The new terms of competition

In this new epoch, firms located anywhere in the temporarily disintegrated value chain can control the evolution of key standards and in that way define the terms of competition not just in their particular segment but in other segments and often, critically, in final product markets as well. Market power has shifted from the assemblers such as Compaq, Gateway, IBM, or Toshiba, to key producers of components (Intel); operating systems (Microsoft); applications; interfaces (Netscape); languages (Sun’s Java); and to product definition companies such as Cisco Systems. What all of these firms have in common is that from quite different vantage points in the informatics value-chain they all own key technical specifications that have been accepted as de fact product standards in the market. Each beat rival standards. In winning, each created a universe of licensees who produce to its standard and add value to its use, just as applications software firms such as WordPerfect, PC assemblers such as Compaq, peripherals producers such as Canon, or content providers such as Grolier’s all produce to Microsoft’s Windows operating system standards. Each standard owner maintains a growing installed base of customers who use the products that conform to the standards. Each has been careful to evolve the standards by adding incremental improvements in performance, functionality, features, quality, or costs within product generations and dramatic improvements between generations (while remaining backwardly compatible with past versions). In that way, each has effectively “locked in” their customer base and their licensees in the sense explored earlier. Given the customer’s investment in all of the conforming products and in how to use them effectively, the customer will normally be unwilling to switch to competing standards unless they offer truly radical and compensatory improvements in price, performance, and functionality. Switching will not occur unless it is even more costly to stay put.

Each Wintelist standard-holder has also effectively shaped the terms of competition in its core market segment. Once the competition to create an open but-owned de factostandard is initially settled, the losers’ strategies must shift to one (or a combination) of a relatively limited menu of alternatives. These include strategies: to sell into the market created by the standard-holder and to differentiate products on traditional bases of cost, performance, functionality, reputation, control of marketing and distribution, after-sales services and the like; to wrest control of the standard over time by evolving it ahead of the creator (as Intel and Microsoft did to IBM); to devise a competing alternative standard that can wrest part of the overall market away from the incumbent (as Microsoft is successfully doing to Netscape in the browser market); to force greater openness and less opportunity to exercise the prerogatives of ownership, by causing industry standards bodies or public policies to embrace a de fact standard and setnon-discriminatory conditions on its use (as happened with Local Area Network standards and in the UNIX operating system market), and always to confine the standard-holder to the markets he currently dominates, if necessary via antitrust attack (of the kind currently focused on Microsoft).

Competitions to set and control the evolution of de fact standards do not always lead to dominant, Wintelist winners, but they do tend in that direction. A briefexploration of the economic characteristics of standards competitions will suggest why. All standards are carriers of technical information in a codified form, around which related industrial and consumption activities can coalesce with heightened predictability and lowered risk: those who produce or use products that implement the standard form of a complementary and reinforcing community or network. The universe of conforming products constitutes the standard network’s installed base. In general, the bigger the network the greater the benefits for users and producers (i.e. network externalities or simply, “network effects”). Thus, for example, Microsoft’s standard PC operating system, Windows 95, drew together a variety of producers of complementary products from PCs and peripherals to applications software and information services into a network with all of the users whose computers run the operating system. The universe of such machines is Microsoft’s installed base for Windows 95. Network effects made adopting Windows 95 increasingly attractive as others jumped aboard (the so-called bandwagon effect), and, consequently, Windows 95 became the dominant PC operating system within only one or two years of its introduction.

As the Microsoft example implies, Wintelist standards are more than mere information vectors. In facilitating the organization of related industrial activities and in creating opportunities for consumption, standards also shape market structure and the terms of exchange. Standards shape market structure, among other ways, by altering relative costs among producers, inducing demand pattern changes, raising or lowering entry barriers, creating opportunities for economies of scale and scope, facilitating a division of labor, and generating opportunities for network externalities in both production and use. For example, World Wide Web standards and the Netscape Navigator family of browsers for interfacing with the Web have had all of these effects. Their adoption altered costs among existing players, facilitating market entry by some, making market entry more expensive for those with other approaches (e.g. CompuServe or Prodigy, who had built expensive proprietary approaches), and ultimately forcing even Microsoft to reorient its entire PC strategy around integrating its operating system with Internet Explorer, its competing browser. By focusing demand from content creators, information services providers and potential consumers on a single set of standards, they permitted a wide range of new software and equipment producers (including those, such as Cisco, who produce the underlying infrastructure equipment) to reach additional scale and prosper. They facilitated an increasingly intricate division of labor, for example permitting specialization in production, before and after production of content, in point casting, and tailored delivery of information services and content, in the production of a growing variety of complementary software (browser plug-ins) and equipment (network computers). Perhaps most important, they are facilitating the emergence of communities of users that cross national boundaries and of a truly global network.

