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Information systems

Chapter 4

This chapter provides you with a framework to understand how new technologies
are shaping the competitive landscape you will encounter as you enter the job
market. Specifically 3 topics will be discussed:

I. Network economies;

II. Information economies;

III. Disruptive technologies.

NETWORK ECONOMICS
Network economics refers to business economics that benefit from the network
effect. This is when the value of a good or service increases when others buy the
same good or service.

Networks are different: value in plentitude

Instagram has significant value now for people (not monetary value but social
relation/entertainment value). But how much would have customers been willing to
pay for the first version of Instagram in 2010, not much ! This is because at the time
very few people used Instagram.

Where do Instagram, fax machines, and WhatsApp draw their value form?

Not scarcity (as physical products, think about diamond example), but rather
plentitude. In fact, the value of the network is proportional to the number of
connected nodes. The insight underlying these examples its that networks differ
dramatically from most other goods, as their value is tied to how many other nodes
are there in the network (plentitude) rather than how few (scarcity).

Physical and virtual networks

Physical Networks: where the nodes of the network are connected by physical links
(railroad tracks, telephone wires).

Virtual Networks: where connections between network nodes are not physical but
intangible (nodes of this network are typically people rather than devices).

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Whether tangible or intangible, network connections enable network nodes to share
and communicate. In a virtual network people in the network can share information,
expertise or just images of their friends.

Size still matters

Whether physical or virtual, the value of the network for its members is a function of
its size — that is, the more nodes the network has, the more valuable it is to it’s
members.

Key concepts and vocabulary

To understand how networks operate and to exploit their potential for firm strategy,
its necessary to introduce some basic vocabulary.

Positive feedback

Adoption of a new technology product or service typically follows the pattern

represented by the S-curve (Figure 4.5). Positive feedback is simply defined as a
self-reinforcing mechanism by which the strong gets stronger and the weak gets
weaker. The positive feedback is a well-known economic phenomenon at the heart
of, for examples, economies of scale. In industries with strong economies of scale
— say, automotive industry — there is a significant advantage stemming from size.

Positive feedback sets in motion a virtuous cycle, benefitting the larger firm, and a
vicious cycle, penalising the smaller one (Figure 4.6). Unless the smaller one is able
to identify a profitable niche or somehow differentiate its product.

Figure 4.5 - classic technology adoption curve

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Figure 4.6 - the dynamics of positive feedback

Negative feedback

Negative feedback is the term used to refer to the opposite dynamic. If feedback is
at play, the stronger gets weaker and the weaker gets stronger. Negative feedback
typically characterises economies of scale and takes effect when the dominant firm
has reached a significant size. Past this certain size the dominant firm typically
encounters difficulties that limit further growth.

Network effects

The network effect is a phenomenon whereby increased numbers of people or

participants improve the value of a good or service. The Internet is an example of
the network effect. Initially, there were few users on the Internet since it was of little
value to anyone outside of the military and some research scientists.

Positive and negative feedback play a crucial role in physical and virtual networks.

Network effects occur when a new node (whatsapp user), while pursuing his or her
own economic motives, creates value for the other members of the network by
making the network larger and thus more valuable.

Evangelist effect: describes the dynamic and the incentive that current members of
the network have to "spread the word” and convince others to join.

Positive feedback associated with traditional economies of scale typically exhausts

itself well before one firm can achieve market dominance, but this is not the case for
network effects. Positive feedback associated with network effects can play out,
without limit, until one firm dominates the network and all others disappear, situation
typically referred as a “winner takes all” dynamic.

A firm finds itself on the losing side of network effects can survive under two
conditions:

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1) It can be compatible with the dominant player;

2) Find a niche.

Tipping point and tippy markets

Tippy market is one that is subject to strong positive feedback such that the market
will “tip” in favor of the firm that is able to reach critical mass and dominate it. A
“tippy”is therefore a market with “winner-takes-all tendencies.

