Instructor’s Manual
Chapter 4
Standards Battles and Design Dominance
SYNOPSIS OF CHAPTER
The focus of this chapter is on identifying the reasons why most industries adopt a dominant
design and why a particular firms’ technology is adopted as the dominant design. The key factors
driving industries to adopt a dominant design include increasing returns to adoption, path
dependency and government regulation. The role of network externalities in the pressure to
adopt a dominant design is also explored. Network externalities often arise when compatibility,
complementary goods and investments in training are important to customers.
The chapter then investigates why some firms learn faster than others. Prior learning and
absorptive capacity are found to be large contributors to the variance in learning rates between
firms.
To answer the question concerning why one firms’ technology is adopted as the dominant design
and not others the chapter explores 1) the nature of value creation in technology based products
and 2) the specific actions a firm can take to encourage the adoption of its technology as the
dominant design. Value is created in two ways. The first way a technology creates value is in the
functionality it provides the customer and is referred to as its standalone value. The second way a
technology creates value is through the network externalities associated with the technology.
Technologies accepted as the dominant design deliver the greatest total value, standalone plus
network externalities. This, in part, explains why it is not always the superior product that is
adopted as the dominant design. Firms can sponsor their technology with the goal of gaining a
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controlling share of market and locking out potential competitors and they can enter early in an
effort to become so entrenched that potential competitors may not be able to gain a foothold in
the industry.
The chapter concludes by considering how the level of market share at which consumer network
externality benefits are attained drive the adoption of single or multiple dominant designs in an
industry.
TEACHING OBJECTIVES
1. To increase students’ understanding of why a dominant design emerges and why it is not
always the most technological superior design that becomes dominant.
2. To identify the primary sources of increasing returns and network externalities.
3. To provide students with the tools needed to determine whether “winner-take-all”
markets are good for consumers.
4. To provide students with a multidimensional model for assessing the value of a
technology to buyers.
LECTURE OUTLINE
I. Overview
a. Why do industries experience pressure to select a dominant design? Market
forces (e.g. increasing returns to adoption, the importance of complementary products,
etc.) and government regulatory action are the two primary sources of pressure to select a
dominant design.
b. Why do some technologies become dominant designs and others do not?
Generally, one design is selected over another because the total value it offers customers
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(standalone value plus network externality value) is greater than the total value offered by
other technologies. The chapter explores consider the multiple dimensions of value that
will shape which technology design’s rise to dominance.
II. Why Dominant Designs Are Selected
a. Why do many markets coalesce around a single dominant design rather than
supporting a variety of technological options? There are many factors that drive a
market to coalesce around a dominant design. These factors often result in a
self-reinforcing process that continues to increase a technology’s dominance even if it is
inferior to competing technologies. These factors include:
i. Learning affects the improvement rate of a technology. Greater use of the
technology leads to greater knowledge accumulation. Greater knowledge
accumulation enables the improvement of the technology.
ii. Network externalities that result when there are increasing returns to adoption
(i.e. a technology becomes more valuable to customers as more and more
customers adopt the technology).
iii. Complementary product creation often occurs at a faster rate as adoption
becomes more widespread.
b. Learning Effectsevidence shows that the more a technology is used the more
developed, effective and efficient it becomes. Learning effects have been demonstrated in
a wide variety of industries including automobiles, ships, semiconductors,
pharmaceuticals, and even heart surgery techniques.
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c. Learning curves represent the cumulative impact of learning on production costs and
productivity. Organizational learning scholars typically model the learning curve as a
function of cumulative output: performance increases, or cost decreases, with the number
of units of production.
i. The learning curve is formulated as y = ax-b, where y is the number of direct labor
hours required to produce the xth unit, a is the number of direct labor hours
required to produce the first unit, x is the cumulative number of units produced,
and b is the learning rate.
