Strategies to Fight Ad-Sponsored Rivals

Transcription

1 Strategies to Fight Ad-Sponsored Rivals Dongmyung Lee MAILab., Dept. of IE, SNU 3/28/2012

2 2/25 Strategies to Fight Ad-Sponsored Rivals Ramon Casadesus-Masanell 1 and Feng Zhu 2 1 Professor, Harvard Business School, Boston, MA Assistant Professor, Marshall School of Business, University of Southern California, Los Angeles, CA Management Science (SCIE, 2.221), 56(9), 2010, pp

3 3/25 Abstract The authors analyze the optimal strategy of a high-quality incumbent that faces a low-quality ad-sponsored competitor Four alternative business models of an incumbent are considered: 1. Subscription-based model 2. Ad-sponsored model 3. Mixed model (Subscription-based + Ad-sponsored) 4. Dual model (two products: (1) Mixed, (2) Ad-sponsored) It is shown that the optimal response to an ad-sponsored rival entails business model reconfigurations Also, the incumbent is more likely to prefer to compete through the subscription-based or ad-sponsored model, rather than the mixed or the dual model, because of cannibalization and endogenous vertical differentiation concerns

4 4/25 Motivation How should I respond? Entrant (l) vs. Incumbent (h) Music Ad-sponsored free music 1 & Subscription-based music Internet Ad-sponsored free dial-up Internet access Subscription-based dial-up service Newspaper Ad-sponsored free newspaper Subscription-based newspaper 1 However, after MySpace acquired imeem, it was shut down, in 2009.

5 5/25 Model Entrant (l)? 1 vs. Incumbent (h) 2 Strategy level Adsponsored Adsponsored Subs.- based pure Mixed hybrid Dual 3 Tactic level A l p h A h p h, A h p h, A h A h Quality (Exogenous) q l < q h Utility U(θ) Net product quality θ(q l - βa l2 ) - p l θ(q h - βa h2 ) - p h θϵu[0,1] is a consumer type which represents the marginal w.t.p. for product quality

6 6/25 1. Subscription-based model Adsponsored Adsponsored Subs.- based pure Mixed hybrid Dual A l p h A h p h, A h p h, A h A h Advertising fee: r i =αd i, iϵ{h,l} r l Advertisers Entrant (l) vs. Incumbent (h) p h Consumers: θϵu[0,1] Entrant Market Share Incumbent Market Share 0 θ * 1 Profit θ * is defined by

7 7/25 2. Ad-sponsored model pure hybrid Adsponsored Adsponsored Subs.- based Mixed Dual A l p h A h p h, A h p h, A h A h Advertising fee: r i =αd i, iϵ{h,l} Advertisers r l r h Bertrand competition Entrant (l) vs. Incumbent (h) Consumers: θϵu[0,1] Profit

8 8/25 3. Mixed model pure hybrid Adsponsored Adsponsored Subs.- based Mixed Dual A l p h A h p h, A h p h, A h A h Advertising fee: r i =αd i, iϵ{h,l} r l Advertisers r h Fixed cost incurred when hybrid model is used: f Profit Entrant (l) vs. Consumers: θϵu[0,1] Incumbent (h) Entrant Market Share Incumbent Market Share 0 θ * 1 p h θ * is defined by

9 9/25 4. Dual model Advertising fee: r i =αd i, iϵ{h,l} Adsponsored Adsponsored A l Subs.- based pure Mixed hybrid Dual p h A h p h, A h p h, A h A h Advertisers Incumbent introduces 2 products: h and h' r l Entrant (l) vs. r h Mixed (h) Incumbent Ad-s d (h ) r h ' 0 Incumbent (h ) Market Share Entrant (l) Market Share Consumers: θϵu[0,1] θ * θ ** p h Incumbent (h) Market Share Incumbent (h) Market Share 1 Profit

10 10/25 Monopoly Strategy - benchmark 1. Only the three business models may arise in equilibrium as the dual model dominates the mixed model Under the mixed model, not all consumers adopt the product ( p h >0) The monopolist can improve its payoff by offering an ad-sponsored free product that gives zero utility The ad-sponsored product does not cannibalize the sales of the high quality product

11 11/25 Monopoly Strategy - benchmark Monopoly tactics for the Dual model Quality of h : θ(q h - βa h2 ) 0 and it is natural that A h < A h Incumbent (h ) Market Share Incumbent (h) Market Share 0 θ * When f=0, the dual model dominates the subscription-based model The marginal effect of ads on consumer utility evaluated at A h =0 is zero On the other hand, the marginal revenue of ads is constant and equal to α>0 Therefore, when f=0, it is always optimal to have a few ads, even if α is very small

