To Hunt or to Scavenge: Competitive Advantage and Competitive Strategy in Platform Industries *

Transcription

1 To Hunt or to Scvenge: Competitive dvntge nd Competitive Strtegy in Pltform Industries * Srit Mrkovich** IDC Hertzliy Johnnes Moenius*** University of Redlnds Mrch 0 BSTRCT Firms choose their competitive strtegies to chieve competitive dvntge. With the help of dynmic model we demonstrte tht in pltform industries ny mrket structure cn be mpped into different types of competitive dis-) dvntge. Numericlly simulting the model llows us to find the optiml competitive strtegy for ech competitive position of firm within given mrket structure. Combining the two concepts we derive guidelines for determining firm's optiml competitive strtegy conditionl on the firm's competitive position within its pltform nd the position of its pltform within the industry. We pply those guidelines to discuss the micro-computer mrket. We would like to thnk Shne Greenstein s well s seminr prticipnts t Hrvrd University Northwestern University University of Redlnds the ZEW conference in Mnnheim nd the 3 rd Isrel Strtegy Conference for very helpful comments. ngel Mlkhov mi Nvon nd Veronic Tong provided excellent reserch ssistnce. ll remining errors re ours. * previous version of this pper entitled "To Hunt or to Scvenge: Optiml Investment Strtegies in the Presence of Indirect Network Effects" received the best pper wrd of the 3 rd Isrel Strtegy Conference. ** rison School of Mngement Hertzliy Isrel sritm@idc.c.il *** School of Business Redlnds C Tel.: 909) ohnnes_moenius@redlnds.edu

2 To Hunt or to Scvenge pge. INTRODUCTION Pltform products hve become ubiquitous in recent decdes: computer hrdwre nd softwre DVDs smrt-phones nd video-gmes to nme few. It is well estblished tht in pltform mrkets the vlue of component innovtion such s softwre crucilly depends on the mrket shre of the comptible pltform. This hs been extensively discussed in the literture for the clssic exmple of computer hrdwre nd softwre e.g. Church nd Gndl 99). Choosing n optiml competitive strtegy in these mrkets however is not s stright forwrd. Specificlly wht is the optiml investment strtegy for firm tht wishes to chieve or foster its competitive dvntge? s it turns out in pltform industries the simple "invest more!" strtegy is more often flse thn true. Bresnhn nd Greenstein 999) define pltform s " [ ] bundle of stndrdized components round which buyers nd sellers coordinte their efforts." Pltform mrkets often referred to s hrdwre-softwre mrkets typiclly exhibit indirect network effects the more ttrctive softwre the more consumers wnt to buy its comptible hrdwre. This in turn ttrcts more firms to develop softwre for this hrdwre. For exmple the lrge selection of pps for the iphone is frequently cited s n importnt driver of the iphone s success. Indirect network effects thus crete synergies between competitors on the sme pltform: dditionl competitors on the sme pltform increse the size of the pltform nd thus grow the pie Brndenburger nd Nlebuff 997) which then cn be split between competitors. The strtegic role of investment in determining how this pie will be split nd its effect on the firm s competitive dvntge in the mrket however hs not been nlyzed. Bresnhn's nd Greenstein's definition revels their insight tht the division between hrdwre nd softwre from n nlyticl perspective is not the defining feture of pltforms - it is the interoperbility reltionship between stndrdized components. We will use the words pltform nd hrdwre interchngebly in this pper. This is in contrst to direct network effects where the size of the instlled bse directly influences consumers' choice see e.g. Ktz nd Shpiro 985; Frrell nd Sloner 985).

3 To Hunt or to Scvenge pge 3 Lippmn nd Rumelt 98) nd dner nd Zemsky 006) re two exmples in the literture for studies tht develop stylized models to demonstrte the importnce of certin fctors on firms competitive dvntge nd competitive strtegy. We follow their pproch to identify softwre 3 firms' competitive strtegy in pltform mrkets. In our model firms cn ffect their competitive position within pltform nd simultneously their pltform s mrket shre through investment in qulity upgrdes. To identify firms competitive strtegy we therefore need to find firms optiml investment strtegies. We find these with the help of forml model in which softwre firms invest in R&D bsed on expected future profits tking competitive responses from other firms into ccount. These responses come from competitors offering softwre for the sme or for competing pltform. Furthermore firms decisions re not only ffected by consumers' softwre choices but lso by consumers pltform choices which in turn re bsed on firms investment strtegies. These responses crete highly complex interctions tht mke it virtully impossible to solve the model nlyticlly for optiml equilibrium investment strtegies. Consequently following Ericson nd Pkes 995) we use numericl nlysis to derive conditions for optiml investment behvior in our model. While the model structure helps identify ctegories of mrket ledership tht fuel competitive dvntge the numericl nlysis delivers interesting nd conceptully useful drivers of optiml investment behvior. The two oint together proffer reltively esy-to-follow guidnce for the choice of competitive strtegy in pltform industries. In order to identify firms competitive strtegy we first need to determine wht fctors ffect competitive dvntge. Mrkovich nd Moenius 00) nlyze this question nd find tht the min drivers of competitive dvntge in pltform mrkets re competitive position nd mrket position. Competitive position is determined by product or process ledership in our model product qulity) within the pltform while mrket position is determined by the compound competitive positions of ll firms on pltform reltive to firms on competing pltforms. Given those drivers we then exmine competitive strtegy. Specificlly we study mrket structures under 3 While we will use the term "softwre" throughout this pper it cn be thought of more generlly s ny type of component within pltform. We will demonstrte this with detiled exmple towrds the end of this pper.

