ثمس
1. Introduction
Numerous high-tech products such as personal computers (PCs)
possess especially complex structures because they are a combination
of components built on platforms. When a product is functionally
interdependent with a majority of the other components of a system,
and the end-user demands the overall system, it may be termed a
“platform” [17]. The platform's market structure is determined by
an innovator's decision regarding the commercializing strategy. An
innovator may possess proprietary control over the entire system in
a vertically integrated production structure, or a monopoly over a
limited proprietary part, or only be a brand-name platform producer,
who integrates the components of the platform that are supplied by
third parties. This presents the intrinsic coordination question regarding
the commercialization of a platform [28]. Two historical examples
from the PC industry present rather different viewpoints regarding
this problem.
Apple Computers has been producing highly integrated PCs and
controlling the proprietary rights over its products since the 1970s.
Generally, the performance of highly integrated platform products is
expected to be superior. However, Apple decided not to establish a
large PC network and therefore did not establish interconnections
with others. Instead, it has been focusing on the development of
mania groups using fancy products. However, this niche strategy is
inherently dangerous in markets with strong network effects [34].
In contrast, by employing an open architecture strategy, IBM offers a
variety of IBM compatible PCs, thereby fulfilling the demand of numerous
customers. Since a majority of the personal computers sold
were IBM-compatible, IBM was recognized as a platform owner in
the market, and others identified their brands as IBM-compatible.
Apple Computers, who was the market leader in the 1970s, lost
their market share to IBM-compatibles; therefore, IBM became the
platform owner in the PC industry in the early 1980s. The competition
between these two extreme marketing strategies indicates that the
network effect is a critical factor that must be considered when a
firm determines a commercialization strategy for its platform product.
Clones were deliberately invited into the incumbent market in
order to maximize the benefit of the network effects [10]. The case
of IBM emphasizes that until the incumbent continues to produce
products of a quality that is superior than those produced by its
clones, the incumbent may be at an advantage when it acts as a monopolist
by protecting its technology. This is because the increased
user-base enables incumbents to enhance their profits by charging
high-value consumers a high price.
However, once IBM's open architecture began permitting numerous
manufacturers of IBM-compatible computers to produce PCs
whose quality was at par with those of IBM's, clones could no longer
be exploited by them to increase their profits and in fact became market
impediments that reduced IBM's profits, which resulted in the
creation of an almost perfectly competitive market. Compaq, the leader
among IBM clones aggressively threatened IBM's position. IBM's
market share declined from 30.7% in 1985 to 16.9% in 1989 [26].
This indicates that IBM's open-standard strategy failed to deliver
long-term success.
In this context, the existence of seemingly conflicting opinions regarding
the open-standard strategy resulted in the emergence of the leverage
theory. The leverage theory [5,9,32] encourages platform
owners to completely withhold proprietary technology in order to
avoid future competition with entrants. An open architecture and a
cloning strategy facilitate the reverse-engineering of proprietary components,
which enables newfirms to enter themarket. If a newcompetitor
succeeds in entering the market using reverse-engineering, the
negative impact of rent dissipation may exceed the benefit derived
from the network effects. Therefore, it is recommended that all components
are included in a vertically integratedmarket structure in order to
restrict the entry of new firms. This strategy is consistent with that of
Apple Computers; however, this strategy also failed [34]. Unlike IBM,
Apple Computers retained all the technological expertise for its Apple
series computers in-house, and therefore produced incompatible PCs.
Apple failed to establish a formidable standard in the PC market and
held only 20% of the market by 1983 [26].
The strategic failures of platform owners in the PC market indicate
the limitations of these two contrary perspectives. Now, we will identify
those aspects of network effects that were overlooked by Conner
[10] in the creation of an effective cloning strategy of a network platform.
Moreover, the reasons for the recent revision of the term “IBMcompatible”
to “Wintel-compatible” will be investigated. Currently,
Intel and Microsoft (MS) are essentially considered to be the platform
owners in the PC market. The term “Platform owner” represents a
firm that possesses the ability to control the evolution of the platform
architecture, and the likelihood of innovation in complementary markets.
