Strategy for Information Markets/Compatibility and Standards

Compatibility, as defined by the American Heritage Dictionary, is "The capability to exist or performing in harmonious, agreeable, or congenial combination." A standard dictates what can be included in a network by forcing compatibility among the network. In terms of the field of the information market, the ability of information goods to perform together productively is integral. Compatibility among mediums allows for companies to cooperatively conduct business, advance technology with a reduced fear of lock-in, and create formal network standards. Companies use these formal standards to ensure compatibility. Standards and compatibility are also pivotal in easing entry for new companies into a market. Compatibility affects competition, welfare, and investment. Being first in a market allows a firm the ability to dictate compatibility and accumulate positive feedback, creating a cleavage between themselves and other firms, giving itself a comparative advantage over its competitor. As dictated in Information Rules, network economies thrive on the ability to create a formal standard. The ability to create this standard can be arduous, but the rewards may be well worth the struggle.

Lock-in

A vital hurdle in the progression of technology is the issue of lock-in. The idea of lock-in comes in two parts: collective and individual lock-in. The idea of collective lock-in has to do with people coordinating their investment into inferior technology and inability to orchestrate into the more advanced or "better" technology. An example of this is the QWERTY keyboard. There were many critics who argued that the Dvorak keyboard was the superior keyboard. However, with an entire workforce of typists already trained using the QWERTY style, the costs of switching to the newer, better technology outweighed the benefits. Individual lock-in is the idea that it is too costly to switch to a new technology so it is not worthwhile to switch. An example of this was the switch from VHS movies to DVDs, or similarly the switch from cassettes to CDs. The disks were clearly better quality than the cassettes, but many people had already acquired a large library of movies, and the cost of buying a new player and to replace their movie library was much to high. Compatibility can allow for companies to bypass both collective and individual lock-in.

Bypassing individual lock-in

Individual lock-in occurs when it is too costly for individuals to invest into newer or better technology, forcing the consumers' continued use of older or inferior technology. Individual lock-in is generally bypassed by a similar strategy as collective lock-in. Producers of the new technology look to reduce switching costs often by the use of backward compatibility. Backward Compatibility is the ability of a newer technology to support the software used in an older technology. One example of this is the Blu-Ray player. In an effort to advance the standard of movie players, Sony allows the Blu-Ray player to support regular DVD's. This way, people can buy and use the new player without having to worry about replacing their entire movie collection. Another example of this idea was the introduction of Microsoft Word. WordPerfect was the standard at the time, but Microsoft introduced Word with "specialized help for WordPerfect users" and an easy ability to convert into Word format. The specialized help offered by Word effectively minimized switching costs for consumers who used WordPerfect by minimizing the amount of time it would take for users to become accustomed to the new format. Many would have most likely been "locked-in" to the WordPerfect format because they did not want to invest the time into the new product. Also, the ability to convert data into Word format allowed an easy compatible transition into the new format. People did not have to re-enter data into the new format, further minimizing switching costs and bypassing individual lock-in.

Reduced consumer lock-in

If the standard is truly open, consumers will be less concerned about lock-in. They can count on future competition. This has worked nicely for CDs, where holders of patents essential to the CD standard, including Sony, Philips, and DiscoVision Associates, have charged only modest royalties. Likewise, consumers expected competition on the PC platform, owing to IBM's open approach. And competition they got – among hardware providers, that is – but not among operating systems, which became dominated by Microsoft.

Bypassing collective lock-in

In collective lock-in, people coordinate on an inferior network, and cannot find a way to coordinate a switch to the better network. If you succeed in establishing a standard, then all products dictated as part of the standard are for the most part compatible (with the exception of forking). Thus the products are competing within the market as opposed to competing for the market. This reduces uncertainty in the market for consumers, allowing them to coordinate into network of compatible goods that everybody is using. If this turns out to be an inferior technology, the network can be advanced using the idea of "evolution." Evolution is the lowering of switching costs in order for firms to gradually enter into the new technology. As opposed to the idea of revolution, in which there will be experience lock-in, evolution allows consumers to enter into a more advanced network with lowered switching costs, which will create a new standard in this advanced technology. Going back to the WordPerfect example, because WordPerfect was the standard, many were well versed in how to use WordPerfect. Thus because the population coordinated on this format, there was an element of collective lock-in. If Word had not come out with help and a data conversion tool, chances are WordPerfect would still be the standard. The effect lowering switching costs and bypassing individual lock-in allowed many to be well versed in the superior format and because so many could use Word, consumers were able to coordinate into Microsoft Word. So compatibility lowered switching costs allowing consumers to bypass individual lock-in which in turn allowed the population to bypass collective lock-in.

