Because learning changes everything.

Chapter 4
Standards Battles, Modularity, and
Platform competition

Strategic Management of
Technological Innovation, 7th Edition
Melissa A. Schilling

© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
 Netflix and the Battle of the Streaming
Services 1

By 2020, there were 1.1 billion subscribers to streaming services like

Netflix, Hulu, Tencent Video, Disney, etc. Globally the overwhelming
leader was Netflix with over 200 million subscribers in over 190 countries.
Streaming services could offer a much wider selection of content than
physical stores, and offered additional services like reviews,
recommender systems, movie trailers, etc.
By 2021, many streaming services were using their data on customer
preferences to create original content tailored to particular market
segments.
They also faced tough choices about making content exclusive: when
companies made content exclusive to their channel, they were gambling
that the boost in subscriptions would be worth more than wider
distribution of that content – a tradeoff that was hard to calculate and
predict.

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 Netflix and the Battle of the Streaming
Services 2

Discussion Questions:
1. Based on your use of streaming services, do you feel the streaming
platforms differ in terms of stand-alone value (For Example, fidelity,
ease of use, recommender systems, etc.)?
2. Again based on your use, how do you feel the streaming services
differ based on the types and quality of content they provide?
3. What factors do you think influence a consumer’s choice of whether to
subscribe to a streaming service? How important are the standalone
features? How important is the content?
4. What are the pros and cons of having content be exclusive to a
service?
5. Do you think the market will eventually choose a few services as
“winners” and the other services will exit (or combine with the
winners) or will the market continue to support many different
services?

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 Overview
Many industries experience strong pressure to
select a single (or few) dominant design(s).
There are multiple dimensions shaping which
technology rises to the position of the dominant
design.
Firm strategies can influence several of these
dimensions, enhancing the likelihood of their
technologies rising to dominance.

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 Why Dominant Designs Are Selected 1

Increasing returns to adoption

• When a technology becomes more valuable the more it is adopted.
Two primary sources are learning effects and network externalities.
• The Learning Curve: As a technology is used, producers learn to
make it more efficient and effective.

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 Why Dominant Designs Are Selected 2

Prior Learning and Absorptive Capacity

A firm’s prior experience influences its ability to recognize
and utilize new information.
• Use of a particular technology builds knowledge base about that
technology.
• The knowledge base helps firms use and improve the
technology.
• Suggests that technologies adopted earlier than others are
likely to become better developed, making it difficult for other
technologies to catch up.

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 Why Dominant Designs Are Selected 3

Network Externalities
In markets with network externalities, the benefit from using a
good increases with the number of other users of the same
good.
Network externalities are common in industries that are
physically networked.
• For example, railroads, telecommunications.

Network externalities also arise when compatibility or

complementary goods are important.
• For example, Many people choose to use Windows in order to
maximize the number of people their files are compatible with, and the
range of software applications they can use.
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 Why Dominant Designs Are Selected 4

A technology with a large installed base attracts

developers of complementary goods; a technology
with a wide range of complementary goods attracts
users, increasing the installed base. A
self-reinforcing cycle ensues:

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 Theory In Action
The Rise of Microsoft
• In 1980, Microsoft didn’t even have a personal computer (PC)
operating system – the dominant operating system was CP/M.
• However, in IBM’s rush to bring a PC to market, they turned to
Microsoft for an operating system and Microsoft produced a clone
of CP/M called “MS DOS.”
• The success of the IBMPCs (and clones of IBMPCs) resulted in
the rapid spread of MS DOS, and an even more rapid proliferation
of software applications designed to run on MS DOS. Microsoft’s
Windows was later bundled with (and eventually replaced) MS D
OS.
• Had Gary Kildall signed with IBM, or had other companies not
been able to clone the IBMPC, the software industry might look
very different today!

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 Why Dominant Designs Are Selected 5

Government Regulation
Sometimes the consumer welfare benefits of having a single
dominant design prompts government organizations to
intervene, imposing a standard.
• For example, the NTSC color standard in television broadcasting in the
U.S.; the general standard for mobile communications (GSM) in the
European Union.

The Result: Winner-Take-All Markets

Natural monopolies.
• Firms supporting winning technologies earn huge rewards; others may
be locked out.

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 Why Dominant Designs Are Selected 6

Increasing returns indicate that technology trajectories are

characterized by path dependency:
• End results depend greatly on the events that took place leading up to
the outcome.

A dominant design can have far-reaching influence; it shapes

future technological inquiry in the area.
Winner-take-all markets can have very different competitive
dynamics than other markets.
• Technologically superior products do not always win.
• Such markets require different firm strategies for success than markets
with less pressure for a single dominant design.

