The Digital Equalizer

The winner-take-all nature of information technology markets is changing, as digital formats create environments where multiple winners can coexist, an outcome that demands new strategies from business managers and gives consumers the peace of mind of not picking the losing technology, according to a new study.

The study—from a team led by Chris F. Kemerer, David M. Roderick Professor Information Systems at the Katz Graduate School of Business; and researchers at the University of Texas, San Antonio, Georgia Institute of Technology, and Carnegie Mellon University—analyzed the flash memory card market in the United States. Flash memory is the primary storage source for digital cameras, digital camcorders, mobile phones, audio players, and video game consoles. The study found that digital convertors—the devices that accept multiple formats, thus resolving incompatibility issues—are carving out space in the market for multiple competing formats. The research has broad implications for future digital format wars, including the e-books war among Amazon's Kindle, Sony's eBook Reader, Apple's iPad, and Barnes and Noble's NOOK.

The paper, titled "Standards Competition in the Presence of Conversion Technology: An Empirical Analysis of the Flash Memory Card Market," is scheduled to be published in MIS Quarterly in 2013. The paper was a main part of the 2008 Katz doctoral dissertation of Charles Z. Liu, now an assistant professor at the University of Texas, San Antonio. View the working paper here.

Standard economic theory "predicts that product markets will tip toward a single dominant standard when there are strong network effects. Consequently, market concentration will typically increase once the installed base of a leading standard has reached a critical mass," wrote the authors.

There is a growing body of evidence to this point. In electronics, the graveyard is littered with losing devices—the Betamax that lost out to VHS, the HD-DVD that lost to Blu-Ray discs, the incompatibility problems that led to the XM-Sirius satellite merger. But history isn't repeating itself with flash memory cards. In this market, no clear winner has emerged, even as the industry's revenues have risen from $10.6 billion in 2005 to $18.7 billion in 2010, according to the market research firm IDC.

"The digital medium allows you to make conversions easily, yielding near-perfect copies. Convertors are the game changer," Kemerer says.

Markets Behaving Differently

Format wars have occurred throughout history. One of the more famous ones happened in the late 1880s: the so-called war of currents between George Westinghouse and Thomas Edison. The inventors backed different methods of electric power distribution—the alternating current (AC) by Westinghouse and direct current (DC) systems by Edison. Ultimately, Westinghouse won the bid to illuminate the 1893 Chicago World's Fair, a feat that helped to propel his technology forward.

For their research on flash drives, Kemerer's team reviewed the six leading product formats. The flash memory's capacities ranged from four megabytes to eight gigabytes. The researchers performed their statistical analysis based on more than 15,000 pieces of data that were collected on retail prices, unit sales, and sales information.

The analysis found that traditional network effects do exist in the flash drive market. This allows leading companies to charge a price premium for their product. However, as digital convertors become more available, those advantages erode. For example, the SmartMedia and Compact Flash formats once controlled a combined 70 percent of the market in 2002, but they lost their leading positions. There are no signs pointing toward market consolidation. In fact, digital convertors make it easier for competitors to stay in the market.

"In contrast to the self-reinforcing loop in classic network effects theory, in the presence of digital convertors, the larger the leading format's installed base, the more such a benefit can be appropriated among consumers of the minority formats, creating an effect that pushes the market away from the potential for high concentration," the researchers wrote.

Historically, a single format has emerged for societal reasons. Markets for complementary goods, such as videotapes for VCRs, and Blu-Ray discs for DVD players tend to desire a single, dominant platform and consumers prefer to adopt the leading platform, and may withhold purchases until the winning format is decided. That, too, may be changing. Consumers can act more aggressively because there is less risk of betting on the wrong format.

"When making a technology choice, the wide presence of digital convertors reduces the consumer's risk of being stranded on a new, but less popular standard, as the chances for survival of a new technology are larger when network effects are less significant," the researchers wrote.

What Managers Should Do

 The evolution of winners-take-some markets demands new ways of thinking from business managers. In the past, companies were encouraged to pour money into early customer subsidies, in anticipation of a jackpot payment when the entire market was won. Now managers must ask if that still makes sense.

"While managers have been taught to expect strong network effects to dominate platform competition this wisdom may not serve them well in a digital environment where content can be converted easily between standards," the researchers wrote.

To further explore the management side of the equation, Kemerer led the same University of Texas, San Antonio and Carnegie Mellon University researchers, and produced a working paper titled, "Strategies for Tomorrow's Winners-Take-Some Digital Goods Markets." View the working paper here.

The researchers predict that firms will increasingly cross-license their products to increase total market size. For example, vendors are already promoting the conversion of digital audio and image files across a variety of formats. Likewise, Amazon provides convertors that allow its users to read Kindle digital-rights-management-protected titles on both Kindle devices and other portable devices, including iPads and iPhones.

"As a result, we expect that consumers will increasingly value product features over mere platform compatibility and that design features and functionality will become key dimensions of competition (See, for example, Apple's recent success with the iPhone and iPad)," the researchers wrote.

The researchers anticipate three primary exceptions to the winners-take-some marketplace. They would come in the form of big vendors with deep pockets trying to follow the old rules, collaborators forming an oligopoly over a monopoly, and instances in which governments intervene to support one form of technology.

The researchers conclude that the new marketplace provides reasons for optimism.

"We see the movement toward greater digitization to bring about an overall better marketplace for both vendors and consumers. It should be a future marked by faster technology innovation, fewer consumer 'deadweight' losses due to technological stranding, more product choices, fewer vendor risks, and more interoperability. Managers need to be prepared to seize the opportunities in this world, and not fight the last war," the researchers write.