Economics of networks and standards

Question 1

What is the network effect on products?

Answer 1

Value of a product to a consumer doesnt only depend on price and attributes but also the number of people that use the product. Utility increases as number of users increases.
Consumption is effected by past decisions (loyalty perks), and future choices such as subscription services)

Question 2

What is a network externality?\
Give examples of positive and negative?

Answer 2

Change to the value of the good or service as the size of the network grows.
Positive - social media
Negative - luxury goods (loses its uniqueness)

Question 3

What are the characteristics of networks?

Answer 3

Single sided- one type of user
Two sided - user and seller e.g ebay, bank borrower and depositor
Sustainability depends on credibility through reputation
switching costs (inertia, existing loyalty, knowledge of existing software) - ‘locked in’ to inferior quality

Question 4

What are the direct effects on consumers of large networks?

Answer 4

• base decision on size and composition of network
• benefit directly from socially or economically interacting with other members in network e.g WAZE social mapping encourages users to report traffic incidents
• more users = more communication opportunities
• companies use same standardised system of microsoft so files can be sent in same format

Question 5

What does Brian Arthur theory state?

Answer 5

Individuals selects between two rival variants of a new tech by evaluating the payoff (Pi) with each variant.
Pi = preference for A + tech improvements that come with previous adoptions (number of past adopters)
[Pi = Xa + r(Na(t)]
If preference for A and B(Xa/b) are the same then key driver for new users decision is installed user base of each tech.
r=incremental innovation (more users = more feedback for steady stream of improvements).

Question 6

What are indirect effects of networks?

Answer 6

More users = more supporting products which are of value to the user/ complements. E.g the value of a DVD system is dependant on number of films available or apps on iphone, credit cards more valuable with more shops that allow customers to use this financial service
This creates scale and scope economies and increase in variety.

Question 7

According to Brian Arthur Model what drives consumption choices?

Answer 7

determined by the marginal choice of the consumer in terms of the number of users each technology variant has installed (r(Na)

Question 8

Why might the market choice of the tech variant be sub-optimal?

Answer 8

Imperfect information, how reliable are reviews. Often a reason why inferior products are chosen

Question 9

How do network effects through complementary products aid determining the optimal tech variant?

Answer 9

Availability and quality of complements affect the success of the product e.g Blu Ray vs HV DVD. HD had headstart but Blu Ray launched playstation 3 in complementary market which boosted Blu Rays sales as storer for PS3.

Question 10

How do network effects in terms of incremental innovation mean inferior tech is often chosen?

Answer 10

Early adoption of new tech creates a snowball effect (r) making it hard for new entrants to enter if old tech has larger user base which allows them t keep innovating.

Question 11

What is a de jure standard?

Answer 11

A formal written document by standard institutions that is open to the public so any organisation can produce a product that adheres to the standard. E.g 5G, wifi, bluetooth.

Question 12

How do de jure standards create competition?

Answer 12

It creates a market and develops the standard using existing and new infrastructure. Initally it eliminates competition so that not one single company owns it allowing different players to use these open standards.

Question 13

Pros and Cons of de jure standards?

Answer 13

Pros;
- produces higher quality than if left to free market as draws on committee of experts from different places to decide optimal standards
- legitimate (agreed, open and transparent procedures.
Cons;
- slow to emerge

Question 14

What is a de facto standard?

Answer 14

Propriety designs that are owned by successful firms that dominate a market, not open to the public or discussed by a pad of experts.

Question 15

What are the cons of de facto standard?

Answer 15

Costly process (market based competition over dominance, losing party undergoes large costs)
Risk of ‘lock in’ to an inferior product, sub-optimal products may be chosen (might be privately profitable but socially undesireable)
Creates undesired monopoly effects

Question 16

Examples of de facto standards?

Answer 16

Apple Iphones
Dyson bagless vaccums
Tiktok short videos that have been copied by instagram reels

Question 17

List the 4 types of standards?

Answer 17

Compatability standard ; ensures we can connect items or use A+B together such as software working on specific hardware. Users can enjoy network effects.
Safety standard / minimum quality; protects the customer and overcomes market failure of imperfect information.
Reduced variety - less variety = benefit from EOS better, degree of compatability exists here though as size 12 cant fit into size 8
Measurement and description standard; standard for the units used to measure and descirbe what they are selling

Question 18

Decide whether each standard type is formal or informal?