In other words, the tipping point is that moment in the evolution of a market where
the organisation or technology reaches critical mass and goes on to denominate it
— the point of no return where winners and losers are defined.

In Figure 4.6 the tipping point occurs somewhere between t1 and t2.

The lower the cost of production and distribution of a product, and the stronger the
network effect, the quicker the onset of tipping point (Figure 4.10).

Figure 4.10 — adoption curve in presence of network effect

Not all markets tip

Not all markets tip, and the winner-takes-all dynamics are more the exception than
the rule. Example: is Garmin a tippy market? NO — if you have a Garmin, you don’t
get any benefit if I purchase it too; WAZE — is an example of tippy market for the
GPS navigation.

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Figure 4.14 — Likelihood of market tippiness

How to recognise a tippy market

Whether a market will tip toward a dominant technology or a dominant player

depends on two factors:

I. Presence and strength of economies of scale: strong economies of scale +

network effect = advantage for large firm

II. Variety of customer needs: customer demand for variety creates the potential for
the development of distinct market niches that the dominant player may be
unable to fulfill.

When economies of scale are significant + customer needs are fairly standard =
conditions for market hippiness are strongest.

When economies of scale are limited + market has wide range of different needs =
potential for market tipsiness is the weakest.

When economies of scale are significant + demand for variety is high = potential for
market hippiness depends on number and size of the available market niches.

When economies of scale are limited + demand for variety is low = potential to
create positive feedback is small and market is unlikely to tip.

Two-sided networks

Positive feedback can also occur in what is called two-sided networks — that is,
networks that have two types of members each creating value for the other.

Example: PDF Adobe acrobat

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More in general, in a two-sided network, the value of the network to one type of
member depends on the number of members form the other side who take part in
the network.

Implications for general and functional managers

Huge implications for managers, as these networks become more ubiquitous, you
must take into account these implications.

THE ECONOMICS OF INFORMATION

As networks of interoperable digital devices have continued to expand, one of the
most important results of managerial interest has been the unprecedented amounts
of data and information that are being captured, stored, processed and distributed
by modern organisations. However, to wring value from data and information you
must understand its economic characteristics. Information, like networks, has some
interesting traits that differentiate it from physical goods. These unique
characteristics have strong implications for a firm in term of strategy and
competition.

Data and information

Information systems researchers typically draw a distinction between the terms data
and information.

Data: is defined as codified raw facts, things that have happened.

Information: is defined as data in context

Data becomes information when they have been given meaning and can therefore
be interpreted by individual users or machines.

Classic information goods

Classic information products are those products that a customer purchases for the
sole purpose of gaining access to the informations they contain. Examples:
software, books, music, Ted talks, etc. A simple test to recognising information
goods is to verify whether the product can be digitalised (put into digital format). If
so, the product is an information good.

The economic characteristics of information

The definition provided above of information goods is fundamental because

information has some unique and interesting characteristics.

Information has high production costs

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The first copy of an information good is very expensive to create in terms of time
and money. Consider the production of a book. Writing the book requires a
substantial amount of time in front of a computer typing first draft, editing in multiple
times, selecting appropriate examples, etc.

Information has negligible replication costs

This is where information goods differ drastically from physical goods. For as long
as it took to create the first copy of a book or the blockbuster movie, the second
copy could be produced at a fraction of the cost.

For many information goods, the second copy, and all subsequent ones, has such a
low cost of production that it is essentially free. This is not true for physical goods,
in a restaurant, food is the second largest component of cost, second only to labor.
Thus no matter how many steaks the restaurant cooks that evening, each one will
consume roughly the same amount of ingredients. The second copy of a steak
(physical good) is not free.

The information is not the carrier

Information has negligible distribution costs

As with replication costs, the distribution costs associated with information goods
are very low.

Distribution costs: expenditures associated with delivering the information good to

the customers so that they can access its content.

