Class 13. Wed Oct. 17 Economics of Info-Technology

Shapiro and Varian- Information Rules

• Basic laws of economics asserted themselves in the drastically different communication technology business.
• Thesis: durable economic principles can guide you in today’s frenetic business environment.
• Cost of production: information is costly to produce by cheap to reproduce. High fixed cost and low marginal cost
• Differential pricing: ex: hardback more expensive but comes out earlier and paperback cheaper for more patient consumers.
• Maximize value, not protection: Legal grant of exclusive rights to intellectual property does not = complete power to control info. But don’t worry—video market became giant revenue source for Hollywood.
• Browsing: look at headlines at newsstand, movie previews, etc.
• Attention: Internet is hybrid between broadcast and point to point medium—matches customers and suppliers. Advertising exploits statistical patterns.
• Technology lets businesses to do more with the same info: ex: home depot can re-order from suppliers using electronic data, analyze cross-store demand studies, discount slow-moving items with minimal human intervention.
• Focus on not only competitors but also collaborators: infotech is dependent on systems. Example: Microsoft-intel- Better choice than apple because lack of competition made apple more expensive.
• Lock-in and switching costs:

- switching cost: ex: Sony and Philips had to switch from long-playing phonograph records because they didn’t work with CD player so they had to deal with consumer switching costs.

- Lock in: can occur on individual, company or societal level. Societal lock in—most people locked into Windows desktop. Company lock in—locked into lotus 1-2-3 spreadsheet (employees trained).

- Lock in cycle: Brand selection→Sampling→entrenchment→lock in (when the sitching costs become prohibitively expensive).

· Positive feedback: installed base of users grow, more and more users find adoption worthwhile. Product achieves critical mass and takes over market. Self-fulfilling expectations manifestation of positive-feedback. You can also call it bandwagon effects.

-example:

Spread of video machine: the more VCRs there were, the greater the demand for vids→more vids=more vcrs. Home video, time shifting, and rental of VCRs got the market to critical mass.

-critical mass=after you obtain a large enough customer base the market will build itself.

· Network externalities/effects: value of product to one user depends on how many other users there are. Telephones, email, fax machines.

· Standard: the product that is expected to become the standard will become the standard.

-success in standards war depends on: control over installed base of users(Microsoft has large base of loyal lockin customers), IPR, ability to innovate(make proprietory extensions for the future), first mover advantage, manufacturing abilities( low cost producer with scale economies and manufacturing competence strong position), strength in complements, brandname and reputation.

· Product preannouncement: try not to let new, improved version of product cut into your own sales of older versions.

· First mover: Moving too late can mean missing the market entirely, especially if customers become locked into rival technologies.

-pricing belong cost (pricing down the learning curve/penetration pricing) common tactic used to build an installed base. Unavoidable in a standards war.

-paying customers to use product: negative pricing. to generate network externalities for other paying customers But will they really use it?

· If you own valuable intellectual property but need to gain critical mass you must decide whether to promote technology unilaterally or make openness commitments (with competitors/partners/suppliers)

· Policy: Battle between MS and Justice Department illustrate importance of antitrust policy in information sector. Competitive strategy in information economy collides with law in: 1. merger and acquisition, 2. cooperative standard setting and 3. monopolization.

-antitrust do not block most companies from their chosen strategies, even when they need to cooperate with other industry members to establish compatibility standards. The Sherman act is flexible enough to prevent heavy hand of monopoly from stifling innovation while keeping markets competitive enough to stay the heavier hand of government regulation from intruding in hardware and software markets.