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 Multiple Dimensions of Value 1

In many increasing returns industries, the value of a

technology is strongly influenced by both:
• Technology’s Standalone Value.
• Network Externality Value.

A Technology’s Stand-alone Value.

• Includes such factors as:
• The functions the technology enables customers to perform.
• Its aesthetic qualities.
• Its ease of use, etc.

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 Multiple Dimensions of Value 2

Kim and Mauborgne developed a “Buyer Utility Map” that is useful for identifying
elements of a technology’s stand-alone value:
Purchase Delivery Use Supplements Maintenance Disposal
Customer Price of Prius Offers Can stop less NA NA
productivity slightly higher speed and often for gas,
than power saving money
comparable comparable and time
nonhybrid to nonhybrid
models models

Simplicity Buyer may NA Operates Refuels like a NA Hybrids have

feel less able like a regular larger
to assess regular combustion batteries that
value of combustion engine vehicle would have to
vehicle engine be recycled
vehicle and disposed
of at end of
life

Source: Adapted from Harvard Business Review. Exhibit from “Knowing a Winning Business Idea When
You See One,” by W. C. Kim and R. Mauborgne, September– October 2000.

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 Multiple Dimensions of Value 3

Purchase Delivery Use Supplements Maintenance Disposal

Convenience NA Will be Does not Can purchase Maintenance is NA
sold have to be fuel at regular similar to
through plugged into gas stations regular
traditional electrical combustion
dealer outlet engine vehicle
channels
Risk NA NA Buyer might NA Buyer might Prius might
face a have difficulty be more
higher risk finding difficult to
of product replacement resell or have
failure parts because lower resell
because it of new value
embodies a technology
new
technology

Source: Adapted from Harvard Business Review. Exhibit from “Knowing a Winning Business Idea When
You See One,” by W. C. Kim and R. Mauborgne, September– October 2000.

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 Multiple Dimensions of Value 4

Purchase Delivery Use Supplements Maintenance Disposal

Fun and image NA Connotes NA NA NA NA
image of
environmental
responsibility
Environmental Buyers feel NA Emits Requires less NA NA
friendliness they are lower use of fossil
helping levels of fuels
support the pollutants
development
of more
environment
ally friendly
cars

Source: Adapted from Harvard Business Review. Exhibit from “Knowing a Winning Business Idea When
You See One,” by W. C. Kim and R. Mauborgne, September– October 2000.

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 Multiple Dimensions of Value 5

Network Externality Value

Includes the value created by:
• The size of the technology’s installed base.
• The availability of complementary goods.

A new technology that has significantly more standalone

functionality than the incumbent technology may offer less
overall value because it has a smaller installed base or poor
availability of complementary goods.
• For example, NeXT Computers were extremely advanced
technologically, but could not compete with the installed base value
and complementary good value of Windows-based personal
computers.

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 Multiple Dimensions of Value 6

To successfully overthrow an existing dominant

technology, new technology often must either offer:
• Dramatic technological improvement (for example, in videogame
consoles, it has taken 3X performance of incumbent).
• Compatibility with existing installed base and complements.

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 Multiple Dimensions of Value 7

Subjective information (perceptions and expectations) can

matter as much as objective information (actual numbers)
Value attributed to each dimension may be disproportional

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 Multiple Dimensions of Value 8

Competing for Design Dominance in Markets with

Network Externalities
• We can graph the value a technology offers in both standalone
value and network externality value:

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 Multiple Dimensions of Value 9

We can compare the graphs of two competing

technologies and identify cumulative market share levels
(installed base) that determine which technology yields
more value.

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 Multiple Dimensions of Value 10

We can compare the graphs of two competing

technologies and identify cumulative market share levels
(installed base) that determine which technology yields
more value.

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 Are Winner-Take-All Markets Good for
Consumers? 1

Economics emphasizes the benefits of competition.

However, network externalities suggest users
sometimes get more value when one technology
dominates.
Should the government intervene when network
externalities create a natural monopoly?

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 Are Winner-Take-All Markets Good for
Consumers? 2

Network externality benefits to customers rise with

cumulative market share
Potential for monopoly costs to customers (for example, price
gouging, restricted product variety, etc.) also rise with
cumulative market share.
Curve shapes are different; Network
externality benefits likely to grow
logistically, while potential monopoly
costs likely to grow exponentially.
Where monopoly costs exceed
network externality benefits,
intervention may be warranted.
Optimal market share is at point
where lines cross.
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 Modularity and Platform Competition 1

In some markets, industry players use modularity to create a

platform ecosystem where many different firms contribute to
the product system.
Modular systems are those that can be separated and
recombined to change their configuration, scale, or functions.
• Standardized interfaces ensure that components are compatible.
• In some product systems modularity enables components from
different producers to be recombined (for example, smartphones with
different apps); in others only components from a single firm are
recombined (for example, Ikea shelving systems).