The coexistence of large potential gains that rise with size, manipulable costs, and influence over market structure and the terms of exchange give to standards battles many of the characteristics of competitions to develop and commercialize new technologies.

Because market conditions are anything but the perfectly competitive equilibrium of neoclassical models, choices of standards are highly dependent on initial starting points, available resources, market context, and event sequence. Advantages can accrue to early movers (whether innovators or imitators, producers or users) who in turn can influence the choices of later players as the market structure shifts. The timing and pattern of developments—choices made by both producers and especially lead-users— can significantly influence the choice of standards in ways that are difficult to reverse (so-called “path dependence”). Seemingly small choices can have big consequences, as occurred with Sony’s choice of focusing the initial recording capability of its Betamax VCR around hour-long TV shows rather than the multiple-hour sporting events that initially drove surging sales of the rival VHS standard. This small choice proved decisive in negating Sony’s early lead in installed bases. As installed bases and the size of the associated standards network grows, players can acquire monopoly-like market power with lock-in. This is true even for products conforming to more open standards, wherever producers can maintain the differentiable features thus creating market niches over which they can act like a quasi-monopolist. Indeed, equipment from almost all producers of open computer platforms that run some version of UNIX will inter-operate better within the brand than across brands, even though all brands conform to the common standards.

The economic characteristics outlined permit multiple competitive equilibrium to emerge, but Wintelist open-but-owned standards tend toward quasi-monopoly or oligopoly outcomes. Such standards permit the standard owner to manipulate its competitive environment in unprecedented ways. The aim is to establish a quasimonopoly position, maintain high and rising barriers to entry and with them high and rising switching costs for one’s locked-in customers, thus reaping standards based rents in the market. By favoring one set of producers or users at the expense of another—which can only be done when evolution of the standard and access to it is controlled through ownership—standard holders can directly influence the allocation of available benefits.

The actions of one standard owner thus directly influence the returns to a rival.16

Market competition consists of strategic thrusts over pricing, licensing, and other assets that anticipate and forestall rival moves while attempting to structure the market to the standard owner’s advantage. As market power begins to accrue with installed bases, the possibilities for manipulation grow commensurately. Over time, there are large opportunities for entry deterrence and competitive preemption of rivals: enormous up-front sunk costs associated with creating an alternative to the existing standard (as the Power PC alliance of IBM-Apple Motorola showed in its futile attempt to dislodge Microsoft-Intel dominance), existing scale and scope economies that must be overcome, the likelihood that the established standard holder will engage in pre-emptive investment (as Intel has done), and predatory pricing (Microsoft’s offering of Internet Explorer for free).

In essence, Wintelist standards competitions are market processes in which the players vie for the available consumer and producer surpluses stemming from the achievement of standardization. The winners—like Microsoft and Intel in PCs— establish de factostandards monopolies and become wildly profitable as more and more of the available surplus accrues to them through consumer lock-in and exit of competitors. And those circumstances can tolerate a high degree of user dissatisfaction, as essentially all users of Microsoft operating systems are by now aware: barely adequate performance or functionality is in most cases more than sufficient to continue the locked-in relationship, especially where a large investment in complementary products such as applications programs and associated learning has occurred. In those circumstances, upgrades and follow-on need not be better or even as good as a rival’s products; they need only be adequate to deter the switch.

Such Wintelist strategies effectively attenuate the link between market power and the ownership of the assets of production that characterized the prior era of competition, and at the extremes, as with a firm like Cisco Systems, can completely decouple control of final markets from the ownership of manufacturing assets. For Wintelist firms, the ownership and manipulation of their de fact standards are considerably more effective barriers to entry than the barriers of scale and vertical control over technology and production in the prior era because they are far harder to duplicate. It still remains true that you cannot control what you cannot produce. But the ways of implementing and controlling production have changed. Wintelism has an organizational counterpart: a distinctive system of production, the cross-border production network.