4 To Hunt or to Scvenge pge 4 which firm should respond ggressively or complcently to successful qulity upgrde of competitor. Finlly we interct firms competitive position mrket position nd optiml strtegy to determine optiml investment levels nd thus provide guidnce for competitive strtegy in pltform mrkets. We find tht in generl firm's choice of competitive strtegy depends on the nture of its competitive dvntge tht is the type nd degree of qulity ledership it or its pltform hs chieved. firm s choice of competitive strtegy is ffected more by its degree of qulity ledership within its pltform its competitive position thn by the mrket position of its pltform. Specificlly the competitive strtegy of within-pltform followers nd leders does not depend on whether the comptible pltform is in led or behind - it only chnges when pltform ledership is contested. Interestingly in this ltter cse we find tht strtegic homogeneity where firms on the sme pltform choose the sme competitive strtegy is common nd profitble. Finlly the strength of competitors on the sme pltform hs lrge effect on the firm's prospect for success: firm tht hs sufficiently strong competitors with it on the sme pltform only needs to be little hed or t lest keep up with the pck. firm tht goes it lone on pltform needs to be hed lot - rule tht pple Inc. hs lerned the hrd wy but now seems to understnd very well. This pper contributes to four lines of literture. We dd to the literture on the nlysis of competitive dvntge s pioneered by Porter 985) nd revisited by dner nd Zemsky 006) by identifying drivers of competitive dvntge in pltform industries. We lso contribute to the pltform literture in economics dvnced by Church nd Gndl 99) nd in business with dvnces from Gwer nd Cusumno 00). While the previous economics literture suggests exit s the only vible strtegy for compnies on lgging pltform we show tht this does not need to be the cse nd if it hs to be which competitive strtegy is optiml before exiting. The pltform ledership literture on the other hnd only identifies "winning" strtegies for leders but not for followers. We close this gp. We lso document the dynmics of innovtion in the

5 To Hunt or to Scvenge pge 5 context of pltforms nd thus contribute to the literture on innovtion. Interestingly our within pltform results resemble those of the existing innovtion literture e.g. Grossmn nd Shpiro 987) while our cross pltform results find previously undocumented dynmics. Finlly we contribute to the competitive strtegy literture s in Porter 980). We not only show how competitive strtegy leds to competitive dvntge in pltform industries but lso how chieved competitive dvntge shpes competitive strtegy. The pper is orgnized s follows: we first present our model then discuss nd document competitive dvntge in its context. This llows us to define competitive strtegy for different mrket environments. We then mp those competitive strtegies into competitive dvntge spce which llows us to derive simple guidelines for competitive strtegy choices given mrket condition. We then discuss n ppliction of our methodology before we summrize nd conclude.. THE MODEL We present our model in two steps. First we stte the ides tht motivted the model specifiction nd the ssumptions tht ttempt to reflect them. Then we present forml version of the model which cn be skipped without loss of comprehension for reders not interested in the technicl detils.. Model ssumptions For ese of exposition we focus on two types of components in our pltform industry: shorter lived softwre nd longer lived hrdwre. Hrdwre-softwre mrkets typiclly feture the following chrcteristics: softwre requires comptible hrdwre to operte on nd consumers typiclly keep their hrdwre for longer thn ust one softwre cycle. Therefore when mking hrdwre decisions consumers form expecttions regrding future qulity levels of ll softwre on ll pltforms. Softwre firms hve higher incentives to upgrde their product the lrger the potentil mrket they cn ddress. Consequently firms incentives to invest in qulity upgrdes depend

6 To Hunt or to Scvenge pge 6 on the current s well s future number of consumers who own the comptible hrdwre. To reflect dependence on future opportunities we ssume n infinite horizon discrete choice model where consumers live forever nd derive utility from the consumption of softwre. Consumers willingness-to-py increses in the qulity of the currently vilble softwre nd decreses in its price. We ssume tht softwre needs comptible hrdwre to operte on but tht hrdwre provides no stnd-lone benefits. Consumers choose the hrdwre for which softwre promises the best expected qulity-price reltionship. To keep the setup simple we ssume tht consumers cn only choose from two incomptible hrdwre pltforms nd tht there re no more thn two softwre firms producing for ech pltform. Every period ll consumers need to renew or replce their softwre licenses. Consumers need to replce their hrdwre on verge every two periods nd cn either repurchse the sme type of hrdwre or switch to the competing hrdwre ssuming it offers them higher net benefits. 4 Since consumers own the hrdwre for two periods when deciding on hrdwre consumers must form expecttions bout future softwre qulities. The investment process is ssumed to be stochstic were the probbility of successful innovtion increses with the firm s level of investment. successful investment increses the firm s qulity by one unit while n unsuccessful investment becomes obsolete. Firms bse their investment strtegies on their reltive position in their pltform mrket s well s on their pltform s position reltive to the competing pltform. The industry s whole will be lrger if it offers higher vlue to consumers thn substitute mrkets do. For exmple TV brodcsts DVDs nd on-demnd streming my lose ttrctiveness for certin ge groups if new developments in the gming industry progress further. Consumers will then be less likely to pursue next best lterntives to video gmes nd the video gme industry will consequently be lrger. We therefore mesure softwre qulity reltive to the qulity of the next best lterntives. In order to cpture dvnces in the qulity of those next best lterntives we ssume tht if the qulity level of them increses by one unit the qulity level of ll 4 We define net benefit to be the benefit to the consumer or the consumer s willingness to py) net of the price of the product.