Hence platform owner leads the commercialization of a system
platform and receives the maximum benefit from a successful commercialization
[17]. By 1986, IBM realized that it had established a
standard and in doing so, they had spawned a number of imitators
by ceding the rights to their most valuable PC components to Intel
and MS [26].When IBM adopted the cloning strategy, it could not ensure
that the quality of its products would be superior than that of its
“clones” unless it maintained a veiled technology. However, IBM possessed
no such proprietary core technology that would enable it to
deliver a higher quality than its clones. Moreover, the term “clone”
implies that their product quality is comparable to that of the incumbent;
therefore, it is unlikely that users perceive IBM's products to be
of a higher quality than that of its “clones.”
These historical examples prompted us to investigate the characteristics
that a platform owner must possess in order to be successful.
An analytical model was developed in order to answer the following
research question: In a high-tech market, which is characterized by
strong network effects and entry threats, what enables a company
to become a sustainable platform owner? In a high-tech market, technological
innovation and consumer acceptance advance rapidly,
which makes it rather difficult for the incumbent to acquire a durable
first-mover advantage [31]. Our results indicate the strategic importance
of proprietary technology management and its synergistic resolution
with the network effects environment.
2. Theoretical background
In this section, we review the studies regarding the leverage theory
and the network effects. These are the two representative theories
regarding product commercialization that offer various insights on
platform strategy. The development of these two strategic schools of
thought is closely related to the production structure in the market.
Therefore, we investigate the meaning of each theory from this perspective.
Moreover, in order to understand our research question
more comprehensively, we further investigate the history and characteristics
of the PC industry in detail.
2.1. Leverage theory
The leverage theory focuses on leveraging the monopoly power of
the incumbent for protecting its position. In this section, we examine
the manner in which this theory is related to the platform strategy of
an innovator. Leverage theory encourages vertical foreclosure of entries
by tying components [5,32]. Basically, tying refers to a strategywherein
a seller ties and sells two or more goods together. However, for an incumbent,
this strategy is more significant than the concept of bundled
sales [4,33]. The incumbent may employ tying in order to protect its
monopolistic position, i.e., to create an entry barrier [5,9,32].
Previous studies indicate the impact of foreclosure of entry essentially
from two perspectives. First, tying reduces incentives of entrants'
investment [8,9]. For example, a monopolistic incumbent of a
PC platform may face competition from potential entrants for all its
components. However, when an incumbent adopts a tie-in sales
strategy for an entire platform, a potential entrant may enter the market
only if it succeeds in innovating all the components of the platform.
Alternatively, in order to complete the platform, an entrant
must depend on another entrants' provision of complementary components.
If an entrant only partially succeeds in innovating its components
and no other player produces the complementary parts, then
the entrant cannot enter the market when the incumbent employs a
tie-in sales strategy. Therefore, a comparison between tying and untying
may reduce the research and development (R&D) investment
incentives of entrants, thereby strengthening the incumbent's monopoly
position [5,9]. In particular, this concept is rather relevant in
a high-tech industry where the innovation of each component requires
substantial investments; however, the success of R&D is characterized
by a significant amount of uncertainty [9].
Second, if the incumbent adopts tying, it can protect its monopolistic
position more easily by employing a price-cost squeeze [2,12].
For example, assume that there exists a monopolistic incumbent
with a tied platform, which comprises only two components, A and
B. If there are two independent entrants for components A and B,
then the incumbent may establish the prices of the components in
such a manner that the price of one component is lower than that
of the entrant's in order to put competitive pressure on the independent
entrants. Although the price that the incumbent establishes for
component B is lower than that of marginal cost, the incumbent
may recover this loss by charging a high price for component A in
the presence of tying. Although such tactics require the incumbent
to charge prices that do not maximize the current profits of the two
components, the incumbent can compensate the lower short-term
profits with higher potential future profits once it has discouraged
the new firms from entering the market [2]. Owing to the practice
of such a prohibitive and predatory pricing, the entrant who considers
component B as a complementary product cannot enter the
market because it has no other components for recovering the loss accrued
on account the predatory pricing of B. Consequently, the entrant
for component B will not be able to enter the market. As a
result, the entrant of component A will also not be able to enter the
market owing to a lack of complementary components [12].
