Strategy 390 Final Study Guide PDF

Lecture 14: Schumpeterian Rents Intro ● ● Fortune 500 Turnover ○ More than half have fell off ○ Hard to get to the top harder to stay at the top Markets are Dynamic ○ slow changers: ex. transportation, hairdressing, insurance ○ Fast changers: ex. phones, computer, software ○ Creative Destruction ■...

Lecture 14: Schumpeterian Rents Intro ● ● Fortune 500 Turnover ○ More than half have fell off ○ Hard to get to the top harder to stay at the top Markets are Dynamic ○ slow changers: ex. transportation, hairdressing, insurance ○ Fast changers: ex. phones, computer, software ○ Creative Destruction ■ ○ ○ “A process of industrial mutation… that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” ■ Schumpeter coined the term creative destruction ■ essential part of capitalism → kill off old firms and create new/better ones ■ Examples: ■ Netflix, Uber, Airbnb, iPhone Schumpeterian Perspective AKA Disequilibrium ■ premise that markets are dynamic not static ■ many changes come from technology ■ can also come from changes in regulation, changing preferences, ex. trends: phenomenal camera companies but post people prefer great cameras within phones, thus preferring apple or Samsung ■ argues that economic rents come from changes, which lead to opportunities ■ timing and adaptation are critical to competition Where have we already seen Schumpeterian rents at work? ■ Ebony ■ Invention of the Internet lead to increased threat of substitutes, lowered barriers to entry, decreased competitive advantage, and eroded value proposition ■ Ryan Air ■ Deregulation of the European airline industry led to… ■ lowered barriers to entry, increased rivalry, gave Ryanair an opportunity ■ Decreased competitive advantage of incumbents, forced incumbents to retreat from low-fare position ■ Disney ■ Invention/Adoption of high-speed internet led to… ■ decreased buyer power, increased barriers to entry ■ caused Disney to forward vertically integrate (Disney+) Lecture 15: Competitive Lifecycles, Technology S-Curves, First and Second Mover Advantage ● ● Competitive Lifecycles ○ First Phase: Emergent Phase ○ people will recognize what the product is going to be ■ dominant design (think of cars how we went from electric in the beginning to realizing we are going to go with combustion engine) ■ Uncertainty: regarding consumer preferences and demand ■ product innovation and differentiation: focused on finding the right product features ■ hard to know what consumers want and need to find out what “sticks” in terms of consumer preferences ○ take VR headsets for example, at the beginning only a few bought them until it took off them more firms came into the industry making them ■ revolves around product innovation ■ It can be high and low ○ ○ ○ ○ ○ Profit Margin Curve ■ most variable/uncertain ● uncertain early because there are early adopters in the emergent phase and have a high willingness to pay ● there is a lot of R&D and costs that go into it → leads to demand to outgrow supply Process Innovation ■ a process innovation is the implementation of a new or significantly improved production or delivery method ■ lowers cost and is not visible to the consumer ● consumers do not care if it was made in an assembly line, they care about the features it has Product Innovation ■ the introduction of a good or service that is new or significantly improved with respect to its characteristics or intended uses ■ occurs heavily in the mature phase Annealing ■ point at which the dominant design, or standard is established ■ uncertainty is dramatically reduced ■ early entrances that did not pioneer the dominant design often fail ■ firms can also die in the annealing phase because they adopted the losing standard ● ex. those who chose to continue to make EVs in the 1900s when combustion engines were dominant ● ● Second Phase: Growth Phase ○ We see growth and adoption ○ ○ ● Shakeouts: ■ As revenues (demand) plateaus/declines, firms start to fail ● Only the best/most efficient firms remain afterward ■ Over entry which dropped profit margins causing firms to start dying out ● Those who survive are the firms who know how to be efficient and realize economies of scale Third Phase: Mature Phase ○ ■ Absent of uncertainty ■ ■ ● All innovation becomes process innovation Profit margins is the hardest to reliably predict in the growth and mature phases ○ Mature phases can last a long time ■ Cumulative revenue is about growth What comes after the Mature Phase? ○ Disruptive Innovation and Technology S-curves ○ ○ ○ Example: physical limit of performance [Chicken growth example from 1957-2005… Chicken got bigger] ○ ○ ○ ● Disruptive Innovations ■ Eventually supplant incumbent technologies ■ Initially perform poorer than incumbent technologies Firms that cannot adapt to new technology are “disrupted”, or driven from the market Each disruptive innovation starts a new competitive lifecycle ■ Sustaining VS Disruptive Innovation ○ Most innovations are sustaining, not disruptive ○ Sustaining innovations improve products/services along dimensions of performance that mainstream customers care about ■ Move up the S-curve ■ Adding 5th blade on a razor for shaving, clearer TV picture ○ Disruptive innovations are initially inferior on the historic performance dimensions, but offer a novel mix of attributes that appeal to fringe customers ■ May be smaller, cheaper, more accessible, or more convenient ■ Creates a whole new curve ○ ● ● ● ● Why do incumbent firms often fail to make the jump from old technologies to the new technologies? ○ They do not always fail, but often do ○ Underestimate the value/success of the innovation ○ Existing resources/capabilities rendered valueless by new technology ○ Tradeoff between short-term and long term (e.g. cannibalization) ■ By adopting a new technology, firms may accelerate the demise of the old technology When do Incumbent Firms Succeed? ○ Innovation requires large amounts of capital or expertise ■ E.g. Nuclear technology - unlikely for a small entrepreneur to disrupt → hard as hell to enter ○ Customers desire assurance of established firms → reputations ■ E.g., universities - incumbents have reputations that upstarts have hard time replicating ○ Incumbent firms have complementary resources (e.g., distribution channels) or capabilities that transfer to new technology ■ E.g. emerson, GE and CAT scanners If a new competitive life cycle is beginning, when should a firm enter? ○ It depends on first or second mover advantage Network Effects: ○ Exist when the WTP for a product depends on the number of other users of the same product ■ EX. People who buy phones need people who also buy phones, thus making it useful ● ● Standard Setting: ○ Standards are norms or requirements for a product/process Complements: Porter’s Sixth Force ○ Are goods whose prevalence enhances the value of another ■ Negative cross price elasticity ■ Lecture 16: Netflix ● Why didn’t Netflix enter earlier? ○ Because of technological constraints such as storing the movies, they needed the internet, lack of distribution center, and had to wait for DVD shipping cost to go down due to form factor going from VHS to DVD → cost of shipping went down because the size and weight of the package went down ● What is Netflix’s value proposition? What resources allow them to deliver value? ○ They are differentiated, appear to offer high willingness to pay ○ Distribution centers were cheaper to set up/ real estate costs were cheap ○ economies of scale was good due to distribution centers ■ Lower avg. cost → but raised willingness to pay ○ Netflix dominated two s-curves: first the DVDs then disrupted themselves with the streaming industry. ● How are Porter's Five (Six) Forces different in the streaming industry than they were in the DVD industry? ○ Substitutes: streaming vs DVD ■ DVD: assuming competitors have similar products: cheaper VHS version compared to DVD version ■ Streaming: YouTube, cable, social media such as Instagram and TikTok ● Why was Blockbuster slow to respond? Netflix Recap Video: ● Blockbuster was in the mature phase ● Netflix’s original business model was only enabled by the advent of the disruptive technology which was DVD… then innovation with DVD by mail ● What were the two technologies? ○ DVD by mail ■ DVD came out allowing for a business model innovation which was DVD by mail and that allowed Netflix to go in and dominate this new business model ○ Fast Wifi/Streaming ● Why did Blockbuster’s total access fail? ○ It basically did everything that Blockbuster did plus everything Netflix was doing ○ It was unsuccessful because of the underlying cost structure that blockbuster had adopted ■ They had all those retain stores which at one time were a competitive advantage but turned into a disadvantage ● Netflix is very impressive because they made the leap from an old technology s-curve to a new technology s-curve. How did they do this? ○ They made the jump with some luck AND their existing subscriber base, the data that they had on them, and the recommendation algorithm Lecture 17: Platform