7 To Hunt or to Scvenge pge 7 vilble softwre on both pltforms) decreses by one unit. Finlly in order to innovte effectively softwre firms frequently possess pltform-specific knowledge: developing softwre for more thn one pltform cn be prohibitively costly. We therefore restrict firms to only one pltform nd for simplicity to only one softwre product. The timing of the gme is s follows: in the first stge consumers nd firms observe current qulities of vilble softwre on both pltforms s well s pltforms mrket shres. Consumers choose which hrdwre to buy nd softwre firms simultneously choose how much to invest in qulity. In the second stge firms compete in prices nd consumers buy one unit of softwre or their next best lterntive. In the third stge nture determines which firms investments were successful nd whether there ws n increse in the qulity of the next best lterntive. Note tht investment reliztion ffects qulities only in the following period.. Forml nlysis We employ the sme bsic set-up s in Mrkovich 008) nd dpt Pkes nd McGuire 994) to incorporte dynmics in consumers decisions. For simplicity we ssume tht ll firms develop the sme type of softwre e.g. spredsheets word-processors or office suites) nd llow for no more thn two pltforms nd B s well s no more thn two softwre firms on ech pltform. Since the nlysis for pltform B mirrors tht of we present here the nlysis for only pltform. Let W={0 K} be finite set of possible qulity levels of softwre nd let W represent the qulity of softwre firm producing for pltform. ) is the vector of qulity levels of both firms producing for hrdwre nd σ is the mrket shre of pltform. 5 σ Finlly S b) denotes the stte of the industry where b is the vector of the qulity levels of ll firms producing for pltform B. 5 σ is the forml equivlent of the "instlled bse s defined in the introduction see Frrell nd Sloner 986).

8 To Hunt or to Scvenge pge 8.. Willingness to Py Consumers derive benefits solely from softwre which needs comptible hrdwre to operte. We ssume tht hrdwre does not provide ny benefit on its own. In ech period hlf of the consumers who own prticulr hrdwre re rndomly selected to replce their units. These consumers cn elect to either sty with the type of hrdwre they lredy hve or switch to the lterntive. Firms license softwre to consumers for one period. fter tht consumers cn either renew the license t the then-vilble qulity level nd price or they cn elect to switch to nother softwre firm. Consumers who re not rndomly selected for hrdwre choice hve to select softwre for the hrdwre they lredy possess. For ny given period the willingness-topy of consumer l who owns hrdwre nd holds license from softwre firm for softwre with qulity level is WP l ) + l = ε where ε l denotes differences in tste mong consumers e.g. within the spredsheet mrket some consumers like Lotus while others prefer Excel). Softwre Choice. Consumers select softwre from the set of qulities nd prices vilble to them. They cquire license for one unit of softwre unless the best consumption lterntive denoted by ε 0 provides them with higher benefits. We ssume tht consumers' preferences ε re independently nd identiclly distributed ccording to stndrd double exponentil distribution. s McFdden 973) shows denoting the price of softwre k by p k consumer l cquires license from firm with probbility: D ; p p exp p) p ) + exp p ) ) = ) + exp Hrdwre Choice. Consumers who cn replce their hrdwre in given period do so by evluting current nd future softwre qulities for ech hrdwre pltform. If consumers purchse hrdwre their expected benefit is the sum of the benefits from softwre they purchse during

9 To Hunt or to Scvenge pge 9 the two periods they own the hrdwre. 6 Consumer l's expected net benefit from purchsing hrdwre is then: U l σ b) = E{[ WP ) p ] σ b} + βe E{[ WP ') p ] σ b})) + ξ ) l lk k l E WPl )) nd E E[ WPlk ' )]) re the consumer s expected willingness to py for licensing softwre in the current period nd softwre k in the next period respectively. ξ l represents consumer l's preferences over pltforms e.g. viewing operting systems s hrdwre some consumers prefer the Windows pltform while others fvor Linux). nd p re next period s qulities nd prices respectively. In order to ssess eqution ) consumers form expecttions bout future vilbility qulity nd prices of softwre bsed on the current stte σb). Consumers will choose hrdwre over hrdwre B if nd only if hrdwre offers higher net benefit thn hrdwre B. Tht is setting hrdwre s nd B s prices t P nd P B respectively consumer l buys hrdwre if nd only if U l σ b) σ B P > Ul b) P B. Once more we ssume tht consumers' preferences ξ k l re distributed independently nd identiclly nd follow stndrd double exponentil distribution. Then gin employing McFdden 973) consumer l purchses pltform with probbility: B exp U P ) Ψ b; P P ) = 3) B exp U P ) + exp U P B ) Given our ssumptions nd eq. 3) pltform 's mrket shre in the next period is given by σ ' σ b; P P B B ) = σ / + Ψ σ b; P P ) / 4).. The Mrket for Softwre 6 s noted before consumers replce hrdwre on verge every two periods. Consequently while some of the consumers replce hrdwre fter one period some hold their hrdwre for mny periods. For simplicity we ssume tht consumers expect to hold the hrdwre for two periods nd mke decisions bsed on these expecttions.

10 To Hunt or to Scvenge pge 0 We now turn to the dynmics in the softwre mrket. 7 Ech softwre firm only develops one type of softwre which is comptible with only one of the pltforms. 8 Softwre firms compete oligopolisticlly on qulity nd prices. If softwre firms wnt to improve the qulity of their product they need to invest. We ssume tht the outcome of this investment is stochstic nd depends on the level of ech firm s investment. Whether the investment is successful is reveled in the following period. Ech firm's qulity level in the next period is determined by three fctors: its current qulity level its level of investment nd whether the substitute industry improved the qulity of its products. We ssume tht qulity levels for ech firm follow Mrkov process where future qulities depend only on current qulities regrdless of how the firm reched this level. s noted before dvnces in the PC gmes mrket negtively ffect the video gme mrket. Tht is dvnces in substitute industries erode qulity dvntges of softwre in our mrket. We therefore mesure softwre qulities reltive to the qulity of those substitute industries. ny innovtion in substitute industries reduces the qulity dvntge of ll softwre on both pltforms by one unit. Consequently if is firm 's current qulity level τ {0 } is the reliztion of firm 's investment nd v {0} represents the success of substitute industries in upgrding their qulity then next period s qulity level is described by the following Mrkov process: = + τ v. We let δ denote the probbility of n improvement in the qulity of the outside good in ech period: p ν = ) = δ. We ssume tht there re no reserch spillovers: ech firm s probbility of 7 In this pper we study only investment strtegies of softwre firms. Softwre firms however cn lso decide to enter or exit the industry which we ignore here to keep the nlysis simple. See Mrkovich 008) for detils. Innovtion in hrdwre cn be viewed s "pltform qulity shifter" nd cn thus be represented by simultneous innovtion in the softwre mrket. While interesting in itself we sty focused on the more complex interctions in the softwre mrket in this pper. 8 The set up costs nd dditionl development costs required in order to port certin softwre from one hrdwre to nother re high nd the porting is typiclly done by different unit within the orgniztion. Once cn therefore think of these two units s two different compnies.

