Winning the Hardware-Software Game Using Game Theory to Optimize the Pace of New Technology Adoption Ruth D. Fisher PRENTICE Upper Saddle River, NJ Boston Indianapolis San Francisco New York Toronto Montreal London Munich Paris Madrid Capetown Sydney Tokyo Singapore Mexico City
Preface xi Acknowledgments xv About the Author xvii CHAPTI-.R 0 Introduction xix 0.1 Game Theory and the Chicken-and-Egg Problem xxii 0.2 Organization of the Book xxv Network Effects 1 1.1 Definition and Sources of Network Effects 2 1.2 Switching Costs 7 1.3 Compatibility/ 11 1.4 Network Effects and the Hardware-Software Game 15 Technology Adoption Lifecycles 17 2.1 Production and Consumption Lifecycles 18 2.2 Lifecycles of Network Effects 21 2.3 Technology Replacement Lifecycles 28 2.4 Critical Mass 33 2.5 Technology Adoption Lifecycles and the Hardware Software Game 39 Technology System Users 41 3.1 User Demand for New Technology Hardware 42 3.1.1 Installed Base 44 vii
viii Contents 3.1.2 The Stock of Content Available 48 3.1.3 Price of New Technology Hardware and Content 51 3.1.4 Numerical Example of Demand for New Technology Hardware 55 3.2 User Demand for New Technology Content 61 3.2.1 Installed Base 61 (3.2.2 The Stock of Content Available 62 3.2.3 Numerical Example of Demand for New Technology Content 64 3.3 Summary of User Demand for New Systems Hardware and Content 66 CllAPTl-R 4 Technology System Suppliers 71 4.1 Provision of Hardware 72 4.2 Provision of Content 82 The Hardware-Software Game 87 5.1 Introduction to Game Theory 87 5.2 Definition of the Hardware-Software Game 92 5.3 Assumptions about Market Dynamics 95 5.3.1 Technology Value and Market Size 95 5.3.2 Sensitivity to Price 97 5.3.3 Strength of Network Effects for Hardware 98 5.3.4 Strength of Network Effects for Software 99 5.3.5 Degree of Content Complementarity 100 5.4 Overview of the Game 101 5.5 Simulation Categories and Scenarios 104 5.6 Profit Frontiers by Category of Network Effects 109 5.6.1 Hardware Manufacturers'Profits 116 5.6.2 Software Providers'Profits 129 5.7 Impact of Speed of Adoption on Profitability 135 5.8 Sensitivity of Profits to Changes in Market Drivers 139 5.9 General Implications 145 5.9.1 Overall Profit Potential 146 5.9.2 Profits and Market Environment 146 5.9.3 Timing of Profits 147 5.9.4 Network Effects Dynamics 148 5.9.5 Value Extraction 149
ix Addressing the Chicken-and-Egg Problem 151 6.1 Statement of the Problem 152 6.2 General Responses to the Chicken-and-Egg Problem 156 6.2.1 Engineer New Systems for Maximum Likelihood of Adoption 157 6.2.2 Create Expectations of New System Adoption 157 6.2.3 Establish a Good Reputation 161 6.2.4 Decrease Relative Value of Old Systems 161 6.2.5 Increase Relative Value of New Systems 163 6.2.6 Switching Costs 172 6.2.7 Summary of General Responses 180 6.3 Scenario-Specific Responses to the Chicken-and-Egg Problem 181 6.3.1 Market Size 182 6.3.2 User Sensitivity to Price 183 6.3.3 Direct Network Effects 184 6.3.4 Indirect Network Effects 185 6.3.5 Summary of Scenario-Specific Responses 186 CHAPII:R 7 Summary, Applications, and Extensions 189 7.1 Key Points from the Analysis 189 7.2 Tools for Applying the Model 192 7.2.1 Assessing Relative Sizes and Sources of New System Values 192 7.2.2 Better Understanding User Demand for New System Hardware 194 7.2.3 Better Understanding Optimal Allocations of Content 195 7.3 Extensions of the Analysis 196 7.3.1 Estimates of Network Effect Elasticities 196 7.3.2 Network System Routes to Market 196 Model of the Hardware-Software Game 199 A. 1 Definition of Key Terms 199 A. 1.1 Technology User Dynamics 199 A. 1.2 Technology Content Dynamics 199 A.2 User Demand Functions 200 A.2.1 User Demand for New Technology Hardware 200 A.2.2 User Demand for New Technology Content 202
A.3 Provision of Hardware 203 A.4 Provision of Content 205 A.5 Three-Period Model 207 A.5.1 Derivation of the Hardware Manufacturer's Problem 207 A.5.2 Derivation of the Content Provider's Problem 213 A.5.3 Equilibrium 214 Al'PKNDIX B Further Information 217 B.I Adoption of VHS versus Betamax 217 B.2 Adoption of Next-Generation DVD 218 B.3 Adoption of HDTV 218 B.4 Adoption of Consumer Durables 220 B.5 Networks and Network Effects 220 B.6 Lock-in and Path Dependence 222 B.7 Standardization and Compatibility 223 B.8 Innovation and Adoption of New Technologies 223 B.9 Product Lifecycles 225 B.10 Critical Mass 225 B. 11 First-Mover Advantages in Adoption of New Technologies 226 B.12 Social Networks and Technology Adoption 227 References 229 Index 233