Therefore, from these two perspectives – reduction of the entrant's
R&D incentives and price-cost squeeze – tying enables incumbents to
maintain their monopolistic position. The logic behind Apple's tying
strategy for its Apple series computers may be understood by focusing
on the leveraging effect of tying. However, Apple's closed architecture
and tying strategy was unsuccessful for their PC products wherein a
number of strongly complementary components had been collectively
employed. In the 1980s, IBM declared an “open-standard,” following
which several IBM clones entered the PC market with PCs that were
rather similar to and compatible with the IBM PCs. However, Appleestablished an individual standard and attempted to differentiate its
products by following a strict non-licensing, patent-regulated policy.
Consequently, although IBM's market share increased to over 50% of
the market by 1984, Apple computers had a rather limited customer
base.
As indicated by the leverage theory, tying may be an effective
strategy for restricting the entry of competitors; however, it is detrimental
in terms of increasing the network of the platform. Apple's
tying strategy indicated that a closed architecture may severely jeopardize
a firm's business in a network effects environment. Now, we
will examine the concept of network effects.
2.2. Network effects and modular production
When a larger network yields a greater economic value for a product,
network effects are considered to be determinants of product
success. Moreover, numerous platform products in high-tech markets
operate through networks [28]. Even though these networks are virtual
and invisible, they may be rather critical because they make the
previously introduced or standardized technology more viable and
competitive as compared to the subsequent superior technology.
Therefore, innovators in the high-tech industry must thoroughly understand
the significance of establishing a large network [13,19].
There exist numerous IS studies that provide theoretical as well as
empirical evidence for indicating the strategic importance of network
effects. In the software market, an innovator may charge a higher
price for a standard program; this trend increases as the network of
the product expands [3,14,15]. In this context, a few studies suggested
that the software manufacturers intentionally permitted piracy
in order to increase their user base. Conner and Rumelt [11]
evidenced that providing software without any piracy protection
may be advantageous for both firms and consumers. Furthermore,
as the network of a software expands, an increased number of aftermarket
services are supplied to the network, which enhances the significance
of the network and increases profits [29].
A strategy for establishing a dominant network for a platform is to
establish the interface standard and adopt modular production with
various suppliers for sub-systems [27], that is, the “open-standard”
architecture. Standard interface components interact effectively
since they are not assigned particular configurations; this reduces
the specificity of a platform and increases its flexibility [1]. For example,
IBM developed the Industry Standard Architecture (ISA) and
combined various components, which were produced by various suppliers
in the industry.
When several firms adopt an industry standard for IBM compatible
PCs, the availability of a large network plays an important role
in enhancing the utility of the platform consumers. These consumers
can share information without converting the data from one format
to another, which further expands the available network effects.
Moreover, the recombination of various components in multiple configurations
enables a platform to fulfill heterogeneous demands with
a lower investment, thereby further enhancing the utility of this network.
All these reasons are responsible for increasing the demand for
this standard product [16,22,30].
2.3. PC industry
Conner [10] maintained that encouraging competitors to enter the
market is beneficial for a monopolist because the benefit derived from
an increased user base exceeds the rent dissipation by entrants under
strong network effects. However, IBM's strategy failed to deliver longterm
success. Originally, the key components of IBM PCs were not IBM
technologies. IBM – the dominant leader in the computer industry at
that time – intentionally adopted other suppliers' components such as
Intel'smicroprocessor and Microsoft's operating systemfor rapidmarket
penetration and success. The only proprietary component that was
maintained by IBM was the “basic input/output system (BIOS),” which
was not sufficient for ensuring that the reproduction of PCs comparable
to that of IBM was impossible. IBM clones like Compaq easily reverseengineered
IBM's proprietary component and promptly reproduced PCs
that were comparable to that of IBM's. By reproducing a product that
was already established and accepted in the market, the IBM clones circumvented
the significant investment and risk that is usually associated
with entering a market. They seized IBM's market share by shifting consumers'
preferences from IBMPCs to IBM-compatible clones, and subsequently
displaced IBM from its leading position in the PC market [23].
