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Networks and Positive Feedback. John Morgan. Important Ideas. Positive feedback Network effects Returns to scale Demand side Supply side. Positive Feedback. How system adjusts to perturbations Negative feedback: stabilizing Positive feedback: destabilizing

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important ideas
Important Ideas
  • Positive feedback
  • Network effects
  • Returns to scale
    • Demand side
    • Supply side
positive feedback
Positive Feedback
  • How system adjusts to perturbations
    • Negative feedback: stabilizing
    • Positive feedback: destabilizing
  • Positive feedback makes a market “tippy” – winner take all
    • Examples: VHS v. Beta, Wintel v. Apple, 56k modems, DVD v DivX
    • “Winner-take-all markets”
sources of positive feedback
Sources of Positive Feedback
  • Supply side economies of scale
    • Declining unit cost of supply
    • Marginal cost less than average cost
    • Example: information goods are all fixed cost
  • Demand side economies of scale
    • Increasing value to users as market share increases
    • A single standard: fax, email, Web
    • Competing standards: VHS v. Beta, Wintel v. Apple, 56k modems, Codec “standards” in Digital Audio
color fax machine
Color fax machine
  • You have a new technology for color fax machines
  • License it to many sellers
  • Technology can only be used by sender if receiver has color fax machine
  • So there is a strong network effect---value to user of technology depends on number of adopters
  • Indicate your adoption of the technology by standing up
  • The number on your card shows that value v (to you) of adopting if you are the only adopter
  • In n people (including you) adopt, your value is nv
  • I will write the price of the fax machine on the board
  • Adopt when your value (strictly) exceeds the price.
  • Standalone values were 10,9,8,…,1
  • vn = p : marginal user wants to adopt
  • n=10-v :everyone with greater value than marginal user adopts
  • Combine to give demand=supply condition
    • (10-n)n=p
    • n=1, (10-1)1=9
    • n=2, (10-2)2=16
    • n=3, (10-3)3=21… n=9, (10-9)9=9
  • Takeoff occurs when p=9
adoption dynamics
Adoption Dynamics


Number of





network effects
Network Effects
  • Demand side economies of scale often referred to as network effects
    • Real networks – telecom
    • Virtual networks – network of users
  • Metcalfe’s Law: Value of network of size n proportional to n2
    • Experiment is an example of this
expectations matter
Expectations Matter
  • What is the difference between success and failure in tippy markets?
  • Expectations Matter:
    • I want to join network that I expect to succeed
  • Central part of successful marketing is setting appropriate expectations
    • Commitment can help
    • Old economy example: Banks
    • New economy example: Microsoft version 1.0 products
virtuous cycles and death spirals 1 2 3 v visicalc
Virtuous Cycles and Death Spirals: 1-2-3 v Visicalc

Value to User

Virtuous cycle

“Death spiral”

Number of Users

direct and indirect network effects
Direct and indirect Network Effects
  • Value to me depends directly on number of adopters
    • Fax machine, telephone, email
  • Value to me depends on adoption of some complementary product
    • DVD player/ DVD disks
    • eBook reader + content
    • Palms and software
are all information markets tippy
Are All Information Markets “Tippy”?
  • AOL
  • Dell
  • Google
  • What are the key drivers of network effects?
chicken eggs
Chicken & Eggs
  • Fax and fax machines
  • VCRs and tapes
  • DVDs: A more complicated problem
  • Online dating
igniting positive feedback
Igniting Positive Feedback
  • Evolution
    • Give up some performance to ensure compatibility, thus easing consumer adoption
  • Revolution
    • Wipe the slate clean and come up with the best product possible
compatibility versus performance
Compatibility versus Performance





  • Offer a migration path
  • Examples
    • Microsoft Windows
    • Intel
    • Borland v Lotus
  • Build new network by links to old one
important considerations
Important Considerations
  • Use creative design for migration
  • Think in terms of whole system
compatibility versus performance1
Compatibility versus Performance


Migration “sweet spot”




technical obstacles
Technical Obstacles
  • Converters and bridge technologies
    • One-way compatibility or two way?
    • Windows for Wordperfect users
    • Importance of UI
legal obstacles
Legal Obstacles
  • May need IP licensing
  • Example: Sony and Philips had advantage since they held the patents on CDs
    • DVD players usually play CDs as well
  • Grove’s law: “10X rule”
  • But depends on switching costs
  • Examples: Nintendo, Iomega Zip, DVD, CD
openness v control
Openness v. Control
  • Your reward = Total added to industry x your share
  • Value added to industry
    • Depends on product and
    • Size of network
  • Your share
    • Depends on how open technology is
  • Full openness
    • Anybody can make the product
    • Problem: no champion
    • Unix v BSD v Linux
  • Alliance
    • Only members of alliance can use
    • Problem: holding alliance together
    • Conflicting incentives: China and DVDs
  • Control the standard and go it alone
  • If several try this strategy, may lead to standards wars
  • iPod/iTunes v MP3 players
  • Positive feedback means strong get stronger and weak get weaker
  • Consumers value size of network
  • Works for large networks, against small ones
  • Consumer expectations are critical
  • Fundamental tradeoff: performance and compatibility
lessons continued
Lessons, continued
  • Fundamental tradeoff: openness and control
  • Generic strategies
    • Performance play
    • Controlled Migration
    • Open Migration
    • Discontinuity
  • Lessons of history