Varian+2003+-+Standards

Varian+2003+-+Standards - 9 STANDARDS 35 them a lower price...

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9 STANDARDS 35 them a lower price, a practice known as “penetration pricing” in this context. Network effects also contribute to lock-in. The more people that drive on the right-hand side of the road, the more valuable it is to me to follow suit. Conversely, a decision to drive on the left-hand side of the road is most effective if everyone does it at the same time. In this case, the switching costs are due to the cost of coordination among millions of individuals, a cost that may be extremely large. 9 Standards If the value of a network depends on its size, then interconnection and/or standardization becomes an important strategic decision. Generally dominant firms with established networks or proprietary stan- dards prefer not to interconnect. In the 1890s, the Bell System refused to allow access to its new long distance service to any competing carriers. In 1900-1912 Marconi International Marine Corporation licensed equipment, but wouldn’t sell it, and refused to interconnect with other systems. In 1910- 1920 Ford showed no interest in automobile industry parts standardization industry, since it was already a dominant, vertically-integrated firm. Today Microsoft has been notorious in terms of going its own way with respect to industry standards and American Online has been reluctant to allow access to its instant messaging systems. However standards are not always anathema to dominant firms. In some cases, the benefits from standardization can be so compelling that it is worth adopting even from a purely private, profit-maximizing perspective. Shapiro and Varian (1998a) describe why using a simple equation: your value = your share × total industry value . When “total industry value” depends strongly on the size of the market, adopting a standard may increase total value so much that it overcomes the possible dilution in market share. Besen and Farrell (1994) survey the economic literature on standards formation. They illustrate the strategic issues by focusing on a standards adoption problem with two firms championing incompatible standards, such as the Sony Betamax and VHS technologies for videotape. Each of these technologies exhibits network effects—indirect network effects in this partic- ular example.
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9 STANDARDS 36 Following Besen and Farrell (1994) we describe the three forms of com- petition in standards setting. Standards war. Firms compete to determine the standard. Standards negotiation. Both firms want a standard, but disagree about what the standard should be. Standards leader. One firm leads with a proprietary standard, the other firms wants to interoperate with the existing standard.
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