Fundamentals ● What is a platform? ○ A platform is a technology, product, or service, that creates value primarily by enabling interactions between users with the potential for network effects ■ Interactions include transactions, communications, meetings, exchanges, etc. ○ Has to enable interactions between 2 parties and has network effects ■ Ex. Ebay → transactions, Tinder → Interactions, Playstation → transactions and interactions ● Platforms are not just digital ○ Not just digital industries, also: ■ Financial services: credit cards (transactions with merchants and stores), stock exchanges ■ Transportation: package delivery, reservation systems ■ Transaction: classified ads → facebook marketplace within news papers ● One-sided versus Multi-sided ○ One-sided platforms enable interactions amongst a single group ■ Email: emailers send and receive emails ■ Meetup: members “meetup” with other members ○ Multi-sided platforms: Users are (mostly) permanent members of a distinct group - a “side” - that interacts with other distinct group(s) ■ Recruiting platforms: job seekers and recruiters ■ Credit card platforms: card holders and merchants ● Are the following platforms one sided or multi-sided? ○ Imessage ■ One sided ○ Uber ■ Multi-sided ○ Netflix ■ Not a platform, they are intermediary ○ YouTube ■ Multi-sided (3 sides) made up of advertisers, users, and content creators ● Network effects ○ Network effects exist when the WTP for a product depends on the number of other users of the same product… EX. iPhone, TikTok ■ For platforms: user’s WTP or WTA (Willingness to Affiliate) depends on the number of other platform participants ○ Network effects can be positive or negative ■ Positive network effects increase WTP as the number of users increase ● Examples: social media users ■ Negative Network effects decrease the WTP as the number os users increase ● Examples: congestion effects, advertisers, trolls ○ ○ ○ ○ ○ ○ ○ As the amount of ads and trolls increases, the less people want to use the platform Direct, or same sided Network effect: exists when the WTP/WTA depends on the number of other users on one’s own side ■ One sided platforms only have direct network effects Indirect, or cross-sided network effects: exist when the WTP/WTA depends on the number of users on another side of the platform ■ Uber example: ● Network effects do not increase linearly ■ Generally, there are “diminishing returns” to increased customers ■ At some point, more users may increaser congestion ● EX. a well-attended party is pleasant, however, a “packed” party is not An “X-sided platform” has X^2 (Potential) Network Effects ■ Example: 1-sided platform has 1^2 = 1 network effect ■ Example: 2-sided platform has 2^2 = 4 network effects Each effect can be positive or negative ■ Two sides are complementors if they have positive indirect network effects Reddit example: ■ ● Platform business models ○ Transaction platforms ■ Create value by enabling direct exchange or transactions ■ Capture value through transaction fees, subscriptions, and/ or advertising ■ Ex: ebay, Grindr ○ Innovation platforms: technological foundations upon which others develop complementary products/innovations ■ Create value by facilitating the development of complementary products (usually without contracts) ■ Capture value by selling/renting/licensing platform products and/or advertising ■ Ex. Windows → app developers build off of windows software ○ *some firms are hybrids, act as both transaction and innovation platforms… EX: IOS and app store* ○ ○ ● Are the following examples single-sided, multi sided, transaction, or innovation platforms? ■ VISA → 2 sided transaction platform ■ Kroger → not a platform ■ Amazon → 2 sided transaction platform ■ Playstation → 2 sided innovation platform Mini Quiz: ○ A grocery store is a 2 sided platform? ■ True or False ● Flase ○ How many network effects does a two-sided network have? ■ 2, 4, 6, 8 ● 4 ○ How many network effects does a three sided network have? ■ 2, 4, 6, 9 ● 9 ○ How many indirect network effects does a three-sided network have? ■ 2, 3, 6, 8 ● 6 ○ Network effects always increase the value of a platform ■ True or false ● Flase Lecture 18: eHarmony ● eHarmony lies between the differentiation and niche quadrants in determining the competitive scope ● Industry: more attractive for this specific niche ○ Hard to imitate, increased barriers to enter for this niche because of their resources ● 2 sided transaction platform with men and women on each side ○ Straight dating platform ○ ● ■ For a gay dating