Show Figure 4.1
d. Organizations learn at very different rates. Firms learn at different rates because their
levels of prior learning and absorptive capacity differ. Learning rates also differ with
the nature of the task and firm strategy.
i. Absorptive Capacity refers to the phenomenon whereby as individuals or firms
learn, they also increase their future ability to learn. For example, the
development of a new technology requires experimentation. Experimentation
helps build a knowledge base that allows the individual or firm to identify what
alternatives are most likely to be successful in the future. Firms that do not invest
in technology development may not develop the absorptive capacity need to
recognize or develop a new technology in the future.
ii. Absorptive capacity also has effects at the industry level. As the number of
firms learning about a technology increases and/or the number of firms creating
complementary technologies increases the more effective and efficient the
original technology will become.
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e. Network Externalities, or positive consumption externalities affect the adoption of a
dominant design because a user’s benefit from using a good increases as the installed base
increases (e.g. railroads, telecommunications, communities of practice, computer
platforms). For example, many people choose a computer that uses the Windows operating
system and an Intel microprocessor because the “Wintel” platform has the largest installed
base, thus maximizing the number of people with which the user’s files will be compatible.
i. Network externalities arise when compatibility (e.g. exchanging computer files)
and the availability of complementary goods (e.g. movies for a VCR , film for
cameras) are important and when investments in training are high (e.g Qwerty).
ii. For example, as Windows’ installed base increased developers became more
likely to expend their efforts on developing products compatible with Windows
rather than the MAC. Thus a virtuous cycle (at least from Microsoft’s
perspective) begins. An increasing installed base attracts complementary goods
developers and the availability of complementary goods increases the installed
base, and so on.
Show Figure 4.2
f. Path dependency often characterizes technology trajectories with increasing returns to
adoption. Path dependency means that small historical events may have a large effect on
the form of the technology adopted as the dominant design. For example,
i. early entrants and their technology may become so entrenched that subsequent,
superior technologies, may be unable to gain a foothold in the market.
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ii. sponsorship by a large powerful firm can help a technology gain a controlling
share of the market, locking out alternative and potentially superior technologies.
g. Coalitions have proven to be an effective strategy for firms trying to affect the selection
of a dominant design.
i. For example, the opening case describes the coalitions backing Sony’s Blu-Ray
DVD standard versus Toshiba’s HD-DVD standard. When Time Warner defected
from the HD-DVD coalition to the Blu-Ray coalition, it triggered a chain reaction
that lead to several of the major retailers (e.g., Wal-Mart, Netflix, Best Buy) saying
that they would exclusively stock Blu-Ray, dealing a fatal blow to the HD-DVD
standard.
h. Government Regulationin addition to the market forces that encourage the adoption of
a dominant design sometimes government regulation plays a role in the selection of a
dominant design. Governments are most likely to intervene when there is a societal or
consumer welfare benefit to having compatible technologies. This has often been the
case for the utilities, telecommunications and television industries. For example,
i. in 1953 the FCC approved the National Television Systems Committee color
standard in television broadcasting to ensure that individuals with monochrome
television sets would be able to receive the color television programs broadcast by
networks.
ii. in 1998, the European Union adopted a single wireless telephone standard to avoid
the proliferation of incompatible standards and to facilitate exchange both within
and across national borders.
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i. The most superior products do not necessarily win. When all of the above forces are at
work, the result can be a natural monopoly (though some alternatives may survive in
niche markets) and winner-take-all markets.
i. The winning firm enjoys high returns and is well positioned to affect the
development trajectory of the technology thereby further enhancing its dominant
position in the industry.
ii. Losing firms, not only have to play catch up after they adopt the dominant design
they also lose the capital, learning and brand equity invested in their original
technology.
j. The influence of a dominant design can be far reaching. Dominant designs affect
knowledge accumulation after their adoption primarily because firms have a tendency to
build on their existing knowledge base rather than build new ones. This means that a
dominant design will influence the technological discontinuity that will replace it.
k. Are winner-take-all markets good for consumers? This is a complex question, made
more complicated by traditional economics emphasis on the advantages of competitive
markets. What makes this a complex question is the issue of increasing returns (of course
the antitrust suits brought against Microsoft are a good example to use here). To answer
this question the benefits accrued by customers when a larger portion of the market
adopts the same technology (s-curve) must be compared with the corresponding
monopoly (exponentially increasing) costs (e.g. higher prices, less product variety,
flatter technology improvement trajectory, etc.)
