficiency in manufacturing, delivering,
marketing or deploying this dominant design rather than
continue to develop and consider alternatives
• There are multiple dimensions of value that shape which
technology rises to the position of the dominant design.
– The strategies of firms can influence several of these
dimensions, enhancing the likelihood of their technologies
rising to dominance.
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Why Dominant Designs Are Selected
• Increasing returns to adoption
– When a technology becomes more valuable the more it is adopted.
– The more they are used, the more they are understood and thus
improved
gmail, linux, etc. what are they doing?
• Revenues generated can be used to further develop and refine
the technology
– As a technology becomes more widely adopted, complementary
assets are often developed that are specialized to operate with the
technology
• This results in a self-reinforcing mechanism that increases the
dominance of a technology regardless of its superiority or
inferiority to competing technologies
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Why Dominant Designs Are Selected
• Two primary sources of increasing returns to adoption are learning
effects and network externalities.
– The Learning Curve: As a technology is used, producers learn to
make it more efficient and effective often with reduced input costs
or waste rates
• The cost of producing a unit falls as the number of units produced
increases.
• This pattern has been found to be consistent across a wide range of
products and services including automobiles, ships, semiconductors,
drugs and even heart surgery techniques
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Why Dominant Designs Are Selected
–Prior Learning and Absorptive Capacity
• A firm’s prior experience influences its ability to
recognize and utilize new information.
– Use of a particular technology builds knowledge base about that
technology
» Even failures can provide a useful learning experience and build a base
of knowledge for future use
– The knowledge base helps firms use and improve the technology
Suggests that technologies adopted earlier than others are likely to
become better developed, making it difficult for other technologies to
catch up.
– As a technology becomes more widely adopted, complementary assets
are often developed that are specialized to operate with the technology
» This results in a self-reinforcing mechanism that increases the
dominance of a technology regardless of its superiority or inferiority to
competing technologies
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Why Dominant Designs Are Selected
–Network or Positive Consumption Externalities
• In markets with network externalities, the benefit from
using a good increases with the number of other users
of the same good.
• Network externalities are common in industries that
are physically networked
– e.g., railroads, telecommunications
• Network externalities also arise when compatibility or
complementary goods are important
– e.g., many people choose to use Windows in order to
maximize the number of people their files are
compatible with, and the range of software
applications they can use.
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Why Dominant Designs Are Selected
• A technology with a large installed base attracts developers of
complementary goods; a technology with a wide range of
complementary goods attracts users, increasing the installed base. A
self-reinforcing cycle ensues
– Example of the cycle: Microsoft’s dominance of the OS market and
GUI market is due to the early adoption of their product which led
to a large installed base and the development of complementary
products. This further increased the installed base and reinforced
the cycle.
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Theory In Action
A Standards Battles in Digital Audio Formats
• 1982:Sony and Phillips jointly developed the CD that replaced the vinyl LP and split
the royalties
• Late 1990s: CD market was saturated, looking for new audio format for continued
growth of the market and prevent music piracy
• 1996: record companies and electronics companies joined together to form the
DVD Audio Consortium to create a new high-fidelity audio format.
• 1999: Sony and Philips unveiled their own high-fidelity audio format, Super Audio CD,
setting the stage for a standards battle similar to the VHS versus Beta battle in video
recorders.
• Fearing a format war that would select one standard as dominant (and one as failed),
many manufacturers decided to bear the extra cost of producing “Universal players”
that would support both formats.
• Neither format has been extremely successful, and popularity of MP3 format may
further dampen demand.
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Why Dominant Designs Are Selected
• Government Regulation
– Sometimes the consumer welfare benefits of having a single
dominant design prompts government organizations to intervene,
imposing a standard.
• 1953: FCC approved the NTSC color standard in television
broadcasting to ensure compatibility to monochrome TV sets
broadcasting in the U.S.
• 1998: EU adopted a single wireless telephone standard the
general standard for mobile communications (GSM) to avoid
proliferation of incompatible standards and facilitate exchange
within and between members countries
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Why Dominant Designs Are Selected
• The Result: Winner-Take-All Markets
– Natural monopolies
• Firms supporting winning technologies earn huge rewards;
others may be locked out.
– Increasing returns to adoption indicate that technology trajectories
are characterized by path dependency:
• End results depend greatly on the events that took place leading
up to the outcome.
– Early technology offerings may become entrenched and block
subsequent superior technologies from being accepted
– Aggressive sponsorship by a large and powerful firm may
ensure acceptance but lock out alternatives
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Why Dominant Designs Are Selected
– A dominant design can have far-reaching influence; it shapes future
technological inquiry in the area.
• Firms will tend to use and build on their existing knowledge base
rather than enter unfamiliar areas
– Winner-take-all markets can have very different competitive
dynamics than other markets.
• Technologically superior products do not always win.
• Such markets require different firm strategies for success than
markets with less pressure for a single dominant design.
– Winners know how to manage the multiple dimensions of
value that shape design selection
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Multiple Dimensions of Value
the rate of return from a product or process
increases with the size of it’s installed base
• In many increasing returns industries, the value of a
technology is strongly influenced by both:
– Technology’s Stand-alone Value
– Network Externality Value
diminishing returns industry - ex) farming
: the farmer will first farm the most fertile land with the most valuable crops.