In contrast, Gawer and Henderson's [17] analysis of Intel's market
entrance strategy emphasizes the importance of strategic handling of
in-house capability and external complementary markets in creating
a successful platform owner position. By entering the complementary
market, Intel managed to establish a position that was strong enough
to control the entire platform. Intel's core competency was the production
of the microprocessors. However, in order to accelerate its
primary business and increase its network, Intel continuously encouraged
the innovation of its complementary products by indicating that
it would not charge excessive rent in these markets and would subsidize
entry into the market [17]. Currently, Intel plays a major role in
developing and distributing the “plug-and-play” interface standards
among component suppliers. Intel focuses on interconnecting the
components and enhancing their performance because faster,
cheaper, and easier use of counterpart components increases the demand
of their own microprocessors. Although Intel controlled the
platform network by focusing on a single component, it encouraged
complementors to invest in additional state-of-the-art platforms.
Moreover, although Intel was an “ingredient brand” of the PC platform,
it made efforts to shift consumer perception from being recognized
as “IBM-compatible” to “Intel Inside,” which essentially made
Intel a platform owner in the PC market.
We developed a mathematical model for explaining the fundamental
reason for Intel's success and providing managerial implications
for firms exploring successful platform owner strategies by
examining this strategic choice of Intel. Furthermore, we explain
why Wintel—the dual platform owner strategy—is sustainable.
3. Model
3.1. Player categories
There are three categories of firms in the market: the innovator,
intermediate goods producers, and potential entrants in the innovator's
monopolistic components market. The last platform is commercialized
as the innovator's brand name. Therefore, an “innovator”
represents a firm that wants to be a platform owner by developing
a few or all the component parts of the platform.
The underlying technology of a product is for a system platform
that consists of numerous components; the innovator must identify
which components it should produce proprietarily and which it
should outsource under an open strategy. In order to formalize this
idea, we denote the monopolistic products as β, which assumes any
value between 0 and 1. In the market, the innovator is the monopolist
for the β portion of the system platform. When the complementary
markets are sufficiently attractive, there are numerous intermediate
goods producers that produce the components for the remainder 1
−β portion of the system. This modular production structure of a
platform is created by the innovator's open technology and licensing
strategies when they develop the technology for the entire line of
components. As indicated in the IBM case, the innovator may occasionally
choose to maintain limited technology for the system platform,
adopt the other suppliers' components, and fuse them with
their proprietary components for producing the final system.
The innovator plays the role of a final platform producer by assembling
its β portion of components with the 1−β portion of thecomponents supplied by the intermediate goods producers. If the innovator
decides to maintain all the technology for the system, there
would be no intermediate goods producers for its final system. Even
if the final platform is produced by third parties, the results would
be identical with those obtained under the current setting of a competitive
final goods market.
Other firms may enter the market by independently conducting
R&D for the innovator's proprietary components. Firms observe the
innovator's market and decide to enter the market only if they expect
their profits to exceed their R&D cost. Henceforth, the subscript i denotes
the innovator, m denotes the intermediate goods producer, and
e denotes the new entrant.
3.2. Demand
In order to derive the demand function, the network effects were
considered for modifying the Conner [10] model. For the final platform,
every consumer possesses a constant valuation or reservation
price,τ, which is uniformly distributed between 1−a and 1: τ ~u
[1−a,1]. Here, aN1; therefore, if their post-purchase cost of learning
to use the product exceeds its benefit, then the reservation price of
the final platform is negative for a few customers. Let the number
of consumers with positive use values (τ≥0) be N. However, the underlying
platform is subject to positive network effects.1 Therefore,
considering the network effects, the following assumptions have
been derived:
Assumption 1. (consumer valuation):
τ~u[1−a+γ(1−β)Q, 1+γ(1−β)Q]
Network effects are represented by the parameters Q, γ, and β. Q
is the expected size of the user base in rational expectations equilibrium,
which is unique and equal to the actual equilibrium demand.2
γ is the marginal value that is offered to consumers when the user
base increases by one person, that is, the magnitude of network effects.
β is the innovator's monopolistic production level. The consumers
can obtain a larger utility with a larger network than with
a stand-alone use of the platform; this is because consumers can
connect with more users (e.g., through email) or collaborate more
easily (e.g., using a word processor) with a larger user base [22].