Formal standards

As the complexity of technology increases, the complexity of standards that define the technology also increases. Compatibility allows for several companies to work cooperatively to achieve an industry standard. Standards are used to ensure compatibility because they dictate what is in the market. They can also be used to increase the market size by adopting an open standard that allows other companies to easily enter the market. An industry standard is important because instead of having companies compete for users on several incompatible network platforms, the industry developers can work to create a single network platform that will benefit from more users, and more users would join a single compatible platform. This way, developers can work in a more focused area knowing that they will have access to all users on the standard network instead of having to compete for more users. In addition, a two-sided platform could be generated meaning the network benefits and connects two different types of users.

How standards influence competition

Standards change competition; having standards in a market decreases the competition for the market. Instead of trying to dominate the market to generate strong network externalities companies will compete within the market, the companies will compete for market share instead of the trying to capture entire market. These companies are forced to compete using the standard. Standards change the focus in competing firms from features to price. This is to say that companies will be creating similar products with similar features because the standards dictate them, and since these products will be similar the differentiation between products will occur at its price. The companies will compete by lowering their prices. This is all relative to the detail of the standard. The more detailed the standard, the less difference there will be in products, and the products will compete more by price. A standard without as much detail can allow for more competition based on features.

Jailbreaking

Jailbreaking is a term to describe any technique which removes the limitations imposed by the manufacturer on the device. For instance, jailbreaking for Apple products is the process of removing the limitations imposed by Apple on devices running the iOS operating system, often through the use of custom kernels. Such devices include the iPhone, iPod touch, iPad, and 2nd Gen Apple TV. Jailbreaking allows users to gain unfettered access to the operating system, allowing iOS users to download additional applications, extensions, and themes that are unavailable through the official Apple App Store. Strictly speaking, it is a form of privilege escalation, and the term has been applied to privilege escalation on other computer systems as well. The name refers to breaking the device out of its "jail", a technical term used in Unix-style systems, for example FreeBSD jail. In most cases, a jailbroken iPhone, iPod touch, or iPad running iOS can still use the App Store, iTunes, and other normal functions, such as making telephone calls.

Unlike rooting an Android device, jailbreaking is necessary if the user intends to run software not authorized by Apple. Under the Digital Millennium Copyright Act, jailbreaking iPhones is legal in the United States, although Apple has announced that the practice "can violate the warranty".

Open and closed systems

The Closed App store

For the App store of Apples for iPhone , iTouch or iPad users: Some of the movies, games or software are open because there's no certain limit for people, like an age limit. You can download those apps and play whenever you want. However, there are a large number of movies and apps that have a certain age limit. For those you can't have, for instance because of the minimum age requirement, those apps represent a closed network to you, because the App store can deny the access to that software/movie. For example, an app called Weixin is the one of most popular for online chatting in the Chinese app market. It's totally free to use, but people need to agree to Weixin's terms of service and have to be the at least 17 years old to do so. For people who don't meet the age limit, they can not install the app as the App Store will deny their request to download and install it on their device, which makes for a closed network for those people.

Jailbreaking makes the App store an open network

However if people jailbreak their device, it makes the App store an open network. After being jailbroken, Apple no longer has the ability to deny access to the apps in the store. There will be no age or any other kind of limits for the people who jailbreak their device, they could download anything that they want from the App store.

Most of the people jailbreaking their devices are doing so because they want to make the App store an open network and they don't want to pay for the apps. In the App store, the app developers try to release new versions of their software to make them non-durable goods in order to make more profit. For example, a game called Angry Birds is one of the most popular apps in the App store. It is a strategy puzzle video game developed by Finnish computer game developers Rovio Mobile. Inspired primarily by a sketch of stylized wingless birds, the game was first released for Apple's iOS in December 2009. Since that time, over 12 million copies of the game have been purchased from Apple's App Store. It would have sold a lot more if there were more jailbroken devices. The most popular apps developers are also the ones who lose the most from jailbreaking. For Angry Birds, there are four different kinds of free versions to allow people to experience the game with limited levels and characters, and also three more versions that need people to purchase it to play the whole game-they have more levels and can get more game experiences. The best way without paying for people to turn their non-durable goods to durable goods is jailbreaking. The non-durable apps in the App store either have a lot of advertisements or limit the game experiences, which makes "versioning" one of the most compelling reasons for people wanting to jailbreak their device: to have more durable goods on their devices.

