We present an economic framework to understand and manage platform growth. This builds from a model of network complements and two sided markets. The intuitions help set prices, openness, and features to absorb into the platform. The intuitions also help shape the transition from a traditional business model to a platform strategy. Presented at the IBM executive education summit July 27, 2011.

1. Open / Closed Platform Strategies:How, When & Why Geoffrey Parker Freeman School of Business, Tulane gparker@tulane.edu Marshall Van Alstyne Boston University & MIT mva@bu.edu,marshall@mit.edu

2. MVA Information Economics Research Platforms & Network Effects Communications Markets Information & Productivity Economics of IP

3. Why we are here today How can firms such as IBM, AT&T and others create nonlinear shareholder value from platforms in ways that Apple, Google, Facebook and Salesforce.com do?

4. 1981-1997 Microsoft beats Apple Apple launched the personal computer market but Microsoft licensed widely, building a huge developer ecosystem. By the time of the antitrust trial, Microsoft had more than 6 times the number of developers. © 2011 Parker & Van Alstyne

5. Apple 1996 Michael Dell “I’d shut it down and give the money back to the shareholders.”

6. Apple 2000

7. Apple passes Microsoft May 26, 2010 Using a platform strategy, Apple becomes the most valuable tech firm in the US, representing $310Bn to Microsoft’s $204Bn. Chart shows % growth. © 2011 Parker & Van Alstyne

8. Technology Smackdown

9. 9 Google vs. Microsoft vs. Apple

10. Technology Smackdown

11. 11 Technology Smackdown

12. 12 Network vs Computer Network as the Computer Computer as the Network

13. Managerial Implications Understand: Winners in a platform market generally have the “best” platform strategy, not necessarily the “best” product Best platform? Open (but not too open) interfaces Modular architectures (easy to build on/extend) Compelling complements (generally result of vibrant ecosystem) Best product? Best standalone value proposition, but while starting here is good, usually not enough to win a platform market Decision for YOU and IBM: product strategies or platform strategies? 13 Source: Cusumano 2011

14. Agenda Understanding platforms Externalities and network effects in ecosystems Winner-Take-All Elements of platform strategy Choke points and platform evolution Pla

15. Ongoing Platform Battlegrounds 15

16. 16 Platform Definition A foundation technology or set of components (could also be a service) used beyond a single firm Allows multiple parties (“market sides”) to transact across the platform Value of the platform may increase non-linearly with more users – depends on strength of network effects.

17. Platform Examples Desktop OS: Unix, Mac, Windows PDAs: Palm, Psion, Newton Game Consoles: Wii, Xbox, Playstation Network Switches: Cisco, IBM, HP Multimedia: Adobe/Flash, MS/Silverlight, Google-Apple/HTML5 Payment Systems: Paypal, Google Checkout, Visa, Apple, Mobile Felica Mobile Devices: iPhone, Android, Symbian, Blackberry Enterprise Systems: Salesforce, Oracle, i2, IBM, SAP Social Networks: Facebook, MySpace, LinkedIn, Monster, Twitter Batteries: Sony, Panasonic, Sanyo, A123 Web Search: Google, Bing+Yahoo!, Baidu Ebooks: Amazon, iPad, Nook, Sony Smart Grids: IBM etc. Health Care: Microsoft, WebMD, IBM etc.

18. Agenda Understanding platforms Externalities and network effects in ecosystems Winner-Take-All Effect Elements of platform strategy Choke points and platform evolution AT&T Platforms: Breakout exercise Pla

19. 19 Pop Quiz: What are “network externalities?” Hint: they matter for pricing, winner-take-all markets, and strategy…

20. 20 A “network externality” is a demand economy of scale. Examples: phone, fax, IM, email networks.

22. Monopolistic supply

23. Utilities, Semiconductors

24. Often falling avg cost

25. Monopolistic supply

27. More competitive supply

29. 23 Reinterpreting Network Externalities Where is the interaction when your neighbor rents “Lord of the Rings”? In fact, his rental may mean you have to wait!

30. 24 Traditional Linear Value Chain Stage 1 Stage 2 Stage 3 $ $ $ Value accumulates from stage to stage Minimal Network Effects

31. Apple iPod pre-Platform User Content Apple $ $ Product First Thinking Standard linear value chain User matches MP3 player to library Minimal network effects © 2011 Parker & Van Alstyne

32. Apple iPod post-Platform User Content $ $ Apple Triangular platform supply network Apple owns financial chokepoint Apple matches users to content Stronger network effects © 2011 Parker & Van Alstyne

33. 27 A two-sided network has four network effects Asame-sideeffect for each side, i.e., preference regarding number of other users on own side Across-side effect in each direction, i.e., preference regarding number of users on other side Side 1 Side 2 $ $ Platform

34. 28 Managing network effects often involvessubsidy; Who should get it?