11 To Hunt or to Scvenge pge successful investment depends only on its own investment. In prticulr if firm s investment level is x then its trnsition probbility is: P x ) = x δ ) + x x δ ) + δ + x + x δ + x if if if = = = + 5) Firms Profits. While investment decisions re dynmic we ssume tht the pricing gme is sttic gme with no future effects or dynmics. 9 Firms choose prices to mximize profits in the current period nd cnnot strtegiclly discount their softwre in order to ttrct more consumers in the future. ll softwre firms on both pltforms tke softwre demnd s given from eqution ) nd set prices such s to mximize per-period profits. Per-period profits for firm on pltform re given by: mxσ * M * D p 0 ; p p ) * p 6) where M>0 is the totl size of the mrket nd in the interest of prsimony we bstrct from mrginl nd fixed costs of production. σ is the percentge of consumers who own pltform. The first-order condition FOC) the derivtive of 6) with respect to p is + exp 0= p ) + exp p )+ exp p ) p It cn be shown tht there exists unique Nsh equilibrium p * ) p * )) of the pricing gme Cplin nd Nlebuff 99). This Nsh equilibrium cn be computed by numericlly solving the system of FOCs. The per-period profit of firm in the Nsh equilibrium of the pricing gme is then given by σmπ ) where 9 Despite the sttic nture of the pricing gme nd the fct tht prices re independent of qulity levels on the other pltform profits do depend on the mrket shre of the hrdwre firm produces for. However this mrket shre is influenced by the qulity levels of firms producing for the competing hrdwre.

12 To Hunt or to Scvenge pge ) ) * ); ) ) * * * p p p D π 7) is firm s profit per consumer. Eqution 7) reltes the mesure of competitive dvntge of dner nd Zemsky 006) to those of other contributors to the literture: profits depend on willingness to py which cn be incresed through the process of vlue cretion nmely investment in qulity upgrdes. However due to competition ech firm cn only pproprite prt of this vlue creted. Since production costs re ssume to be zero firms with superior vlue cretion qulity lso hve bove verge profits t lest on their pltform. Tking the stte of the industry ) b S σ = s given incumbent softwre firms select optiml investment strtegies by solving n intertemporl mximiztion problem. For exmple firm on pltform mximizes its expected future pyoff ) S V by solving the following Bellmn eqution: 8) where x is firm 's investment on pltform. x B x nd B x re defined similrly. P. ) is given by eqution 5) nd Eσ' S) is given by eqution 4). The right-hnd side of eqution 8) consists of two prts: the profits from the pricing gme in this period σmπ p) nd the expected discounted vlue of ll future profits. The expected vlue of future profits depends on the stte of the industry S= σb) s well s on ll ctive firms' investment levels. Note tht the expected vlue of future profits is the mrket vlue of the firm. s cn be seen from the dependence of 8) on current nd expected qulity levels of ll firms firm cn only hve sustined higher profits s compred to its competitors if it hs superior vlue cretion ) ) ) ) ) ) ) ) ) ' ) 0) ) 0) ) 0) ) 0) ) ' ) sup ) 0 σ δ ν ν ν ν β δ ν ν ν ν β π σ = = = = + = = = = + = E S x b b P S x b b P S x P x P S V S x b b P S x b b P S x P x P S V x p M S V b B B b B B x

13 To Hunt or to Scvenge pge 3 in our model qulity upgrdes through investment over time. This implies tht reltive mrket vlue of firms cn be used to cpture the ide of sustined competitive dvntge s proposed by severl uthors. Note however tht mrket vlue only reflects the vlue cretion tht firms re ctully ble to cpture. We get bck to this point in the next section. Equilibrium. Following the literture we consider the Mrkov Perfect Equilibrium MPE) of the gme see Mskin nd Tirole 00). Ech period firms simultneously decide on their investment levels given the current stte of the industry S nd their future expecttions. Investment strtegies re defined for every stte of the industry regrdless of how this stte hs been reched. Mrkov Perfect Equilibrium for the gme described bove is defined by Investment strtegies x k σ b) for =; k=b nd every possible stte σb). Vlue functions V k σ b) for i=; k=b nd every possible stte σb). Such tht: i) The strtegies x k σ b) re optiml given the vlue functions V k σ b). ii) For every stte S=σb) the vlue functions describe the present vlue of profits relized when both firms ply the equilibrium strtegies x k σ b). full forml equilibrium definition nd the computtionl lgorithm cn be found in Mrkovich 008)...3 Prmeteriztion. We chose the following set of prmeter vlues for the equilibrium computtion. We ssume totl of ten consumers in the mrket i.e. M=0. Since our focus is on softwre we normlize hrdwre prices P = P B to be equl to zero. Mrket shres of pltforms run from 0% to 00% nd re clculted in increments of 5%. We think of ech period s one yer nd set the discount fctor β = 0.9. Given these prmeter vlues softwre firms find it unprofitble to invest in