Modularity is more valuable when there are a) diverse

technological options that can be recombined, and b)
customers have heterogeneous preferences.
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 Modularity and Platform Competition 2

Traditional integrated
product bundle:
• Provider tries to meet
buyers needs itself.
• No customization, no
external compatibility.

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 Modularity and Platform Competition 3

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 Modularity and Platform Competition 4

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 Platform Ecosystems
In a platform ecosystem, some core part of a
product (such as a video game console) mediates
the relationship between a wide range of other
components or complements (for example, video
games, peripherals) and prospective end-users.
• A platform’s boundaries can be well-defined with a stable
set of members or amorphous and changing.
• The success of all members of the ecosystem depends in
part upon the success of other members.
• Members often invest in co-specialization or exclusivity
agreements.

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 Platform ecosystems strike a balance between
pure modularity and pure integration
Pure Modularity Platforms Pure Integration
Combinations take Components not owned, Combination
place in the market – but curated. pre-determined by
no co-specialization firm (no
Choice and reconfiguration)
Choice and
reconfigurability reconfigurability, but Captive supply (no
Competition shepherded by platform competition)
incentivizes firms to sponsor
High co-specialization
increase quality and Competition still ensures components
decrease price
incentivizes optimized to work
Quality and together
compatibility is Producer exerts some
control over quality and Producer controls
uncertain (can be
compatibility quality and
hard for customer)
compatibility

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 Discussion Questions
1. What are some of the sources of increasing returns to adoption?
2. What are some examples of industries not mentioned in the chapter
that demonstrate increasing returns to adoption?
3. What are some of the ways a firm can try to increase the overall value
of its technology, and its likelihood of becoming the dominant design?
4. What determines whether an industry is likely to have one or a few
dominant designs?
5. Are dominant designs good for consumers? Competitors?
Complementors? Suppliers?
6. In what kinds of industries will platform ecosystems be more valuable
than pure modularity or integrated hierarchies?

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 Supplemental Video
Two short videos on
Innovation Strategy: Network Externalities
https://youtu.be/CIp7TR2R4gg
Innovation Strategy: Platform Ecosystems
https://youtu.be/J0kdOlqgF6E

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 Because learning changes everything. ®

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© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
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 Why Dominant Designs Are Selected – Text 1

Alternative
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The first graph illustrates a decrease in the cost per unit

corresponding to an increase in cumulative output. The
second graph illustrates an increase in the performance on
each unit corresponding to an increase in cumulative output.

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 Why Dominant Designs Are Selected – Text 4

Alternative
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In this cycle, the two factors complement each other. A large

installed base attracts producers of complementary goods.
The availability of complementary goods attracts users,
which in turn increases the installed base.

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 Multiple Dimensions of Value – Text 6

Alternative
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Technological utility, installed base, and availability of complementary

goods are components that determine the value of technology. Existing
technology is considered valuable if it contains a stand-alone
technological utility, an installed base, and complementary goods. New
technology competes only on the value of its stand-alone utility. For a
new technology to be considered valuable, its technological utility should
be able to eclipse the combined value of the technological utility, installed
base, and complementary goods availability of an existing technology.
This provides a marginal value increase for the new technology when
compared to the existing technology. When the new technology is
compatible with existing technology's installed base and complementary
goods, a moderate value of technological utility may be able to help attain
a marginal value increase for the new technology when compared to the
existing technology.

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 Multiple Dimensions of Value – Text 7

Alternative
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Perception of technology is proportional when the perceived

and anticipated value components of the technology match
its actual value components.
Perception of technology is disproportional when one or more
perceived value components and/or anticipated value
components do not match actual value components.

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 Multiple Dimensions of Value – Text 8

Alternative
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There are two graphs that are labeled “a” and “b.” The x-axes of both
graphs represent installed base, and the y-axes represent value to users.
The graph labeled “a” illustrates the following: The value of technology
increases at a slow pace initially. As the installed base increases, the
value to users increases exponentially, continues at a steady rate of
increase, and then reaches a plateau after which the value does not
change. The graph labeled “b” illustrates the following: The value of
technology increases at a slow pace initially. As the installed base
increases, the value to users increases exponentially, continues at a
steady rate of increase, and then reaches a plateau after which the value
does not change. The value of technology illustrated in graph “b” is
greater than that of graph “a.” This is because the value of technology in
graph “b” is bolstered by technological utility. Hence, though the
progression of value is identical in both graphs, the overall value is
greater in graph “b.”