35. Pricing Ability to capture cross-side effects Mistake of Netscape See: Eisenmann, Parker, Van Alstyne (2006). “Strategy for Two-Sided Markets,” Harvard Business Review.

36. Pricing Ability to capture cross-side effects User sensitivity to price & quality Mistake of Netscape Denver vs. Boston real estate markets See: Eisenmann, Parker, Van Alstyne (2006). “Strategy for Two-Sided Markets,” Harvard Business Review.

37. Pricing Ability to capture cross-side effects User sensitivity to price & quality Value added Mistake of Netscape Denver vs. Boston real estate markets Mistake of 1984 Apple See: Eisenmann, Parker, Van Alstyne (2006). “Strategy for Two-Sided Markets,” Harvard Business Review.

38. Pricing Ability to capture cross-side effects User sensitivity to price & quality Value added Marginal costs Mistake of Netscape Denver vs. Boston real estate markets Mistake of 1984 Apple Mistake of FreePC See: Eisenmann, Parker, Van Alstyne (2006). “Strategy for Two-Sided Markets,” Harvard Business Review.

39. Pricing Ability to capture cross-side effects User sensitivity to price & quality Value added Marginal costs Interfering same-side effects Mistake of Netscape Denver vs. Boston real estate markets Mistake of 1984 Apple Mistake of FreePC Mistake of Covisint See: Eisenmann, Parker, Van Alstyne (2006). “Strategy for Two-Sided Markets,” Harvard Business Review.

40. Pricing Ability to capture cross-side effects User sensitivity to price & quality Value added Marginal costs Interfering same-side effects Marquee users Mistake of Netscape Denver vs. Boston real estate markets Mistake of 1984 Apple Mistake of FreePC Mistake of Covisint Mistake of Microsoft See: Eisenmann, Parker, Van Alstyne (2006). “Strategy for Two-Sided Markets,” Harvard Business Review.

41. Agenda Understanding platforms Externalities and network effects in ecosystems Winner-Take-All Effect Elements of platform strategy Choke points and platform evolution AT&T Platforms: Breakout exercise Pla

42. Homing and Switching Costs 1 SETUP + 1ONGOING Mono-homing 2 SETUPS + 1 TERMINATION + 1 ONGOING Switching 2 SETUPS + 2 ONGOING Multi-homing See: Eisenmann, Parker, Van Alstyne (2006). “Strategy for Two-Sided Markets,” Harvard Business Review.

43. When do Winner-Take-All Networks Emerge? Large Supply/Demand Effects (FB vs gas engine) Large Multi-Homing Costs (OS vs credit cards). Niche specialization is less feasible. Windows © 2011 Parker & Van Alstyne

44. How Apple is killing standalone platforms Usr Book Usr Mus Kindle Zune Sony Amazon Microsoft Usr Gam User Music TV User Dvpr HTML Publi PSP MP3 Video Calls Games Web eBooks Apple has vastly stronger network effects. © 2011 Parker & Van Alstyne

45. How Apple is killing standalone platforms Usr Book Usr Mus Kindle Zune Sony Amazon Microsoft Usr Gam User Music TV User Dvpr HTML Publi PSP MP3 Video Calls Games Web eBooks Sony could have done this – has many great standalone products. Google is not making this mistake with Android © 2011 Parker & Van Alstyne

46. How Apple is killing standalone platforms Usr Book Usr Mus Kindle Zune Amazon Sony MS Zune Usr Gam User Music TV User Dvpr HTML Publi PSP MP3 Video Calls Games Web eBooks Message for IBM: A great standalone product might not be sufficient. © 2011 Parker & Van Alstyne

47. How Apple is killing standalone platforms Usr Book Usr Mus Kindle Zune Sony Amazon Microsoft Usr Gam User Music TV User Dvpr HTML Publi PSP MP3 Video Calls Games Web eBooks See: Eisenmann, Parker, Van Alstyne (2011). “Platform Envelopment,” Strategic Management Journal.