14 To Hunt or to Scvenge pge 4 qulity upgrdes regrdless of mrket structure if they rech qulity level of K=6. Once softwre firm hs reched this qulity level it chooses not to invest t ll. We therefore fix K t 6. We will present ll of the results with grphs. Since it is impossible to disply our results for ll possible vlue combintions of the model we select intermedite strting vlues for the grphs: ech pltform strts with mrket shre of 50% nd the level of outside competition δ is lso set to 0.5. Deprting from these vlues only chnges the reltive mgnitude of the effects while the principle mechnisms sty the sme COMPETITIVE DVNTGE IN PLTFORM INDUSTRIES Vrious definitions of competitive dvntge hve been proposed in the literture See Rumelt 003). In the context of pltforms identifying nd ctegorizing firms with competitive dvntge is even hrder thn in mrkets without pltforms: for exmple does the firm with the highest qulity softwre nd the highest profit mrgin hve competitive dvntge even if it is on n otherwise inferior pltform? lterntively does firm tht is follower in terms of qulity nd profit mrgins hve competitive dvntge when it is on the leding pltform? simple lederfollower clssifiction s in Grossmn nd Shpiro 987) is therefore not useful in the context of pltform industries. Similrly to Besnko et l. 000 p. 389) we find vlue cretion reltive to competitors i.e. ledership nd mrket conditions specificlly mrket structure to be the most useful concept of competitive dvntge for the purpose of this nlysis. In our model vlue cretion reltive to competitors hs two dimensions: Qulity ledership within- nd crosspltforms. s we will see reltive vlue cretion within- nd cross-pltforms is the min driver for the selection of competitive strtegy while specific mrket conditions expnd or shrink the pplicbility of ech competitive strtegy. 0 Figures with other prmeter vlues re vilble upon request from the uthors.

15 To Hunt or to Scvenge pge 5 For our nlysis we define pltform position s the sum of qulities of the softwre comptible with tht pltform. To study how qulity ledership nd mrket structure ply out in the context of pltforms we disply possible qulity combintions of firms on pltform nd fix the qulity levels on pltform B. We cll the qulity difference between the two firms within pltform -intr nd the difference between the sums of qulities of both firms on ech pltform - inter. We select ll cses from our model tht llow us to void corner solutions where one or more of the firms hs no incentive to invest) s much s possible. The qulity combintions for ll -intr nd -inter tht fulfill this criteri re displyed in figure. In prticulr we set the qulity level of both firms on pltform B to 3 so the totl qulity level on pltform B is equl to 6. Pltform ledership is reflected in the res where -inter is positive. If the firms on pltform for exmple ssume qulity levels 5 nd 3 the sum of their qulities is 8 which leds pltform B by two qulity units nd -inter =. If both firms on pltform ssume qulity level of pltform is behind nd -inter = 4. Within pltform ledership on pltform is reflected by positive -intr. Using the sme exmples from bove -intr = in the first exmple nd - intr = 0 in the second. The figure provides complete list of qulity combintions for ll -intr nd -inter used in the grphs. We divide the spce into nine sections bsed on the dimensions of ledership: ) Leder Contested Ledership nd Follower within pltform - the firm s qulity reltive to the competing firm on the sme pltform; ) Leder Contested Ledership nd Follower cross pltforms - the pltform s position reltive to the competing pltform. For exmple for firm on pltform section LF corresponds to the cse where firm is leder within its own pltform L) nd pltform is follower s it lgs behind pltform B F).

16 To Hunt or to Scvenge pge 6 - intr -inter ) 5) 6) n.. 4 n.. 04) 5) 6) n.. 04) 5) 6) 03) 4) 5) 36) n.. 3 LF 03) 4) 5) 36) n.. 03) LC4) 5) LL 36) 0) 3) 4) 35) 46) 3) 4) 35) 0) 3) 4) 35) 46) ) 0) 0 ) - ) 0) - 0) -3 30) n.. -4 n.. ) ) ) 3) 0) 30) FF 40) n.. 3) ) ) CF ) 3) ) 3) 4) 30) 40) 34) 45) 56) 3) 34) 45) 3) 34) 45) 33) 44) 55) 33) 44) ) CC 55) 33) CL 44) 43) 54) 65) 3) 43) 54) 3) 43) 45) 4) 3) 4) 5) 40) 4) FC 53) 4) 5) 4) 5) 5) 6) 5) 64) 53) 53) 64) 63) n.. 63) 5) FL 63) n.. 6) n.. 6) Figure : Types of qulity ledership in pltform industries. The horizontl dotted lines in the figure seprte the within-pltform qulity leder from the follower with the middle row corresponding to the cse where ledership within pltform is contested tht is both firms re competing for ledership within their pltform. The verticl dotted lines seprte the leding pltform from its follower where the middle column corresponds to hed-to-hed pltform-competition. We hve thus mpped reltive vlue cretion through qulity ledership into the mtrix of bsolute vlue creted or the qulity distribution of firms which together with mrket shres represent mrket structure. To see the link between competitive dvntge nd competitive strtegy we need to complete two more steps: First we need to mp firms' competitive strtegies into the qulity distribution of firms; second we need to nlyze the role of mrket structure s determinnt of competitive dvntge nd thus ultimtely s determinnt of competitive strtegy to rech competitive dvntge.

17 To Hunt or to Scvenge pge 7 4. COMPETITIVE STRTEGY The nlysis bove suggests tht firms competitive strtegy depends on their type of competitive dvntge. In our model superior dvntge is chieved through investment nd thus competi- tive strtegy in our cse is bout firms investment strtegy. In order to cpture the dynmics in firms optiml investment behvior given its reltive position in the mrket we study firms intheir response to compet- vestment responses to their own successful qulity upgrde s well s itor s qulity upgrde. We define firm's own-investment-response to be the percentge chnge in the firm's investment given one percent chnge in its own qulity level. firm's crossis the percentge chnge in firm's investment given one percent chnge in its competitor's qulity level. Figure shows firm 's on pltform ) own- nd cross- invest- investment-response ment-responses s function of firm s reltive position in the mrket. In ll figures below we set the qulity level of both firms on pltform B to 3. Figure : Own- nd cross-investment-responses. In generl firm cn increse or decrese its investment in response to n own- or crossqulity-upgrde. We cll n increse in the firm s investment n ggressive response nd cll decrese in investment complcent response. We strt with own-investment responses. s the Unless explicitly stted otherwise in the rest of the pper we lwys refer to the competitor on the sme pltform. Formlly responses in our clcultions re elsticities. Since our model cn only hndle discrete chnges in qulities the percentge chnges for the responses hve been clculted bsed on unit chnges. For exmple n increse from qulity 4 to qulity level 5 represents 5% chnge.