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 Multiple Dimensions of Value – Text 9

Alternative
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In both graphs, the network externality returns curves for technologies A and B
are plotted opposing each other. Because of this, the x-axes are bidirectional. The
x-axes represent market share, and the y-axes represent value to users. In the
first graph, the externality returns curves for technologies A and B are equal and
they oppose each other. This illustrates the following: When technology A
possesses less than 50 percent of market share, technology B will possess more
than 50 percent, making technology B more attractive to customers. When
technology B possesses less than 50 percent of market share, technology A will
possess more than 50 percent, making technology A more attractive to
customers. When market share is split between both technologies evenly,
customers will be indifferent toward both of them. These factors hold true as long
as the technological value of A and B are the same. In the second graph, the
externality returns curve of B is higher than that of A as the technological value of
B is greater than that of A. Because of this, the market is indifferent toward both
technologies at a point when technology A possesses 60 percent of market
shares, and technology B possesses 40 percent.

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 Multiple Dimensions of Value – Text 10

Alternative
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The network externality returns curves for technologies A and

B are plotted opposing each other. Because of this, the x-axis
is bidirectional. The x-axis represents market share, and the
y-axis represents value to users. The graph illustrates that
the curves flatten out sooner, implying that the maximum
amount of network externality value is obtained by customers
at low levels of market share. The indifference region within
which neither technology dominates the market is large.

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 Are Winner-Take-All Markets Good for
Consumers? – Text Alternative
2

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The x-axis of the graph represents market share. The y-axis

is not labeled. There are two curves. One is a typical network
externality returns curve, which illustrates the increase in the
value of technology A to customers as market share
increases. The other curve illustrates the increase in
monopoly costs to customers as market share increases.
According to the graph, at a market share of X, the monopoly
cost to customers is equal to the value that consumers
accrue from network externalities. If the market share
exceeds X, the monopoly cost is higher than the value
accrued. As long as the market share is less than X, the
value accrued outweighs the cost.

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 Modularity and Platform Competition – Text 2

Alternative
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The figure titled integrated product with bundled options

(no customization) shows a hexagon at the centre with 6
hexagons adjacent to it sides. The hexagon at the
centre is marked graphics chip. The hexagon on top is
marked software. The hexagon on the top right is
marked game 3. The hexagon at the bottom right is
marked game 2. The hexagon at the bottom is marked
game 1. The hexagon at the bottom left is marked RAM.
The hexagon on the top left is marked micro-processor.

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 Modularity and Platform Competition – Text 3

Alternative
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The figure on the left shows 3 hexagons arranged one on top of the other.
The hexagon on the top is marked game 4. The hexagon in the middle is
marked game 5. The hexagon at the bottom is marked game 6. On the
top left is the following caption with 3 arrows pointing to the 3 hexagons:
compatibility with third-party options expands choice for buyer. On the
right is a figure titled integrated product with bundled options and
compatibility with third-party options which shows a hexagon at the centre
with 6 hexagons adjacent to it sides. The hexagon at the centre is marked
graphics chip. The hexagon on top is marked software. The hexagon on
the top right is marked game 3. The hexagon at the bottom right is
marked game 2. The hexagon at the bottom is marked game 1. The
hexagon at the bottom left is marked RAM. The hexagon on the top left is
marked micro-processor.

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 Modularity and Platform Competition – Text 4

Alternative
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The figure titled complementary resources in the ecosystem enable even more
configuration options shows 3 hexagons arranged on one top of the other. The
hexagon at the top is marked app 4. The hexagon in the middle is marked app 5.
The hexagon at the bottom is marked app 6. The figure on the right shows 2
hexagons on the right, one on top of the other. The hexagon on the top right
contains 2 hexagons with the above hexagon marked RAM 1. The hexagon
below contains 2 hexagons, the hexagon above is marked micro-processor 1.
Adjacent to the bottom left side of the hexagon top are 2 more hexagons with the
hexagon on to marked production capacity 1. Adjacent to the bottom left side of
the hexagon below are 2 hexagons with the hexagon above marked marketing
capabilities 1. The figure on the right titled modularized product using third party
resources contains 4 adjacent hexagons. 2 hexagons are placed one above the
other and 2 hexagons are adjacent to the hexagons on the left. The hexagon on
the top right is marked app 3. The hexagon below is marked app 2. The hexagon
at the bottom left of the hexagon on the top is marked software. The hexagon
below is marked app 1.

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