Leveraging Network Effects and Competing Without

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Mike Pangburn

Agenda

Understand meaning of network effects (“positive network externalities”) 1-sided and 2-sided examples Implications for competition

Discuss competing without network-effects advantage Need for superior operations, not superior technology Need for superior use of information Consider case of Zara

Network effects

When network effects are present, the value of a product or service increases as the number of users grows

Most products aren’t subject to network effects “you probably don’t care if someone wears the same

socks, uses the same pancake syrup, or buys the same trash bags as you” -- J. Gallaugher

As a manager, it’s critically important to recognize when a product does exhibit network effects

Network Effects

More users = More value

Where does that value come from? Exchange

Interact with others. The value isn’t typically $. Switching costs

Save ($ or time) by sticking with initial choice Are your customers “barnacles” or “butterflies?”

Complementary products Associated products that develop

“Exchange” examples?

Telephone / Skype / fax

Local “exchange value” example(s)?

Switching costs example

“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, our lack of a sexy vision at times, and many other difficulties…. it would be so much work to move over that they hope we just improve Windows rather than force them to move…. without this … we would have been dead a long time ago.”

Comments from a Microsoft General Manager in a memo to Bill Gates

Local “switching cost” example(s)?

Switching costs recap

The core “switching cost” idea isn’t that customers have already invested $ in some past product/service A past/irrecoverable investment is sometimes referred to as

a sunk cost, which we should, as rational decision makers, ignore

The core switching cost idea is that moving to the new product or service will imply some new investment in time or $.

Complementary products

??

Example: iPod related products 90 brands selling some

280 models of iPod speakers systems

34 auto manufacturers now trumpet their cars as being iPod-ready

Each enhances the value of choosing an iPod over a rival like the Microsoft Zune.

Local (UofO / Eugene) “complementary products” example(s)?

How do network effects change competition?

Network markets experience early, fierce competition.

Often winner-take-all environments. Examples:

Apple -- controls over 75% of digital music sales. Football?

Best product or service doesn’t win. Example: Xbox 360 was earlier than Playstation 3, gained

early success due to inferior specs

Want to compete against an incumbent firm? …High hurdle to clear!

Facing an incumbent enjoying networking effects

Subsidize new adoptions Example: PayPal gave $15 off $30 to each new customer to

promote its service. eBay was less generous but then ended up later buying PayPal for $15 * 100,000,000

Counterexample: Bing!

Move early If you don’t? Consider that eBay waited 5 months after Yahoo!

to start auctions in Japan… never recovered in that market

Redefine the market Look for “blue ocean” (W. Chan Kim and Renée Mauborgne) Example: Nintendo’s Wii strategy

Encourage complementary products Example: Facebook’s fbFund: up to $250,000 funding per firm

writing apps

Network effects and IT

Savvy managers look for ways to design-in network effects E.g., Facebook

Exchange value, Switching cost, Complementary products

Thus, Information Technology can establish competitive advantage via network effects with your firm’s product

The strategic role of IT is not limited to tech products with network effects IT as product versus IT as enabler

The latter applies even for non-tech products Zara provides a powerful example of leveraging IT as

strategic enabler

Agenda

Understand meaning of network effects (“positive network externalities”) 1-sided and 2-sided examples Implications for competition

Discuss competing without network-effects advantage Need for superior operations, not superior technology Need for superior use of information Consider case of Zara

Consider Zara

What? Most successful apparel company on the planet

Where? Based in the ship-building town of La Coruña, Spain

Who? Founded by Amancio Ortega, the world's 3rd richest man

with assets worth more than $50 billion Not much of a marketeer, has more a product/process

focus

Network effects and Zara

For the type of products that Zara sells, why might network effects not be very strong?

Generally speaking, network effects (“network externalities”) can be either positive or negative When a product exhibits negative network externalities, the

resulting challenge for a firm a severe What product-line management strategy would you

recommend to a manager facing that challenge?

Core aspect of Zara’s strategy

“If you see something and don’t buy it, you can

forget about coming back for it because it will be

gone.”-- 20-something Zara shopper

Consider this tension (challenge)

Accounting rule

Inventory = an asset

Retailing adage“Inventory equals death”

Use of technology

As a manager, your focus should not be on having better technology

Focus on having better information and processes, with minimal technology costs

Zara is information/process focused, not tech focused “Whether measured by IT workers as a

percentage of total employees or total spending as a percentage of sales, Zara’s IT expenditure is less than one-fourth the fashion industry average.”

Technology ≠ Effective ProcessesJust Ask Prada

Contrast with Prada’s “Manhattan project” to create the ultimate fashion store PDAs would let staff check inventory immediately glass dressing room foot pedals would allow customers

to turn walls opaque, into a combination mirror and heads-up display

dressing room computer would recommend matching accessories

How did it turn out?

Technology ≠ Effective Processes

An information system (IS) is much more than just hardware and software. An IS also includes data used or created by the

system, as well as the procedures and the people who interact with the system

Successful information systems (IS) must integrate these 5 critically-important components: hardware, software, data, procedures, and people.

Zara, the new Dell?

Dell was the low-inventory, short lead-time, high product variety competition-killer of the 90’s

Dell is facing more heat now from its competitors.

Is Zara “the new Dell”? How do they differ?