18 To Hunt or to Scvenge pge 8 left pnel shows the more firm lgs behind firm -intr < 0) the more ggressive its investment response to its own qulity upgrde. Once firm leds the opposite effect cn be observed. The intuition behind this is s follows: if firm lgs behind successful upgrde increses the probbility of ctching up nd gining competitive dvntge nd thus increses the firm s incentives to invest in qulity upgrdes. The increse in incentives is the lrgest when qulity differences between firms re still lrge. However once firm hs become fr leder it cnnot win dditionl mrket shre on its own pltform only from the other pltform decresing the leding firm s incentives to invest. Therefore fr leder behves complcently nd decreses its investment in response to its own qulity increse. The effect of pltform position on investment is quite different. Specificlly firms investment-responses to own increses in qulity re the strongest when qulity differences cross pltforms re smll - the mrket is very competitive nd smll chnges in qulity levels hve reltively lrge effects on mrket shres. Firms therefore increse investment ggressively to gin pltform ledership nd enhnce the ttrctiveness of their pltform. Once their pltform is hed or behind incentives re lower the effect of chnges in qulity on mrket shre nd ttrctiveness to consumers is not s lrge nd so is the investment response to n increse in their own qulity. In generl cross-investment responses re mostly complcent. firm responds complcently when one pltform s led is lrge nd responds mostly ggressively when this led is smll. We consider first the cse when one pltform's led is lrge. In this cse in equilibrium the leding pltform commnds lrge mrket shre nd competitors on this pltform behve s if they were lone in the mrket focusing on their ledership position within-pltform. Consequently rections both ggressive nd complcent) re the strongest when both firms on the leding pltform re of similr qulity nd -intr is smll. For lgging firm on lgging pltform if the leding firm successfully upgrdes its qulity two effects hppen simultneously: the firm continues to lose mrket-shre within the pltform which reduces its incentive to invest even further; but the

19 To Hunt or to Scvenge pge 9 pltform overll gets stronger. This ltter effect increses the pltform s survivl probbility nd future profit opportunities for the firm; thus it increses the firm s incentives to invest. 3 When the second effect is lrger thn the first typiclly when the pltform does not lg too much behind) the firm responds ggressively nd increses its investment. The opposite is true for the leding firm. qulity upgrde by the lgging firm strengthens the survivl probbility nd thus the overll ttrctiveness of the lgging pltform. For the leding firm this mens the burden to ensure pltform survivl is reduced. The reduction in within-pltform mrket shre nd the reduction of burden to ensure survivl both work in the sme direction thus the leding firm rects the more complcently to successful qulity upgrde by its competitor the more it is hed of it. Cross-investment responses re positive when intr-pltform differences re smll: the smller intr-pltform differences the stronger re cross-investment responses. When pltforms re of similr qulity levels qulity upgrde by the competing firm improves the mrket position of the entire pltform. This in turn increses the firm's incentives to upgrde its softwre. This is lso true in the other direction: qulity upgrde by the firm itself leds to incresed investment from the competing firm. Consequently investments by the two firms on the sme pltform re gross complements. This reltionship exists only in the neighborhood of eqully strong pltforms nd it is the strongest when firms re close competitors on the sme pltform. Once inter-pltform differences increse firms on the sme pltform find it more profitble to fight ech other rther thn to fight their rivls on the competing pltform. 4. Txonomy of Competitive Strtegies The grphs bove isolted the response to firm's own upgrde nd its competitor s upgrde. We now investigte the interction of these two upgrdes i.e. chnge in firm s competitive 3 In ccordnce with the previous literture in economics Mrkovich nd Moenius 009) define the second effect s the network effect - the chnge in pltform's mrket shre driven by n increse in the qulity level of one of its firms.

20 To Hunt or to Scvenge pge 0 position. Given firms own- nd cross-investment-responses the mtrix below identifies the optiml competitive strtegy for firms in pltform industries. n increse in your competitor s qulity mkes you ggressive Complcent n increse in your own quli- ggressive Pck Hunter Lone Wolf ty mkes you Complcent Puppy Wolf Scvenger Tble : Competitive Strtegies s tble shows we cll firm tht responds ggressively both to its own upgrde nd its competitor s upgrde "Pck Hunter". This is the cse when both firms work together to improve the reltive position of their pltform. We cll firm tht seeks to get hed by itself "Lone Wolf." "Lone Wolf" firm is encourged by its own success nd discourged by the success of other firms. Thus its own qulity upgrde mkes it ggressive but its competitor's qulity upgrde mkes it complcent. 4 "Puppy Wolf" firm seeks to keep the current distnce from its competitors: Thus it rects ggressively to competitor s upgrde nd complcently to its own qulity upgrde. Finlly we cll firm tht finds it optiml to seize current profits nd is neither encourged by its own nor by its competitors' success "Scvenger." This will be the cse when firm rects complcently to both upgrdes. s discussed bove firms strtegic behvior depends on their competitive position nd the mrket position of their pltforms. Figure 3 plots the different types of competitive strtegies s function of mrket structure bsed on the results of our numericl simultions. 4 Note tht the Lone Wolf corresponds to the behvior found in the typicl R&D literture; e.g. Grossmn nd Shpiro 987).