Where the infrastructure for digital distribution has been created (app store), the
distribution cost of the information goods is indeed negligible — free in practice.
Information goods are therefore characterised by high fixed costs and very low
marginal costs. The cost of producing the first copy is steep, whereas the cost of
making and delivering incremental copies is almost free.

Costs are sunk

Unrecoverable costs — those expenses that the firm has incurred to create its
product or service but cannot be recuperated — are sunk costs.

Information goods are unforgiving. If nobody is interested in reading the book of

information systems after it available for sale, Mr. Pigni and Mr. Piccoli wont be able
to get back the expenses incurred for producing the book and publishing it.

Information has no natural capacity limits

Information goods face almost no constrains to reproduction.

Information is not consumed by use

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Perhaps the most intriguing characteristic of information is that it can be reused
multiple times. With physical goods this doesn’t happen.

Implications

The unique economic characteristics of information and classic information goods

described above have some important implications for you as a GM or FM:

• Information is customisable: information goods can be modified with relative ease.

Physical goods are much more difficult to modify.

• Information is reusable: information not consumed by use.

• Information is often time valued: The value of information is tied to the user’s
ability to employ it (ex. Information on stock market with 15 days delay has no
value).

• Information goods can achieve significant gross profit margins: because of their
economic characteristics —high production costs and low replication and
distribution — firms that produce successful information goods can enjoy vast
profit margins.

Information-intensive goods

Products or services that need information or where information is embedded in the

product itself as knowledge. Example: self-driving car, its value proposition is
creating time to people that wont have to drive. But can it be defined as an
information good? Not really, it has more of a information intensive good, as its
value proposition depends on the ability of the car to analyse huge amounts of data
from its sensors in order to make appropriate decisions on the road.

INFORMATION IN NETWORKS
The richness and reach trade-off

Richness: amount of information that can be transmitted, degree to which the

information can be tailored to individual needs, and level of interactivity of the
message.

Reach: number of possible recipients of the message

Representative example of this phenomenon: Travel agency

Traditionally, before the advent of widespread information networks, a firm with fixed
budget would have to decide whether it was willing to reach a smaller audience with
a richer message (e.g., individual consultations with a travel agent) or use use a
leaner message to reach a larger audience (e.g., create a brochure and mail it to
perspective travellers).

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Figure 4.25 - gives representation of the frontier of optimal decisions

With the advent and widespread adoption of a cheaply and easily accessible
information structure, such as the internet and the services it makes available, these
constrains are increasingly being lifted. Ubiquitous communication networks and
powerful computers are quickly enabling firms to decouple information from the
physical objects that traditionally carried it.

Figure 4.26 -Technology pushing the richness/reach frontier.

Implications

Implications for a general or functional manager, as a new technology eases the

trade-off between richness and reach:

1. Continued questioning of traditional business models: Traditional business

models where predicated on the fact that information was constrained by its
carrier. Such business models have been facing, and will continue to face
challenges form focused organisations that exploit emerging information
technology. Example: travel agents business model, in the past they based their
value proposition on the fact that travellers didn’t have the ability to book their

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own travel. With hotels, airlines and hotels opening their own bookable websites
and travel intermediaries as kayak.com and sky scanner made it easy for the
customers to find valuable options and to effectively book their own travels.

2. The importance of the customer interface: If information is allowed to travel

independently of its carriers, it becomes feasible to unbundle traditional
products and services and bundle products that could never be brought
together before. Example: retail banking. Traditionally, a customer would
purchase a bundle of services from the bank (say, checking account, a savings
account, certificates of deposit, mutual funds, car loan, etc.). the important
value driver of this value proposition was about the convenience of one-stop
shopping. Today, the same customer may use Quicken or mint.com to manage
her finance his finances, thus being able to interact directly with individual
providers of each of the services she needs, even through a cell phone.