Show Figure 4.9
III. Multiple Dimensions of Value
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a. So if technological superior products don’t always win, what determines which
technology and which firm wins? The company that wins usually is able to effectively
manage the multiple dimensions that comprise total customer value. Customers
compare the value of two or more competing technologies based on each technologies
standalone and network externality value.
b. Standalone Value Chan Kim and Renee Mauborgne developed the “Buyer Utility
Map” to help managers determine what aspects of a new technology will be valued by
potential customers (e.g. the functions it enables the customer to perform, its aesthetic
qualities, its ease of use, etc.). They recommend considering six utility levers and the six
stages of a buyers experience cycle (purchase, delivery, use, supplements, maintenance,
and disposal) in order to fully understand a new technologies standalone value to a
customer. Of course, each benefit has to be considered in light of its cost.
Show Figure 4.3
i. For example, a new online ordering system alters the value proposition offered to
the customer by simplifying the purchasing process (i.e. a change in a single cell)
while the Toyota Prius hybrid-electric vehicle offered customers greater benefits in
the use and maintenance stages of the buyers experience cycle (i.e. change in
multiple cells).
c. Network Externality Value is a function of the size of the installed base and the
availability of complementary goods.
i. The value of the Windows operating system, for example is due to the ability of the
system to make it easy for consumers to use the computer (standalone value)
plus two sources of network externality value: 1) its large installed base which
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translates into a large number of computers with which the user can easily interact,
and 2) the availability of compatible software developed for Windows as its
installed base increased.
ii. An incumbent technology may thwart the adoption of a new technologically
superior technology because the total value (standalone + network externalities) it
offers is higher (NeXT computers are a good example to use here).
iii. In order for a new technology to compete on only standalone value, that value
must exceed the total value offered by the incumbent technology or the new
technology must be compatible with the incumbent’s installed base and
complementary goods.
Show Figure 4.4
d. All of the above has been based on the consumer’s reliance on objective information.
But consumer choice is also affected by subjective information (i.e. perceptions of
value). So each value component has a corresponding perceived or anticipated value
component that can be considerably different from the actual value. This is an excellent
time to talk about recent standards battles (e.g., Apple iOS versus Google Android) and
how students perceive the current and future value of their installed base and
complements.
Show Figure 4.5
e. Firms can take advantage of consumer reliance on perceptions by creating a large
‘mindshare’ through heavy advertising that makes the installed base appear larger than it
actually is and/or make the availability of complementary goods appear greater than they
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actually are (Sega and Nintendo’s battle for dominance in the 16-bit video game console
market is a great example to use here).
f. Another tactic firms use to capitalize on consumer reliance on perceptions is
preadvertising. Preadvertising markets “vaporware” (a product that is not yet on the
market and may not even exist) in an attempt to persuade customers to wait for the new
product instead of buying a competitor’s product that is already available (here again the
game console industry is a good example to use with your students).
g. Competing for Design Dominance in Markets with Network Externalities―Do
network externalities create pressure for a dominant design or a few dominant designs?
How large of an installed base is necessary before most of the network externality
benefits are captured? The answers to these questions can be demonstrated to your
students by examining the graphs in the chapter.
i. Consider the rate at which value increases with the size of the installed base, and
how large of an installed base is necessary before most of the network externality
benefits are achieved. These graphs are usually characterized by a threshold level of
adoption below which the externality benefits are very low and above which the
benefits increase significantly. This type of graph “shifts up” when the base level
value of a technology is greater.
Show Figure 4.6
ii. Now you can show students transparency eight that compares the effects of relative
market share on two competing technologies with the same base value. This graph
shows that at every point where A has less than 50% market share (and thus B has
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greater than 50% market share), B will yield greater overall value, making B more
attractive to customers and vice versa. However, when one technology offers
greater standalone value the indifference point is shifted in its favor.
Show Figure 4.7
iii. What is the competitive landscape like when customers attain their desired
level of network externality benefits at low levels of market share? The
customer has a greater region of indifference between the two technologies (a good
example here are video game consoles) and firms in these markets may compete
very successfully with multiple dominant designs.
Show Figure 4.8
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