21 To Hunt or to Scvenge pge -intr Pck Hunter Lone Wolf Puppy Wolf Scvenger -inter Figure 3: Mrket Structure nd Optiml Competitive Strtegies ccording to the grph when pltforms re of similr mrket positioning firm behves s if it were "hunting" in pck it rects ggressively to its own nd its competitor s qulity upgrde. The firms behve s if they oin forces nd invest ggressively in order to strengthen the reltive mrket position of their pltform. They do so s long s both firms re of similr competitive positions nd pltforms re of similr mrket position. firm behves s "Lone Wolf" when it is in competitive position-disdvntge on pltform with either lrge mrket position disdvntge or sufficient mrket position dvntge. In these cses competition is mostly centered within pltform rther thn cross pltforms. Successful investment then mkes the firm more ggressive since it cn stel business from its competitor on the sme pltform. The "Scvenger" rects complcently to its own- nd its competitor s qulity upgrde. Scvengers re firms with little incentives to upgrde the qulity of their softwre. For exmple leding firm on leding pltform hs no incentive to further increse its investment s it is not eoprdized by neither its competitor nor by the other pltform; the firm thus prefers to hold onto most of its profits insted of reinvesting them. When the Scvenger is leding firm on the lgging pltform

22 To Hunt or to Scvenge pge it cnnot win ginst the competing pltform lone. Consequently it ust "feeds" on whtever mrket shre its pltform lredy hs. The "Puppy Wolf" rects ggressively to competitor's qulity upgrde but complcently to its own qulity upgrde. This hppens when the pltforms mrket positions re similr but there is lrge discrepncy between the qulity levels of firms on the pltform. In this cse ny ctch-up of the lgging firm increses the chnce to win pltform ledership nd thus mkes the "Puppy Wolf" more ggressive if it cnnot keep the competitor t distnce it turns into "Pck Hunter." 5 5. COMPETITIVE DVNTGE ND COMPETITIVE STRTEGY In the finl step of our nlysis we overlp the mtrix of the types of competitive dvntges with the mtrix of competitive strtegies s suggested by the numericl simultion. This llows us to nlyze the structurl reltionship between the two which we believe is lrgely independent from the prticulr set-up of the model nd the resulting specific numericl results. For ese of presenttion we provide the stylized results in tble where the firm s optiml strtegy is t the bottom-left of the box nd its competitor s optiml strtegy is t the top left corner of the box. -inter Leder -intr Contested Follower Follower Contested Leder Lone Wolf Scvenger Lone Wolf Lone Wolf Scvenger Lone Wolf Pck Hunter Puppy Wolf Pck Hunter Pck Hunter Puppy Wolf Pck Hunter Lone Wolf Scvenger Lone Wolf Lone Wolf Scvenger Lone Wolf Tble : Types of qulity ledership nd competitive strtegy 5 Note tht the mtrix is not perfectly symmetric since the qulity levels on the other pltform re fixed t 33)

23 To Hunt or to Scvenge pge 3 The overlp revels severl interesting fetures. First the effect of within pltform ledership on firms competitive strtegy is lmost uniform regrdless of pltform ledership. s long s pltform ledership is not contested while followers nd leders within pltform choose different competitive strtegies they choose the sme respective strtegy regrdless of the position of their pltform within the mrket. Furthermore followers do not chnge their strtegy s they strt contesting within-pltform ledership. Leders in contrst chnge strtegy nd become more ggressive once their within pltform ledership is contested. Interestingly both leders nd followers on pltform chnge strtegy - get more ggressive gin - once they strt contesting pltform ledership. The closer the competition within nd cross pltforms the more ggressive competitors become fighting for cross-pltform ledership in ddition to within-pltform ledership. closer look t the different competitive strtegies revels tht leders within-pltform behve s Scvengers nd live minly on pst investment. The mrginl return from investment for these firms is reltively smll nd thus they do not find it profitble to invest ggressively. 6 Pck-Hunters nd Puppy Wolfs cn be found right where pltform ledership my chnge. In this cse firms fight for competitive dvntge cross pltforms regrdless of their competitive dvntge within the pltform. Finlly s the literture on innovtion suggests the Lone Wolf is the dominnt species. Nevertheless the Scvenger on the leding pltform my hve the longest lifespn - especilly if eventully stndrdiztion occurs. Tble presents the investment-response of both firms within the sme pltform. Since the mrket position of pltform determines the mrket position of the competing pltform the tble llows us to nlyze strtegic homogeneity cross firms within the sme pltform s well s cross pltforms. The results show tht both firms respond in the sme wy exhibit strtegic homogeneity within pltform when firms within pltform compete hed-to-hed. In this cse if pltforms lso compete hed-to-hed both firms respond ggressively to n own nd cross 6 Note tht being Scvenger does not men tht the firm does not invest t ll. It rther corresponds to the chnge in investment level given the chnge in mrket structure.

24 To Hunt or to Scvenge pge 4 qulity upgrde in the hope to win pltform ledership nd become the leder within the pltform. In contrst if the pltform is either in the led or lgs behind firms remin competitive but respond ggressively only to their own qulity upgrde. In this cse firm s ggressive response enhnces ny dvntge the firm hs lredy succeeded to cquire. In generl ggressive firms typiclly wish for their competitors to step bck nd behve complcently. Our nlysis however shows tht this does not hold when competition within- nd cross-pltforms is close.. In this cse both firms behve s Pck-Hunters; ny less-ggressive response of the competitor would decrese the firm s vlue s it reduces the probbility tht its pltform becomes the leder. Consequently strtegic homogeneity is optiml for both firms. 6. DISCUSSION ND N PPLICTION The discussion bove suggests tht knowing the type of competitive dvntge firm enoys within nd cross pltform determines the choice of competitive strtegy the firm should employ. Furthermore the firm s type of competitive dvntge conveys when the firm should chnge its strtegic response nd become more or less ggressive. In generl one cn summrize the results with the following two prctices: If your pltform does not compete for dominnce: If you think you commnd sfe led over your competitors on the sme pltform enoy Scvenger fest enoy profits from your investments nd reinvest modertely. In ll other cses behve like Lone Wolf - whenever you re successful be more ggressive next time round. If your pltform competes for dominnce: If you think you commnd sfe led over your competitors on the sme pltform be Puppy Wolf when others re successful brk bck to keep the distnce but lso to mke winning pltform ledership more likely. In ll other cses be Pck Hunter: be ggressive whenever nyone on your pltform is successful - including yourself. While full empiricl exmintion is beyond the scope of this pper next we demonstrte how the forces we identify plyed out in the competition between pple nd IBM in the microcomputing mrket. Our nlysis will focus on two mechnisms in reference to pple nd IBM-