3. Decreasing value of asymmetric information: perhaps the most evident

implication of the emergence of technologies that ease the trade-off between
reach and richness is the amount of information modern customers have
available to them. This has put significant pressure on organisations that benefit
from asymmetry of information. Example: today, within a few minutes you can
shop for a car online, find out the factory price from edmunds.com, research
various dealer packages, find out the value of your used car trade-in, and walk
into a dealership ready to negotiate.

Obstacles

There are many examples of industries where the effects of the easing trade-off
between reach and richness are being felt, there are a number of obstacles that
have been slowing and will continue to slow down this process.

1. New technology must replace all characteristics of the old one

2. Retaliation form incumbents

3. Human resistance to change: perhaps the most powerful bottleneck of them all
is human inertia (human resistance to the change brought by new tech).

4. Attention challenges: peoples time and attention is perhaps the scariest

resource an organisation has to deal with. The scarcity of attention leads to slow
adoption rates for all but the most revolutionary of innovations.

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A NOTE ABOUT DISRUPTIVE TECHNOLOGY
As a functioanal or general manager, it is important that you are aware of the
potential disruptive impact of new technologies. Specifically, you should be able (as
a GM or FM) to identify, and to the extent possible, manage the impact of emerging
disruptive technologies. New technologies can be characterised as sustaining or
disruptive.

SUSTAINING TECHNOLOGY

The defining characteristic of sustaining technologies is that they maintain or

rejuvenate the current rate of performance improvement of the products and
services that use them.

Figure 4.31 - product performance improvements over time

I. Introduction of technology: the S-curve suggests that as the product is first

introduced, its performance is limited.

II. Growth: design refinements permit a growth period where substantial

improvements in performance are achieved.

III. Technical limits of technology: technology underpinning the products

performance plateaus and further performance improvements become marginal.

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Figure 4.32 - performance improvements over time

Sustaining technologies are those new technologies that enable a product’s

performance to continue to grow — in other words, sustaining technologies extend
the useful life of the product as the market demands further and further
improvements.

DISRUPTIVE TECHNOLOGY

Two characteristics define disruptive technologies:

I. The technology offers a different set of attributes that the firm currently uses in
its products;

II. The performance improvement rate of technology is higher than the rate of
improvement demanded by the market (figure 4.33).

Figure 4.33 - market expectations for performance and new technology

performance improvement over time.

Implication for managers

Familiarity with the dynamics of disruptive technologies is important for modern FM

(functional manager) and GM (general managers) because disruptive technologies
typically blindside leading firms (nokia/apple-Blockbuster/Netflix), who see their
position of dominance lost to those upstarts that were able to ride the disruptive
technology wave. Three characteristics of disruptive technologies:

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1. Differentiate rates of improvements: most deadliest characteristic of disruptive
technology is its rate of evolution on the currently established performance
metrics. As shown in Figure 4.33 a disruptive technology begins with
performance that is well below the needs of the firm’s mainstream customers.
The disruptive technology will likely not improve at a rate sufficient to overcome
the existing or sustaining technology (this is misleading for managers). In truth
its irrelevant if the technology will outstrip the current one on key performance
metrics. Rather, you should estimate whether, in the foreseeable future, the
disruptive technology will catch up to market on the critical performance
dimensions (become good enough for mainstream customers).

2. Different sets of attributes become relevant: as disruptive technologies close the

gap between the performance level they offer and mainstream customer needs,
the novel set of attributes they offer may become increasingly attractive to
potential customers.

3. Listening closely to customers might spell trouble: A firm is well served by

listening closely to its customers in an effort to develop the product and services
that best serve their needs. Word of caution: listening attentively to your most
aggressive customers will create a bias toward prompt adoption of sustaining
technology and a reluctance to buy into disruptive technology.

What to do ?

Those who study disruptive technology change suggest to following framework:

I. Monitor market and determine if the emergence of new technologies brings to

sustaining or disruptive kind.

II. When disruptive technologies emerge, envision the new market they would likely
be best suited for.

III. Spin-off a new division that focuses exclusively on the commercialisation of

products based on the disruptive technology.

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