Network

The online App store created a two-sided platform: The App store connects two different kinds of users.

1. Apple get more benefits when there are more app developers
2. App developers get more benefits when Apple gains more users for their app market by getting more people to use iPhones

Selling apps is one of the most profitable revenue streams for Apple. Of course Apple wants to keep the App store closed, because if people jailbroke their iPhones and made the network open for those users, Apple would get no money for those apps that it should have otherwise sold.

Jailbreaking can also be considered as a two-sided platform. People get benefits when more jailbreaking developers join the network, so they could jailbreak their devices better and have more available customizations. Jailbreaking developers benefit when more people do jailbreaking. Most of the hackers doing jailbreaking are not doing it because of money, though, it's just for a sense of achievement. In fact, most of the jailbreaking software produced and shared publicly has been without any charge to the user.

For the App developers, the marginal cost of producing each unit decreases as more units are produced. The marginal cost for one software/song/movie is nearly zero. For the "free app," jailbreaking will not influence the developer or Apple much, because the marginal cost can be ignored. Moreover, the profit for the "free app" is mostly from advertisement. Jailbreaking doesn't help the users get rid of the advertisement in the game at all which means jailbreaking doesn't negatively influence the free app developer much– it may even help them to get more users. Apple profits from each app they sell which makes the "jailbreaking free games/software" does not influence them as well.

Pros and cons for Apple and app developers

App store is sponsored by Apple. Apple get benefits from the Apps it's selling. In this way, jailbreaking is definitely a "con" for Apple-jailbreaking would decrease the profit Apple should have got from the apps that the jailbreaking users downloaded without paying. In some countries like China, jailbreaking is even becoming an industry. There are thousands of mobile repair shops-one of the main income they get is from help people jailbreaking their phones. After the jailbreaking, they will ask the customer what kind of Apps the customer want to install then they will install them for the customer(the customer also could get the App themselves if they want, the whole jailbreaking and installing Apps only for 20$). In this situation it really hurts Apple's Chinese App market because there are so many people jailbroke their iPhones and not much people want to pay for a App.As a news said:Translating App Store success from the U.S. to China isn’t a straightforward task. Localization is very important to Chinese customers, so investments like translation and culture-specific settings, contexts and themes are key to attracting downloads. But according to Distimo, there’s another problem facing developers: Chinese app buyers aren’t as willing to pay for software as their western counterparts. Revenue share from the Chinese App Store is still behind its share of downloads. Even though the Chinese consumer is not willing to pay much for the Apps, it showed that jailbreaking actually help Apple to take over the Chinese market. There are a large amount of the download is from jailbreaking devices. Take higher percentage of the market is also what Apple wants to see even it's from jailbreaking.

Pros

• Network externalities
• Better user experiences
• Get inspirations
• Makes more people know about the product/brand

Cons

• Less profit from selling the Apps for both Apple and app developers
• Makes Apple lost the control of the closed network
• Makes less developers want to develop Apps

Pros and cons for users

Jailbreaking has many pros and cons for users as well. For instance, jailbreaking makes more people join the network of a game which would make the game more competitive and more fun to play with more people. So people would benefit that a member of this network receives when the people who jailbreaking their device that joins this network.Also, if one person jailbreaking to get more apps, it doesn't mean that other people get less-it's non rival. On the other hand, if one person get an App, he can't keep another person from getting it-it's non excludable. In conclusion, jailbreaking to get more apps doesn't hurt the other users for the reason of the Apps are non rival and non excludable for users.

Advantages

• Jailbreaking can remove the limitations imposed by the operator which allow the user could download every Apps for free
• More features:Total UI Customization
• Easy to do: Jailbreaking usually takes less than 30 minus, people could easily learn how to do it from some website.
• Make their device/software durable goods for free
• Lots of "free" third party apps

Disadvantages

• Updates can break warranty: people lost their right to get warranty if they jailbreaking their phone
• Increased instability
• Fear of the Brick: sometimes people would "Brick" their phone when they doing jailbreaking

Why are standards necessary?

Standards establish a clear connection between the producers and the buyers. When standards are in place they improve compatibility and therefore increase the value for users by increasing the network size. In addition to establishing a clear connection and increasing value to the users, a standard helps identify the proprietary standards. Proprietary Standards are considered to be the standards an entire market sector must meet based on what the company with the greatest amount of market share sets them to. Standardization creates platforms that are open to augmentation for complementary products and services while at the same time upholding the dominance necessary to establish lock-in effects. There are strong implications in standards now that they play a significant role for competing electronic service environments. In some cases, customers are a driving force behind standards, and in other areas, they participate to ensure their needs are met.