25 To Hunt or to Scvenge pge 5 comptible computers: ) the effect of the intensity of competition in components on the speed of innovtion nd ) the role of competitive responses. Our model predicts tht the intensity of investment in qulity upgrdes nd the resulting speed of innovtion in components re crucil for the success of pltform. Within microcomputing two pltforms existed the IBM-comptible PC nd the pple computer. pple ws initilly fr hed of the PC in terms of mrket shre. 7 While IBM chose n open rchitecture llowing lrge groups of firms to prticipte in technologicl innovtion of pplictions nd comptible components e.g. CPUs floppy-disc drives screens etc.) pple only llowed competition in the pplictions mrket. Trnslted into competitive strtegy ctegories IBM chose strtegy tht creted first Lone Wolves nd lter Pck Hunters. pple s limited monopolistic) competition model in the component mrket is consistent with one of the complcent strtegies - the Scvenger or Puppy Wolf. Our model predicts tht the complcent investment-responses on pple s pltform would result in slow innovtive upgrding of components leding to lower vilble qulities reltive to IBM. Our simple prctices suggest tht initilly when pple hd lrge led the Scvenger strtegy my hve been indeed optiml. However once IBMcomptibles strted to threten pple's pltform ledership our rules suggest tht switch for more ggressive investment-response strtegy i.e. to Pck-Hunter or Lone Wolf should hve been clled for. We think of hrdwre nd softwre in terms of reltive life durtion nd tke hrdwre to be longer-lived nd softwre to be the shorter-lived. Given this brod definition since the components bove re ll shorter-lived thn the computers rchitecture components cn be viewed s "softwre." pple s nd IBM-comptible PC s rchitectures cn be then viewed s "hrdwre." We found resonbly useful dt for CPUs floppy discs nd grphics dpters. The following three grphs provide some insight into the competitive sitution in the components mrket for pple nd IBM-comptible computers. Remrkbly ll three grphs show the sme bsic pttern: 7 See for exct numbers of mrket shres for the two systems downloded on /3/06.

26 To Hunt or to Scvenge pge 6 t lmost ny point in time the components for IBM-comptible PCs outperformed those used by pple. 8 Kb Comprison pple-ibm Floppy-Disks IBM 8 inch IBM 5¼-inch IBM 3½-inch pple 5¼-inch pple 3½ / 3¼-inch yer MHz Comprison CPU Speed ibm-cpu pple-cpu index = core-speed x bus-speed) / 8 more detiled description of the construction of the grphs s well s dt sources cn be found in the ppendix.

27 To Hunt or to Scvenge pge 7 index Resolution of Grphics Crds ibm-bw ibm-color pple-bw pple-color index = Resolution x color-bits) /3 Figure 4: Evolution of the Components Mrket: pple vs. IBM While pple users could only choose models from the pple fmily nd for those models could only customize limited set of components users of IBM-comptible PCs could choose from wide vriety of verticlly nd horizontlly) differentited models. The grphs show tht there ws substntil qulity competition nd upgrding in components on both pltforms. Nevertheless IBM-comptible mchines not only clerly hd technicl edge in ll component mrkets over pple s mchines for prolonged periods of time pple's component upgrdes lmost lwys lgged those of IBM-comptible mchines. The recent switch of pple to lso use Intel s its min supplier of CPUs shows tht pple indeed perceived its CPU to underperform the IBMcomptible CPUs. This highlights the importnce of investment in qulity under vrious circumstnces. Components mnufcturers on the IBM pltform rpidly nd forcefully orchestrted their competitive efforts to win mrket shre from pple. This cn be esily trnslted into our investment response mtrix bove: in the erly stges of the micro-computer industry components mnufcturers oined forces nd becme "Pck Hunters" when they closed in on pple. More generlly whenever competitors on ny of the hrdwre-pltforms IBM tried to control including their minfrme computers cught up with IBM we sw IBM responding ggressively. In these cses IBM s position moved from being "Scvenger" tht does not invest much to being "Lone

28 To Hunt or to Scvenge pge 8 Wolf" or s in the Micro-computer segment "Pck-Hunter". rgubly while Microsoft still enoys the "Scvenger" position for some of its products like its operting system) Intel for exmple ws pushed towrds being "Lone Wolf" in its segment of components by MD. Four lessons cn be lerned from this discussion. First firms on the lgging pltform will more egerly cooperte thn firms on the dominnt pltform s long s initil qulity differences cross pltforms re smll. Second firms on the lgging pltform will lso more egerly invite competition in order to bet the dominnt pltform while firms on the dominnt pltform will try to monopolize the mrket. Third if competitor on the leding pltform gets into the relm of dominnt firm competitive responses will be ggressive e.g. Intel). Finlly strtegic flexibility is necessry to pick the optiml competitive strtegy t ny point in time. 7. SUMMRY ND CONCLUSION In this pper we study how the existence of competing pltforms influences competitive dvntge nd competitive strtegy in the form of investment in qulity upgrdes. We find tht investment behvior is driven by competition cross pltforms s well s competition between firms on the sme pltform. t ny point in time pst vlue creting ctivities determine firm's current competitive dvntge. The nture of the competitive dvntge tht firm chieved mnifested in its own or its pltform's ledership position then determines which one of four competitive strtegies the firm should choose: If pltform ledership is not contested the "Lone Wolf" strives to chieve ledership within its pltform. Once within-pltform ledership ws chieved the "Scvenger" lives off pst success nd tkes profits. If pltform ledership is t stke oining forces s "Pck Hunters" is optiml for roughly eqully strong competitors to either win or defend pltform ledership. Finlly only fr leder cn fford to ct s "Puppy Wolf" tht keeps the distnce to competitors nd simultneously contributes to winning pltform ledership.