Answer 18

Compatability - Formal or informal
Safety - Formal
Reduced variety - informal and formal
Measure unit - formal

Question 19

What is the standards race?

Answer 19

Compares two product variants based on 2 properties of consumption value (network of users and quality).
Product A is an established standard with a large network vs product B = better replacement.
Used to show market growth compared to market share.

Question 20

Comment on the following when the scenario; neck and neck
- indifference curve
- market growth
- market share

Answer 20

Median customer is indifferent to A and B
- inbetween flat and steep
- growth is the same, no one ever wins the race
- 50% consume A and 50% consume B so market share is equally split

Question 21

Comment on the following when the scenario; established surges ahead
- indifference curve
- market growth
- market share

Answer 21

Median customer prefers the established network
- flatter IC so MRS is low (willing to give up only a small amount of network users for an increase in quality).Initially product A is on the higher IC, by the end of period 6 A’s IC is much higher than B’s as more users adopt A the value of the network increases at a much quicker rate than B (utility dependent on network of users and quality(which remains constant for both so the IC for A is now significantly higher.
- A grows at a higher gross rate than B
- over 50% will choose product A in the period so competitive position of existing standard strengthens.

Question 22

Comment on the following when the scenario; the better replacement catches up
- indifference curve
- market growth
- market share

Answer 22

Median customer prefers the better replacement
- steeper IC so consumers more willing to give up the number of users in their network for a rise in quality, product B is on the IC
- B grows at a higher gross rate than A,
- over 50% will choose product B in that period so competitive position of better alternative strengthens; B will capture whole market at certain period

Question 23

List strategies that can be used to win a standards race?

Answer 23

• product preannouncement to prevent customers purchasing rivals existing products by encouraging them to wait for new release. Delays the growth of rivals networks
• Bring product to market before it is perfect (can’t wait too long otherwise market will change/ satisfy a new entrant)
• release early versions of software to high value customers to encourage them to understand the software and identify faults before general release
• build indirect effects of networks by getting companies to produce add on products
• develop gateways from other products to theirs (decrease switching costs)

Question 24

What is a technological lock in?

Answer 24

occurs between rivals when launching new tech
exists due to network effects increasing returns to adoption meaning that sometimes sub optimal tech is chosen by the market making inferior tech the standard. Arises from imperfect info, complenetary products and incremental innovation.

Question 25

How do lock ins and dominant designs happen?

Answer 25

Initally no company has a lock, variants of designs are experimented with.
One design gains acceptance, an industry standard is established.
Innovations become incremental and process oriented and the industry becomes dominated by a few firms. Lock in is created which limits diversity. E.g iphone created homogeneous outcomes for smartphones.

Question 26

Explain the standards race between VHS and Betamax?

Answer 26

Two incompatible systems. assumed that Betamax would dominate as entered the market first
Difference in networks effects were not large
VHS was small so had to license suppliers to sell their own version of the VHS. Betamax did not, was a closed standard
VHS sales surged ahead.
Costly for Betamax and for customers that assumed Betamax would dominate that brought their product initally.

Question 27

Advantages of open standards in terms of public policy?

Answer 27

• allows for specialisation
• internatinoal standards allow internatinoal trade as it lowers barriers to entry. Compatability standards allow firms to offshore or outsource overseas.
• enhance competition and innovation (diffusion of information). Allows competition to focus on characteristics of products and service like quality.
• encourage add on products produced by small new entrants and allow consumers to exploit network effects
• trust with supplier = decreaae transaction costs. Promotes compatability between products and procceses.
• optimise compliance with regulations as have to meet health and safety, risk management requirements.

Question 28

Give an example of where a dominant design is not optimal?

Answer 28

Qwerty keyboard
Letters are not arranged in the fastest way but the computer would lag if any faster.

Question 29

How are open standards contributing to international trade between Africa and UK?

Answer 29

Ghanas standard authority run the Standards Partnership Pilot which aimed to strengthen their national quality infrastructure systems to comply with recommended international standards.