What are some of the advantages of standardizing first?

1. There is a manufacturing cost advantage.
2. You can create a brand name for yourself through being the first to capture a sizable network.
3. It allows the more dominant company to create compatibility for the market.

Voluntary standards

A voluntary standard is an agreement, usually in the form of a document, intended to facilitate communication within an industry by describing characteristics of a product. These characteristics include performance, safety, materials used, etc.

Why are voluntary standards created?

Voluntary Standards are meant to:

1. Provide information among the industry
2. Ensure product compatibility between manufacturers
3. Establish satisfactory product qualities
4. Limit product variety so production economies can be achieved

Groups influencing voluntary standards

Buyers and Sellers are the two groups of individuals that can prompt the declaration of a voluntary standard. These two groups will only attempt to influence the necessity of a voluntary standard if they have the incentive to do so.

Buyers:

Buyers will push for a voluntary standard if it will decrease their transaction costs. Transaction costs arise in multiple ways. One such way is as a result of asymmetry in information about the quality of a product, between the consumers and producers. If a buyer knows more about a product, their doubt about that particular product may decrease and their effective price will decrease due to the decrease in search costs. Also, if a buyer’s purchasing confidence is increased then the demand will increase which would potentially bring down the price and increase the quality of the product thus effectively lowering the buyer’s transaction costs.

Sellers:

Sellers will push for a voluntary standard for many potential reasons. One is that voluntary standards may create a barrier to entry for new firms. A second reason is that production costs could be decreased with a limit on the variety of dimensions of a product. This limit on variety could create larger scale production and help the seller achieve economies of scale. And the last reason a firm will push for a voluntary standard is to create a form of competition, not related to price, that could eliminate firms from the market.

Industry characteristics influencing voluntary standards

Product complexity:

The more complex a production process is, the more difficult it is for buyers and sellers to agree on the performance characteristics of products. This creates a necessity for a voluntary standard.

Unionization:

In firms with strong unionization, a voluntary standard may be useful, for management, in combating the bargaining strength of the union.

What are the negatives of creating a standard?

Creating formal standards for an network has many benefits, but some problems will often arise. A major criticism of standards is given by Joseph Farrell and Garth Saloner in Converters, Compatibility, and the Control of Interfaces, "the process of standardization may be costly." They go on to elaborate, "These costs include resources spent on standard committees and the delay cost caused by their slow decision making processes." Another aspect brought up by Farrell and Saloner is that standards retard innovation. Innovation is essentially delayed because when a market is more standardized and compatible it becomes more costly and time consuming to coordinate mass conversions to a new standard, even if it is better. The costs associated with conversion to a new standard make markets reluctant to convert to new standards and thus retard innovation. An example of this is analog television which was the standard for televisions for quite a while. Digital offers much more capabilities including "It has allowed stations to offer improved picture and surround sound (enhanced audio)." Also, "It has allowed some of the spectrum to be auctioned to companies that will be able to provide consumers with more advanced wireless services (such as wireless broadband)." Often times innovating, and yet attempting to stay compatible on a network can lead to issues.

Cooperation

Allies are crucial in order to minimize your risk when coming into a new market. Many companies are generally looking to create a 2-sided platform, i.e. one that will benefit from more users and more developers. A common way of achieving this goal for companies is to cooperate with other companies in order to create an open network standard on a single network of compatible users. It is pivotal to gain allies when introducing and maintaining a formal standard. It is essential to find other firms who will support your standard in order to gain positive feedback, where positive feedback is the notion that, "As the installed base of users grows, more and more users find adoption worthwhile." If your firm is smaller with very little product recognition or name recognition, it may be beneficial to ally with a company with a large consumer base and network externalities, in order to gain support for a product standard utilizing positive feedback. It may also be beneficial to ally with a rival, or incumbent as a standard would expand network externalities allowing for control of a much larger network.

New companies

Generally, jumping into an industry can be difficult especially if there are already established companies in the field. Compatibility of a network will allow new companies to easily affiliate themselves into the industry without having to compete with existing companies for a network platform. It is difficult for new companies to enter a market due to externalities, lock-in, and path dependencies. One of the most unyielding tasks for these upcoming companies is create a strong network through positive feedback.