platform which is a Two One-sided platform: ■ Video Recap ○ 2 sided platform of men and women with strong indirect network effects ○ Had long questionnaire and rejected people from the platform during a lengthy screening process ■ They had strong governance rules and there is a tradeoff as they increase quality but can decrease quantity ○ Niche strategies are still viable platforms especially if people’s preferences are very different in the dating market Lecture 19: Advanced Platform Strategy ● What to know: Platform Fundamentals ○ Know the definition of a platform ■ Be able to distinguish from a traditional intermediary (like netflix) ○ Be able to identify the number of sides a platform has ■ Some are one sided and others are multi-sided ○ Be able to identify how many direct and indirect network effects a platform has ○ Know that network effects can be positive or negative ○ Know how network effects related to the value proposition ■ Increasing WTP based on how many people use the platform ○ Know the difference between a transaction and innovation platform ● Network Effects and Value Propositions ○ Network Effects are demand-side economies of scale ■ Increase value creation by raising WTP ○ Distinct from “supply side” economies of scale that increase unit margins by spreading fixed costs ● Strong network effects are not sufficient for monopoly (winner take all) ● Platform Industry will be more concentrated when: ○ MES is high relative to (mature) market size ○ Other barriers to entry are high OR ○ Network effects are positive and string, AND ○ Consumer preferences are homogeneous (meaning everyone wants the same thing and think the same) or platform can selectively offer features to users who are willing to pay, AND ○ Multi-homing costs are high ● Heterogeneous consumer preferences: consumers want different things ○ Meaning multiple platforms ● Multi-homing ○ The practice of simultaneously affiliating with multiple platforms ■ Ex. artists putting their music on multiple platforms ○ Can weaken Network effects ■ Not adding as much value to one platform as possible ● Mono-homing ○ The practice of only affiliating with a single platform at a time ■ Giving full attention to one platform ● Ex. choosing a music platform *Each side of the market may home differently* ● Multi-homing costs ○ costs /investments incurred by user due to platform affiliation ■ If high, users are more likely to mono-home ■ If low, users are more likely to multi-home ○ ○ ● Examples: ■ Do phones have high/low switching costs? Multi-homing costs? ● High switching costs and high multi-homing costs ■ Do email services have high/low switching costs? Multi-homing costs? ● High switching costs (not always financial) ○ Because terminating emails is a pain due to to having to update everything ● Low multihoming costs ○ Importance of multi-homing costs vs. switching costs ■ To predict market concentration (winner take all/monopoly) ● Focus on multi-homing costs ■ To predict whether there is a first mover advantage ● Focus on switching costs (and other factors we’ve discussed) ■ To predict whether incumbent platform is likely to be displaced by a new platform ● Focus on both multi-homing costs and switching costs Mini-Quiz ○ Which of the following is least important in determining whether a platform-dominated industry will be concentrated? ■ MES, barriers to entry, multi-homing costs, switching costs ● Switching Costs ○ Which type of cost is generally most important in determining a platform's multi-homing costs? ■ Setup costs, termination costs, ongoing costs, switching costs ● Ongoing costs because it can be really hard to maintain both platforms ○ If a platform’s switching costs are high, its homing costs must also be high ■ True or false ● False ● ● ● ● Chicken and Egg Problem ○ If side 1 depends on side 2 and side 2 depends on side 1, how do you get a platform started when you have neither side yet? ■ Ex. Uber Solutions to the chicken and egg problem ○ Subsidize: give away or discount affiliation on one side ■ Yellow pages free to residents ■ DVD players sold at a loss to early adopters ○ Exclusivity: pay high-value, marquee users to only affiliate with your platform Main problem: both are expensive ○ Develop or buy complements: apple started the app store with its own “remote” app ○ Provide cheap/free tools to ease complement development ■ Apple provides software development kits to ease app development ○ Offer standalone value to one side ■ Start as a “normal” merchant/vendor, become platform later Are more