Economics of Standards

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Economics of Standards

http://www.vernetzung.de/eng/b3/

The Standardization Problem

- An Economic Analysis of Standards in Information Systems -

Peter Buxmann, Tim Weitzel, Falk v. Westarp, Wolfgang König

Research Program 403 “Competitive Advantage by Networking"Research Project B3 “Economics of Standards”

Institute of Information SystemsJ. W. Goethe-University

Frankfurt am Main, Germany

Economics of Standards in Information Networks

• Communications standards can be generally defined as rules which provide the basis for interaction between actors (man, as well as machine).

• We developed models for centralized and decentralized networks illustrating the advantages and disadvantages of using standards.

• Economic parameters are based on empirical research.

• Approaching a general framework for analyzing the standardization problem, we combine three different research approaches: Formal analysis, a simulative approach and empirical studies (questionnaire, case studies).

• The framework is being developed as part of a general network theory within the interdisciplinary research program "Competitive Advantage by Networking" at Frankfurt University

Economics of StandardsThe standardization problem: A basic model

• The nodes represent the costs of standardization (Ki) for the respective network actors i

• The edges show the costs of their communications relations (cij) with their respective partners. These costs include costs of information exchange, as well as opportunity costs of sub-optimal decisions

• Cost reductions can be realized only when both communicating nodes i and j have introduced the same or a compatible standard

1K1

2K2

c12

c21

Network (n=2)

1K1=10

2K2=20

Economics of Standards in Information Networks

Economics of StandardsCentralized coordination

Centralized coordination: A central decision making unit (e.g. the state or a parent firm) is credited with the aggregate results

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ij1j

ijij

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ijji yM2xx

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Economics of StandardsCentralized coordination

Centralized coordination determines a first-best solution, but...

Data problem: Given asymmetric information distribution and opportunistic behavior, complete information cannot be retrieved from all nodes at acceptable costs considering that the nodes' reporting induces resource allocation

Complexity problem: The centralized standardization problem is a combinatorial problem. Even solutions to simple centralized coordination problems are difficult because of their integer structure

Implementation problem: Systems of control and incentives guaranteeing that a given, preordained solution will be implemented by all actors also involve costs

Network (n=2)

1K1=10

2K2=20

Economics of Standards in Information Networks

Economics of StandardsDecentralized coordination

Decentralized coordination:

Autonomous actors make individual standardization decisions

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ij1j

iijij Kcp)]i(U[E

If E [U (i)] > 0, then i standardizes

Economics of StandardsDecentralized coordination

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Using all assumed data, node i can estimate pij as the probability of standardization in node j by attempting to imitate j's decision behavior:

Economics of StandardsNumerical simulations

• A simulation model shows the problem of decentralized coordination: The Standardization Gap

– 20 nodes– information costs are randomly generated (approx. normally

distributed) with a standard deviation of =200– standardization costs (normally distributed) with µ=10,000

and =1,000

Economics of StandardsThe standardization gap

Nutzenvergleich dezentrale und zentrale Heuristik

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Informationskosten je Kante (Erwartungswert)

Einsp

arungen

(Net

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me)

dezentral zentral

mean expected information cost per edge

savi

ngs (n

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——— decentralized centralized

Quality of decisions in a decentralized model based upon ex post network-wide savings on information costs for alternative E[cij]

Economics of StandardsComparison of centralized and decentralized coordination

• Generally, the frequency of standardization ceteris paribus increases with cij or a growing installed base and decreases with Ki

• The risk of incorrect decisions under decentralized coordination leads to less willingness to standardize within the moderate range of values.

• Network-wide savings attainable through centralized coordination determine the critical value for the costs of coordination above which a centralized solution is no longer advantageous. This value corresponds to the perpendicular distance between the curves.

Interdisciplinary Research Program SFB 403 of the J. W. Goethe-University,

Frankfurt am Main, Germany

Competitive Advantage by Networking -

the Development of the Frankfurt and Rhine-Main Region

http://www.vernetzung.de/eng/