Therefore, the demand for a large network platform increases with
an increase in the number of users. We capture this network effect
by γQ. Furthermore, as β decreases, the platform becomes more
open and standardized since the production of various compatible
components enables a more flexible re-configuration and assembly
of the platform. This technological openness enables the platforms
to meet the demand of heterogeneous consumers more effectively,
which in turn increases the demand for this platform and expands
the network effects. This network effect is reflected in the openness
of the platform, (1−β). Considering this effect, we assume that the
consumers' utility is enhanced byγ(1−β)Q,which changes the original
distribution of τ as assumed in Assumption 1.
Assumption 2. (potential buyers):
1+γ(1−β)Q
Once again, it is assumed that despite the network effects consideration,
there exist consumers with negative utility, 1−a+γ(1−β)
Qb0. Under such conditions, based on Assumption 1, the number of
potential buyers is N(1+γ(1−β)Q. Here, we normalize N to be 1,
which results in 1+γ(1−β)Q.
Assumption 3. (utility function):
U(τk,pf)=τk−pf.
If sf and pf represent the quality and price of the final platform, respectively,
then consumer k's utility from the final platform consumption
is defined as U(τk, sf,pf)=sfτk−pf. Since the valuation on the
platform quality, τk, varies for each consumer, let sf be 1 assuming
that the quality of the original product is consistent. Therefore, the
utility function is as provided in Assumption 3.
Assumption 4. (demand for final platform):
qf ¼
1−pf
1−γً1−βق
:
Assumption 3 presents the condition for product purchasing such that
τk≥pf. Therefore, consumers whose τ is between pf and 1+γ(1−β)Q
will purchase the product (see Assumption 1). When F(⋅) is a cumulative
distribution function of τ conditional on τ≥0 among potential buyers, the
demand for the final platform is qf={1+γ(1−β)Q}{1−F(pf)}. Since qf
indicates the market demand for the product, it is equal to the user base
Q in rational expectations equilibrium, that is, Q=qf. Moreover, since F
(⋅) is conditional on τ≥0, F(pf)equals pf
1γً1−βقqf
. Therefore, the resulting
demand is given as 1−pf
1−γً1−βق
.
Assumption 5. (magnitude of network effects):
0bγb1.
In order to guarantee a downward sloping demand function (see
Assumption 4), we assume that 0bγ(1−β)b1. Here, the magnitude
of network effects, γ, is an exogenous variable of the innovator,
which is given in the market and cannot be limited by the size of
the endogenous decision variable β. In other words, 0bγ(1−β)b1
must always be satisfied for any value of β between 0 and 1, and Assumption
5 has been employed in order to ensure this. This assumption
is identical to that used in Conner [10].
3.3. Cost
Assumption 6. (intermediate good):
ci(x)=ce(x)=cm(x)=cx for x∈[0, 1].
The system platform is a set of infinitely small intermediate goods,
which are uniformly distributed between [0, 1]. In order to eliminate
the impact of economies of scale on production, which may induce
the innovator to curtail proprietary control, we assume that every
producer of intermediate goods has a constant unit cost c for each intermediate
good x∈[0, 1]. In addition, for the sake of simplifying
1 Instead of network externalities, this study employs the concept of network effects.
Originally, network effects referred to those circumstanceswherein the net value of an action
is influenced by the number of agents undertaking the same action. In this context, if
the consumption utility of a good is based on the number of other agents consuming the
good, then such a good is believed to demonstrate ‘network externality’ [19]. Here, the difference
between network externality and network effect is characterized by the existence
of market failure. Therefore, Liebowitz and Margolis [21] indicated that the application of
the concept of network externality is limited since network externalities as market failures
are theoretically fragile and empirically undocumented, whereas the concept of network
effects is commonly accepted and important. Liebowitz and Margolis [21]
emphasized that numerous external effects of network size are merely pecuniary; therefore,
network externality was considered to be a particular type of network effect where
equilibrium exhibits unexploited gains from trade regarding network participation.
According to the distinction suggested by Liebowitz and Margolis [21], ‘network effects’
is the more appropriate term for this paper.
2 Rational expectations equilibrium is typically based on the fundamental economic
assumption that people behave in ways that maximize their utility; therefore, all relevant
information has been used in formulating expectations for economic variables.
Therefore, it is assumed that expectations must not be systematically biased and must
essentially constitute informed predictions of future events [24]. Although, it is a
strong assumption that the expected Q equals the real Q, this assumption has been
adopted in several previous studies [7,10,18,20].
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