Chapter Nine The New Economy: Technological Change and Innovation

Chapter Nine

The New Economy: Technological Change

and Innovation

• The term NEW ECONOMY refers to the results of the technological changes occurring in information processing and communication.

• Business gurus are telling us that what the NEW ECONOMY means is that nothing we are used to will remain the same in the future.

• A headline in the Wall Street Journal, January 1, 2000, read:“SO LONG SUPPLY AND DEMAND”

• Consider the following statements reported in the Journal:

• “Conventional economics is dead.” ---IBM’s global knowledge manager

• “The axiom of scarcity does not apply to information.” ---Peter Drucker

• “…mankind has been fighting scarcity since the beginning of time. There does seem to be some possibility that the war with scarcity is tapering off. There will be enough for everyone.” ---Saul Bellow

• What do you think of the following passage from a book:

• “As the century closed, the world became smaller. The public rapidly gained access to new and dramatically faster communication technologies. Entrepreneurs, able to draw on unprecedented scale economies, built vast empires. Great fortunes were made. The government demanded that these powerful new monopolists be held accountable under antitrust law.”

• A prophecy for the next decade? No. This is a description of what happened a hundred years ago.

• The view that “economics is dead” is terribly mistaken.

• The so-called new economy • Is a technological change.

• Is changing the face of business.

• But is not changing human nature.

• Are you Star Trek fans?

• Do you remember the episodes where money and scarcity supposedly disappeared?

• Of course, these episodes also contain various species fighting over airspace or a planet or power or resources and also typically include some solution to a problem involving trade.

• Scarcity is and always will be with us – it is simply part of the human spirit.

Copyright © Houghton Mifflin Company.All rights reserved. 9–10

Compare Stock Performances of the 80s and 90s

1980s Top Performers

Company % Change

1. Circuit City 8,252

2. Limited 6,100

3. Hasbro 5,582

4. Home Depot 4,997

5. Wal-Mart 4,032

1990s Top Performers

Company % Change

1. AOL 79,630

2. Dell 72,445

3. EMC 69,638

4. Cisco 64,498

5. CMGI 61,187


Consider what happened to Encyclopedia Britannica

• Price for the encyclopedia set: $2000

• They were sold door-to-door.

• The company’s greatest cost was its direct sales force.

Encarta• This encyclopedia was provided as part of a

Microsoft package.

• Its price was $50 if purchased separately, but it was usually free.

• No Sales Force

• Britannica went from a peak in 1989 of $650 million in revenue and a sales force of 2300 to a point where it won’t release financial figures, and it has about 300 employees.


October 19, 1999

• Encyclopedia Britannica announced that its full set will now be available for free to anyone with internet access.

• Virtually every supply chain is affected by the technological changes occurring in information processing and communication.

• Supply chain: People usually mean the flow of physical things when they refer to this.

• But a great deal of information also flows along the supply chain.

• When information is carried by things -- by a salesperson or a piece of direct mail -- it goes to where the things go and no further.

• Once everyone is connected electronically, information can travel by itself.

Consider Britannica again• Its barrier to entry was its sales force.

• In the face of the new economy, it tried to retain its sales force by raising prices and it nearly killed itself.

• Where once a sales force, a system of branches, a printing press, a chain of stores, or a delivery fleet served as barriers to entry in the new economy, these could become liabilities.


Part of The Supply Chain for Newspapers

Journalists

Advertisers

Copy

Editors

Printing presses

Distribution/

delivery

CUSTOMER

• Technological change allows journalists and editors to go directly to the customer.

• Freed from the necessity of subscribing to entire physical newspapers, readers will be able to mix and match content from a virtually unlimited number of sources.

• Newspapers will be DECONSTRUCTED.


Part of The Supply Chain for Newspapers

Journalists

Advertisers

Copy

Editors

Printing presses

Distribution/

delivery

CUSTOMER


Will there be such a thing as a “bank”?

• Accounts will be changed and funds transferred from one account to another.

• How will a bank create loyalty?

• This same phenomenon will occur in many industries.

• In banking, people will soon be able to go to any financial institution online.

• Intuit’s Quicken and Microsoft’s Money are close to this now.

• This means firms will specialize in providing databases on interest rates, risk ratings, and service histories.

• Others will provide bulletin boards on which individuals can post their desires and wait for the best offer – auctions will be held.

• This is occurring now: You can post your desired loan and allow institutions to bid for your business.