To expand the farm's business, the farmer will have to cultivate progressively
less fertile land and will have to grow less valuable crops (once the demand
for the most valuable crop has been met).
In general, the bigger a business gets, the less optimal its last venture
Gucci misunderstood their own business
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Multiple Dimensions of Value
• A Technology’s Stand-alone Value
– Includes such factors as:
• The functions the technology enables customers to perform
• Its aesthetic qualities , Its ease of use, etc.
– Kim and Mauborgne developed a “Buyer Utility Map” that provides
a guide for managers to consider multiple dimensions of
technological value and multiple stages of the customer experience
• The benefits have to be considered with respect to the cost to
the customer of obtaining or using the technology – the benefits
to cost ratio determines value
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positioning
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Multiple Dimensions of Value
• Network Externality Value
– In industries characterized by network externalities, the value of
technological innovation to users will be a function not only of its
stand-alone benefits and cost, but also of the value created by:
• The size of the technology’s installed base
• The availability of complementary goods
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Multiple Dimensions of Value
• Network Externality Value
– A new technology that has significantly more standalone
functionality than the incumbent technology may offer less overall
value because it has a smaller installed base or poor availability of
complementary goods.
• Value to customers of Windows OS is due to stand-alone value
(makes it easy use computer), the installed base (number of users
you can interact with) and availability of compatible software.
This is what makes it difficult for OSs that are better than
Windows to gain a foothold in the market
• NeXT Computers were extremely advanced technologically, but
could not compete with the installed base value and
complementary good value of Windows-based personal
computers. They were not compatible with Wintel machines
which had become the standard.
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Multiple Dimensions of Value
– To successfully overthrow an existing dominant technology, new technology
often must either offer:
• Dramatic technological improvement (e.g., in videogame consoles, it has
taken 3X performance of incumbent)
– Greater stand-alone value is not enough, needs greater overall value
see Fig 4.4(b)
• Compatibility with existing installed base and complements see 4.4(c)
– Super Audio CD (SACD) from Sony and Philips is a new audio format
based on Direct Stream Digital technology.
» It is much better than standard CD technology but they made it
backward compatible so that people would not have to throw out
their existing CDs when they buy the new player and the new
disks can be played on old CD players as well
» Thus they maintained compatibility with the existing installed base
and complementary goods
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Multiple Dimensions of Value
• When comparing the value of a new technology to an existing one,
users are weighing a combination of:
– Objective information; actual benefits, installed base and complementary goods
– Subjective information: perceived benefits, base and complementary goods
– Expectations: anticipated benefits, base and complementary goods
• These three may be proportional or not
– For example, perceived installed base may be greater than actual.
– How is this accomplished? Marketing, stretching the truth, vaporware
• When Sega and Sony introduced their 32-bit video game consoles, Nintendo
was far from having one in production. Instead, Nintendo began promoting
the development of a 64-bit system in 1994 even though it didn’t appear until
1996. But many customers believed Nintendo and held off buying the 32-bit
systems.
• Post mortem: Sony developed the PlayStation2 with more than 2x the
processing power of the Nintendo 64, made it backward compatible, made
sure there was a large supply of game titles available at launch, marketed it as
if it would the product everyone would by and sold it at a very low price.
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Nintendo never regained market dominance
Actual, Perceived & Expected
Components of Value
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Multiple Dimensions of Value
• When customer requirements for network externality value
are satiated at lower levels of market share, more than one
dominant design may thrive.
– This may be the case in the video game console industry. While a
larger market share may increase network externalities so that
customers have more games and more people to play against,
those benefits can be achieved without attaining a majority of the
market
• Sony has a majority share of the US video game market and
neither Nintendo’s GameCube nor Microsoft’s Xbox has greater
than a 20% market share
• Yet, there is still an abundance of game titles for all three
consoles and a significant pool of people to play games against
• Such markets may not experience great pressure to select a
single dominant design; multiple platforms may successfully
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exist
Are Winner-Take-All Markets
Good for Consumers?
• Economics emphasizes the benefits of competition. However,
network externalities suggest users sometimes get more value when
one technology dominates.
• Some would argue that Microsoft has clearly engaged in
anticompetitive behavior in its quest to dominate the PC operating
system market, others would counter that it’s overwhelming market
share has created greater compatibility among computers and
software applications.
• How can a regulatory board determine if a firm has become too
dominant?
• One way is to compare the network externality returns to market
share (value customers reap by more people using the same product)
with corresponding monopoly costs (benefits form gets when their
product is dominant)
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Are Winner-Take-All Markets
Good for Consumers?
• Network externality benefits to customers rise with
cumulative market share
– Greater availability of complementary goods
– More compatibility among users
– More revenues that can be channeled into further developing the
technology
• Monopoly costs to customers also rise with cumulative
market share
– Price gouging
– Restricted product variety
– Product innovation may be stifled or purposely delayed
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Are Winner-Take-All Markets
Good for Consumers?
• Network externality returns to market share often exhibit an s-shaped curve
• Monopoly costs to market share are exponentially increasing
• The two costs trade off against each other
– Where monopoly costs exceed network externality benefits, intervention may be
warranted. Optimal market share is at point where lines cross.
– A firm can choose not to charge the highest price the market will bear
Microsoft does not charge the
maximum price for Windows OS but
they have been able to control the
evolution of the market by
selectively aiding some suppliers or
complementors more than others
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