Strategic Management of
Technological Innovation
Melissa Schilling
Chapter 4
STANDARDS BATTLES
AND DESIGN DOMINANCE
The Rise of Microsoft
• In 1980, Microsoft didn’t even have a personal computer (PC)
operating system – the dominant operating system was CP/M written
and sold by Gary Kildall through his company Digital Research
• 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.
• 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!
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The Rise of Microsoft
Discussion Questions:
1. What factors led to Microsoft's emergence as the
dominant personal computer operating system
provider? Is Microsoft's dominance due to luck, skill, or
some combination of both?
2. How might the computing industry look different if Gary
Kildall had signed with IBM?
3. Does having a dominant standard in operating systems
benefit or hurt consumers? Does it benefit or hurt
computer hardware producers?
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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
• 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 exchnage
within and between members countries
• The Result: Winner-Take-All Markets
– Natural monopolies
• Firms supporting winning technologies earn huge rewards; others
may be locked out.
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Why Dominant Designs Are Selected
– 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
– 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
• In many increasing returns industries (the rate of return from
a product or process increases with the size of it’s installed
base), the value of a technology is strongly influenced by
both:
– Technology’s Standalone Value
– Network Externality 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 managewrs 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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Multiple Dimensions of Value
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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
• 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
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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 64bit 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. Nintendo never regained market dominance
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Multiple Dimensions of Value
Actual, Perceived and 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 exist
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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 – some
say that Microsoft does not charge the maximum price for Windows OS but
they are able to control the evolution of the market by selectively aiding some
suppliers or complementors more than others
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Discussion Questions
1. What are some of the sources of increasing returns to adoption?
2. What are some examples of industries not mentioned in the
chapter that demonstrate increasing returns to adoption?
3. What are some of the ways a firm can try to increase the overall
value of its technology, and its likelihood of becoming the
dominant design?
4. What determines whether an industry is likely to have one or a
few dominant designs?
5. Are dominant designs good for consumers? Competitors?
Complementors? Suppliers?
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