The point is that many different types of businesses will be deconstructed.

• Automobiles

• Currently, dealerships provide information in showrooms and on test drives;

• they hold inventory and distribute cars;

• they broker financing;

• they make a market in secondhand cars;

• they operate maintenance and repair services.


Networks

• Networks are gaining more publicity.

• Networks include internet, operating systems, HDTV, and . . .

• old networks such as railroad gauges and electricity transmission.

• The argument often given is that once a network becomes a standard, no other network has a chance, even if it is more efficient.


Mergers and Acquisitions

0

2

4

6

8

1983 1985 1987 1989 1991 1993 1996 1998 1999

Mergers &Acquisitions

Divestitures

Failed M&A w/in 5yrs.

thousands

Due to the new economy


Mergers Are Occurring at a Record Pace

• Large companies are in acquisition overdrive.

• Eight of the 10 largest mergers in history took place in 1998-1999.

• GD acquired Gulstream Aerospace.

• AT&T purchased MediaOne.

• Mobil merged with Exxon.

• BankOne and First USA merged.

• Mergers and acquisitions are seen as a way to GROW earnings.


The Other Main Factor of the New Economy Is:

• Globalization

Even if you don’t directly interact with companies in other nations, you are affected by international developments.

• If the exchange rate changes, and your manufacturing costs change, that affects you.

• If the exchange rate changes and the prices of products produced in other nations changes, your customers are affected.

• Completed global merger and acquisitions volume was up nearly 50% in 1998 and again in 1999.

• Alliances made across borders are accelerating exponentially.


You will hear of the “relationship enterprise.”

• These are the networks serving as the primary vehicle of global consolidation – as opposed to mergers and acquisitions.


Examples include:

• The aerospace industry, where Boeing and Airbus each have more than 100 partners.

• Telecommunications, where the Global One alliance includes Sprint, Deutsche Telekom, and France Telecom and serves 65 countries.

• The Star Alliance in airlines includes United, Lufthansa, SAS, Varig, Thai Airways and others.

• In the new economy, each of these might be a separate business.

• Some will specialize in test drives, providing those automobiles a customer has specified.

• Distributors might have a single warehouse from which the desired car would be shipped.

• Car purchasers could obtain financing via an auction on an electronic bulletin board.


Networks

• What is a network?


The Keiretsu

Bank Insurance Company

Mitsubishi

Firm A

Firm B

Firm D

Firm C


Keiretsu 2Keiretsu 1

Bank Insurance

Company

Bank Insurance

Company

These two “families” don’t trade with each other.


Networks

• Networks have positive feedback or positive network externalities.

• The value of network is proportional to the number of members:

• Value = n x (n-1)

• With a value of $1 for a single user, then the value of a network of size 20 is:

• 20 x (10)

• With a network of size 200:

• 200 x (199)


Lock-In

• The value of the network increases exponentially as members increase linearly.

• A lock-in occurs because:

• It is increasingly costly for a single member to switch from this network to another.


Tipping

• Winner Takes All

• The point at which an “epidemic” explodes is called the tipping point

Tipping Point


Tipping Point

• When does a market become “tipped” or “tippy?”

• The potential for tipping depends on:

• Positive feedback.

• Demand for variety.


Tipping

• When a market does tip, the “winner takes all.”

• This means there is no choice of substitutes; there is just one.

• Thus, if consumers want differentiation, it is less likely that tipping will occur.


Reason for Tipping

• Scale economies?

• Positive feedback?

• Both must be present.

1. Scale economies are not sufficient:

LRATC

Demand


Reason for Tipping

1. Scale economies and feedback.

LRATC

D1D2 D3


Markets That Might Tip

1. The existence of positive feedback (network externalities).

2. The existence of scale economies.

LRATC

D1D2 D3


Strategy

• How do you control a market that might tip?


Networks

• Examples:• QWERTY

• Windows

• VHS


Networks

• Contagiousness is related to networks.

• The costs of not being infected by the contagion is greater than the costs of being infected.

• If a manager wants to create an epidemic for her firm, then the net costs of being infected must be raised or the net costs of not being infected lowered.


Networks

• Managers must focus on the MARGIN: An example pointed out in the book Tipping Point is crime in New York City.

• Crime had hit epidemic proportions in the 1990s; authorities began doing minor things like cleaning graffiti off the subway cars, arresting subway free-riders, etc. These minor things turned the tipping in the other direction, and crime fell dramatically.