sides better? ○ Not necessarily ■ Tradeoffs to more sides ● Potential pros of more sides ○ Potentially stronger network effects ○ Access to more sources of creativity, value, and revenue ● Potential Cons to more sides ○ Increased complexity ■ Harder to solve chicken and egg problem with more sides ○ Conflicts of interest: one side wants one thing another side wants something else ○ Less control and integration ■ Apple generally higher quality than windows or android because apple makes its own hardware (fewer sides) Pricing strategies ○ Multi-sided platforms have several “customers” ■ Where will revenues/profits come from? ■ Which side(s) should a firm charge? Which to subsidize? ○ Pricing principles ■ Profit from the side: ● With more inelastic demand or higher WTP ● That adds least value (or diminishes value) for others ■ Subsidize (or give away to) the side that: ● Creates the most value for (most positive network effects) other users ● Mini Quiz ○ When starting a platform, firms should always begin with as many sides as possible to maximize the network effects ■ True or false ● False ○ When deciding how to price each side of a two-sided platform, a firm should generally profit from (charge) the side that: ■ Creates the most value for the other side OR creates the least value for the other side ● Creates the least value for the other side Lecture 20: Wii Encore ● ● ○ They should make money from the gamer, but they do not follow this principle Monopoly Rents ○ Porter's five forces plus a six force of complements and cross-price/demand ○ Complements: Porters Sixth Force ■ Are goods whose prevalence enhances the value of another ● Negative cross price elasticity ● ○ ○ ○ Complements affect our consumer surplus Suppliers affect our cost Strong indirect network effects biggest issue is the chicken and the egg problem ■ In the gaming industry to overcome this, Nintendo made their own games to serve as complements ■ They also use exclusivity ■ They sold consoles for a loss (AKA Subsidizing) ● ● ● ● ● Why do companies like playstation tell everyone how much the console will cost months before they release them? ○ Telling people how much the console costs lets the developers know how much they will sell and how the willingness to pay will be high Royalties that console companies make developers pay, ensures that the bad developers stay out and keeps the competition going to ensure quality games Karate game example: ○ Negative network effect because of how bad the game was ● ● ● ● Game consoles are a quintessential example of two-sided innovation platforms with strong indirect network effects Indirect network effects are good and bad ○ Increase barriers to entry (less competition) & WTP ○ Chicken and egg problem Indirect network effects are determined by quantity and quality (which can be at odds with one another) ○ Governance decisions (excluding developers, limiting # of games) work to balance quantity and quality With consoles, a three sided platform is difficult because existing consoles have such low prices that third-party hardware makers would not be able to be profitable (and if they charged higher prices the platform would fail) Video Recap: ● 2 sided innovation platform with strong indirect network effects ○ Have the power to increase WTP on each side ○ There is a chicken and egg problem ■ You need to convince developers to get on first so that there would be games for users to play ● They advertised low prices which told developers that people were going to buy the consoles due to the low prices ● Royalties kept quality high and gave incentives for developers to make good games to get in ● Widows is a 3 sided platform and video game consoles are a two sided platform ● Dell has no incentive to come in an create hardware for Xbox ○ They do not have an ability to differentiate ○ They were going to be competing with playstation who were giving away their consoles at cost so if Dell did it they would have to give them away for free so the platform would fail so it is not an industry where you can have a three sided platform ● Why does windows not charge royalties, but xbox does? ○ Razor blade model ■ Gamers WTP and the number of games they buy has a high correlation ○ Making money on the side of the games, it allows you to price discriminate and extract more money from the side or group of people that have a higher willingness to pay ○ With windows this is not true, because there is a high WTP for the computers, but not the applications/programs so there is not a high correlation