12 12/25 Monopoly Strategy - benchmark 3. Low (high) α favors the subscription-based (ad-sponsored) model 4. As f increases the range of α such that the dual model is optimal shrinks

13 13/25 Duopoly Strategy To kill the entrant 1. When α is small, either the subscription-based or the mixed model is optimal; when α is large, the ad-sponsored model is optimal When α is small, the incumbent prefers to co-exist with the entrant (i.e., S or M), as the additional ad profits from its ad-sponsored product after killing the entrant would be small and there is also cannibalization in the case of dual model But when α is large, the incumbent has incentives to push the entrant out, as it wants the market share from the entrant to earn ad profits even at the cost of cannibalization Lower the A h (or A h ) Smaller (ad) revenue larger (ad) user utility Competes with its own (mix) product Cannibalization

14 14/25 Duopoly Strategy 2. Compared to the monopoly case, neither the mixed model nor the dual model dominates the subscription model for all α when f=0 From lemma 1, when q h 2q l, the incumbents profits are maximized when α 0. But when α=0, it is effectively using the subscription model. Hence, > For the dual model, cannibalization lowers profits for the incumbent

15 15/25 Duopoly Strategy 3. Compared to the monopoly case, the dual model no longer dominates the mixed model The intuition is the same as the previous result We now have cannibalization between the two products offered by the incumbent in the dual model When the cannibalization is intense, the mixed model may be better (which was never the case in the monopoly setting)

16 16/25 Duopoly Strategy 4. When α is sufficiently large, the ad-sponsored model is the optimal business model. When f is sufficiently large, only one of the two pure business models can be optimal

17 17/25 Duopoly Strategy Proposition: When q h 2q l, three possible business models might be optimal (the mixed model is dominated); when q h > 2q l, all four business models may be optimal

18 18/25 Definition of strategy Strategy vs. Business model While the business model is observable, the strategy is typically not (fully) observed Ex) Strategy: If the potential entrant does not enter, then continue operating with the dual model, but if he does enter, then adopt the subscription-based model Thus, all that an observer can see are the equilibrium outcomes of strategies but not the strategies themselves Equating strategy to business model may lead to wrong decisions Entrant Adsponsored wrongly stay out of the market Incumbent Dual Observable business model enter and enjoy positive profit Dual Subs.- based Incumbent s strategy Which is optimal too! See next slide

19 19/25 The value of (contingent) strategy Question: Will firms want to develop contingent strategies? To compute the cost of not having a contingent strategy, the following is defined Profit loss = Incumbent s profits when it makes use of strategy and tactics to fight the ad-sponsored rival Incumbent s profits when it does not consider changing its business model but reacts by optimally changing its tactical choices

20 The value of (contingent) strategy 20/25

21 21/25 The value of (contingent) strategy The profit loss ranges from 0%~60%!!! The value of contingent strategy may be substantial!!!

22 22/25 Increased strategic focus Having established that there is value in having (contingent) strategies, it is natural to ask: What should such strategies look like? Specifically, compared to the monopoly situation, should we see the incumbent become more pure or more hybrid in response to the contingency that the ad-sponsored rival enters? The left figure reveals that the region of parameters s.t. it is optimal to be hybrid shrinks The reason is that, in the duopoly, the use of a hybrid model implies either: Cannibalization (in dual model) or Erosion of vertical differentiation (in mixed model) cf) In the mixed model α A h A l Quality difference Competition Incumbent Profit

23 23/25 Increased strategic focus It can be concluded that increased focus (by competing through a pure business model) is more likely to be optimal when facing an ad-sponsored rival compared to the monopoly situation

24 24/25 Conclusion Competing through business model reconfiguration is more relevant everyday given the increasing number of opportunities for business-model innovations enabled by technological progress, changes in customer preferences, and deregulation IBM s 2006 and 2008 Global CEO Study show that top management in a broad range of industries are actively seeking guidance on how to innovate in their business models to improve their ability to both create and capture value The authors hope that the analysis of strategies to fight ad-sponsored rivals is helpful to researchers and practitioners willing to consider competition beyond tactics in all sorts of competitive settings The model presented here can be applicable to other competitive situations where firms choose strategies to fight low-cost entrants (Ryanair, Telmore ), open source projects (Linux, Apache ), platform players (shopping malls, video game systems ), or the like

25 25/25 THANKS AND QUESTIONS