Strategy

• What does it take for a new technology to succeed in the marketplace?

• How can a new technology become tipped?

• How can you make network externalities work for you?

• Evolution: offer consumers an easy migration path – reduce switching costs.• (This is what Microsoft did when it included

extensive help for WordPerfect users.)


Strategy

2. Revolution: offer a product so much better that people will bear the costs of switching.


Igniting the Positive Feedback for You

• OPENNESS VS. CONTROL

• Do you offer an open approach by providing others the necessary interfaces or:

• Do you keep the system proprietary?

• If your system “takes off,” a proprietary system gives you a monopoly.

• If consumers fear lock-in, then you it may be better to offer an open system.


Igniting the Positive Feedback for You

• ALLIANCES

• By building alliances, you are more likely to attract more members to your system.


Networks

• STANDARD: A means to create compatibility


Standards

• Who wants a standard?

• Do consumers prefer standards?• Consumers do not want to be “locked in.”

• A standard reduces the lock-in.


Standards

• A standard shifts the locus of competition from a battle for dominance to a battle for market share.

• Instead of competing FOR the market, companies compete within the market (using the common standard).

• Standards shift competition away from features and more toward price.

• Standards shift the competition from systems to components.


Standards

• Who wins and who loses from standards?

• Consumers generally welcome standards, although:

• There is a loss of variety.

• Sellers of complements welcome standards. For example AOL sells internet access, a complement to modems – AOL then benefits from the use of standardized high-speed modems.

• Incumbents may be greatly harmed by standards.


Standards

• Incumbents may be greatly harmed by standards.

• Standards drive tipping.

• Strategies for incumbents to combat standardization:

1. Deny backward compatibility to would-be entrants.

2. Rush to introduce a new generation of equipment.

3. Ally yourself with the new technology.


Standards Wars

• When two incompatible technologies struggle to become a standard, they are engaged in a standards war.

• Key Assets: • Control over an installed base of customers.

• Intellectual property rights.

• Ability to innovate.

• First mover.

• Manufacturing abilities.

• Complement strength.

• Reputation and brand name


Standards Wars

Tactics:

• Preemption: Build an early lead so you take advantage of the initial positive feedback, that is, the epidemic.

• With learning by doing, the positive feedback is achieved through lower costs.

• With network externalities, the positive feedback comes on the demand side.


Standards Wars

• How can you build the lead and create the tipping?

• Suppose the product has a marginal cost that is nearly zero?

• Managing expectations – vapor ware: this is the process of announcing a new product when that product is really just a dream or vision.


Standards Wars

• Suppose two firms are vying for the standard. They have a choice of cooperating and making standards compatible or of not cooperating and making the standards incompatible.

• The payoffs for their actions are as follows:


Standards

HDTV 1

HD

TV

2

Compatible Incompatible

CompatibleHDTV1 10

HDTV2 10

HDTV1 100

HDTV2 5

IncompatibleHDTV1 5

HDTV2 100

HDTV1 5

HDTV2 5


Standards

HDTV 1

HD

TV

2

Compatible Incompatible

CompatibleHDTV1 10

HDTV2 10

HDTV1 100

HDTV2 5

IncompatibleHDTV1 5

HDTV2 100

HDTV1 5

HDTV2 5


Strategy

• What if the situation a firm faces looks like this – in other words, there could be a tippy market. What do you do?

Tipping Point

% of market

time


How to Get Out of the “Dilemma”

• Firms could cooperate and define a common standard.

• Firms could agree to let another body define a standard – thereby forcing cooperation.

• Firms could keep competing until one is able to dominate – to trigger the tipping of the market.


SUMMARY: Network Strategy

• You must have a distinct capability.

• You must have a market in which that distinct capability has value.

• You must determine whether your entrance has value and to whom.

• You must determine whether the market is tippy.

• If there is positive feedback and if there is lock-in, you must determine how to capture that feedback effect for yourself.

• You must decide whether to pursue an open or proprietary system.

• You must create the tipping event.


SUMMARY: Network Strategy

• Sustainability: You must ensure that your distinct capability continues to have value.

• You must create barriers to entry.

• You must increase the costs of switching, that is, ensure that lock-in occurs.

• You must ensure that others don’t offer migratory strategies.

• You must ensure that better products don’t take over the market.

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Chapter Nine The New Economy: Technological Change and Innovation