Some of the strategies that newly emerging companies must compete with are the following:

1. Expectations management

Any sort of action taken in order to curb expectations about a network

2. Penetration pricing

Simply, penetration pricing is a marketing strategy for firms in the market without dominant control by lowering the pricing scale oppose to price inflation. Penetration pricing is used to overcome critical mass, or the certain level of customers needed to make their product more valuable than costly to consumers.

3. Network externalities

Use expectations management and penetration pricing to surpass critical mass and allow positive feedback to grow the demand.

Who benefits from standards?

Consumers

A product standard for consumers is generally beneficial to health, safety, and quality of life, increasing overall utility. A product standard both reduces uncertainty for a network, and forces competition on price. Both of these are beneficial to consumers. Food and Water standards are common examples of products that greatly benefit the consumer when standardized. Without health and quality standards for food and water, for example, the consumer would have no idea if any packaged food or water were safe to consume. Organizations like the FDA (Food and Drug Administration) enforce standards to ensure a product's readiness and safety for the consumer.

Uncertainty

The problem for consumers is that generally they are uncertain about a product or network because they fear they may invest into the wrong technology and experience lock-in. The effect of having a market standard is that uncertainty is reduced. Users will not have to guess or be hesitant about a technology because of its compatibility factor. The market has already decided the standard that will prevail, therefore consumers will have no fear of buying into the network. Standards eliminate a large portion of the risk involved for consumers because a standard with a lot of support will increase the credibility of the new product. The risk of experiencing lock-in can be eliminated by an open standard because it allows for competition to easily enter the market.

Price

Due to a network standard being created, there is very little competition on features because features will be similar across the companies. However, since there will still be competition in the market, companies will be forced to compete using prices. This of course is beneficial to consumers, as they will benefit from both a lower price and similar features. They will lose out when it comes to penetration pricing to enter the network, but it is a small price to pay.

Network

The most important prospect of a network standard is the expansion of the network. Therefore, if there are network effects, the users already in the network will benefit from more users. This also occurs for a two-sided platform, where users benefit from more developers on the expanded network as well. Although the product will be improved through open standards, a "fork" can evolve. "Forking" a standard essentially is the process of a single network, no matter if it is two or one-sided, branching off into two parallel networks. The idea of a network being forked is driven by the increase in competition for the features of a network.

Loss of variety

The main aspect where consumers can lose out in a standardized network is a loss of variety. This means that the competing products will be similar. In some ways this is good for the general market because products can be viewed as identical. This happens when standards are open and encourage manufacturers to compete with price rather than features because the features will be similar within the market. The standard could be inconvenient for some users, since they have no leverage of determining which manufacturer has the superior product. However, a loss of variety means that there most likely will not be an alternative option.

Complementors

Complementors also generally benefit from a standard because of the expanded network. Because the network has increased in size, a complementary product has access to a larger network who demand accessories. Therefore it is beneficial to the producers who supply these goods. Due to this fact, an increase in network externalities brings added value to the market as a whole and gives more of a positive result for complementors.

Incumbents

Incumbents generally lose when it comes to standards. The problem is that a incumbent will tend to have an established base of users and name recognition. However, if a standard emerges with compatibility to the incumbent's network, they will lose market share. If they are not able to properly adapt to the standard quick enough, they may lose respectability and name recognition in the network. Thus, they may be pushed out of the network. However, if an incumbent is able to ally itself with a proper firm, they may be able to use name recognition to stay on top as the network expands. They would still need to adapt their technology properly to stay afloat in the network.

Innovators

Innovators of new technology usually embrace standards because they can increase the size of the market and it can be essential for the introduction of the market. A potential disadvantage for an innovator initiating an early standardization encompasses the risk that technologies have not yet adequately been coordinated. A potential negative outcome of standardizing too late is the potential danger for investors, leading to less future investments. A standard can have many different effects on innovators, but it can benefit them all collectively.

Further reading

• Farell J., and G Saloner, “Standardization and variety”. Economic letters, Volume 20, N. 71 1986
• Katz,M.l.,and C. Shapiro, “Technology adoption in the presence of Network Externalities”. Journal of Political economy, Vol. 94, pp. 822-841, 1986.
• Katz, M.L., and C. Shapiro, “ Product compatibility choice in a Market with technological Progress” Oxford Economic papers, forthcoming 1986.
• Dybvig,P.H., and C.S. Spatt, “Adoption externalities as Public goods” Journal of Public Economics, vol. 20.1983