48. Agenda Understanding platforms Externalities and network effects in ecosystems Winner-Take-All Effect Elements of platform strategy Choke points and platform evolution AT&T Platforms: Breakout exercise Pla

50. Telecom – CPE equipment, physical pipe (last mile), billing

51. Online retail (Amazon.com) – customer base, distribution infrastructure, affiliate relationships

53. 45 Openness vs. Control Maximum protection ≠ Maximum Value Proprietary Your Share Open Industry Value Add Set-Top Boxes were too closed, 3rd parties never added value.

54. 46 Openness vs. Control Maximum protection ≠ Maximum Value Proprietary Your Share Open Industry Value Add Linux is so open (viral GPL) it’s difficult to control and make money.

55. Does Openness Work? What did Facebook do in early 2007?

56. Does Openness Work? It opened to developers and overtook MySpace!

57. Why does openness work? Platform sponsor gives away (yellow) platform value Price V1 p1 q1 Quantity Downstream enhancements add value See: Parker, Van Alstyne (2011). “Innovation, Openness & Platform Control,” SSRN.com.

58. Why does openness work? V2 Platform sponsor gives away (yellow) platform value Developers build apps for installed base, adding new layers of value. Benefits: Sponsor from increased sales, and downstream royalties. Developer from cost savings and installed base. Price V1 p1 q1 Quantity Downstream enhancements add value See: Parker, Van Alstyne (2011). “Innovation, Openness & Platform Control,” SSRN.com.

59. V4 V3 V2 Why does openness work? Platform sponsor gives away (yellow) platform value Developers build apps for installed base, adding new layers of value. Benefits: Sponsor from increased sales, and downstream royalties. Developer from cost savings and installed base. Repeat Price V1 p1 q1 Quantity Downstream enhancements add value See: Parker, Van Alstyne (2011). “Innovation, Openness & Platform Control,” SSRN.com.

60. Platforms get enormous value from 3rd party developers Most firms can only concentrate on most valuable apps Profits increase when others add to platform’s “Long Tail” Consider an operating system like MS Windows, Apple Mac, or Google Android

61. 53 What does control mean? Split IP rights from point of customer contact. Open access Extend platform Touch customers Change platform Side 1 Side 2 Side 1 Side 2 Platform Platform Provider Platform Provider Platform Sponsor Platform Sponsor

62. 54 What does control mean? Split IP rights from point of customer contact. Open access Extend platform Touch customers Change platform Side 1 Side 2 Side 1 Side 2 Platform Provider Platform Provider Platform Sponsor Platform Sponsor

63. 55 Actually Parallels Concepts from OSS Split IP rights from point of customer contact. Consider 4 “freedoms” of open source: Ability to access & execute Side 1 Side 2 Side 1 Platform Provider Platform Sponsor

64. 56 Actually Parallels Concepts from OSS Split IP rights from point of customer contact. Consider 4 “freedoms” of open source: Ability to access & execute Ability to study how the program works and change it. Side 1 Side 2 Side 1 Side 2 Platform Provider Platform Sponsor

65. 57 Actually Parallels Concepts from OSS Split IP rights from point of customer contact. Consider 4 “freedoms” of open source: Ability to access & execute Ability to study how the program works and change it. Ability to redistribute copies. Side 1 Side 2 Side 1 Side 2 Platform Provider Platform Provider Platform Sponsor

66. 58 Actually Parallels Concepts from OSS Split IP rights from point of customer contact. Consider 4 “freedoms” of open source: Ability to access & execute Ability to study how the program works and change it. Ability to redistribute copies. Ability to distribute mods. Side 1 Side 2 Side 1 Side 2 Platform Provider Platform Provider Platform Sponsor Platform Sponsor

67. 59 Apple tried to control too much of the original Mac Remember MacWrite, MacPaint? Charged ~$10,000 for SDKs. Controlled OS & HW and dominant Apps. Vertical integration choked network effects. Users Claris Apple Mac Mac OS

68. 60 Microsoft opened much more of its ecosystem Microsoft had 6-10X developers Open APIs / Cheap SDKs Controlled OS, licensed. Strong network effects. Users Dvprs IBM Dell … HP MS Windows

69. 61 For real profits, control full layer Users Users Users Dvprs Flights Dvprs Providers Acer Provider Dell … HP Sponsors Debian Sponsor RedHat Ubuntu … Linux: No one driving the bus. Limited scope of control. Joint Venture: e.g. Orbitz airline collaboration Licensing: e.g. Google Android

70. 62 Danger! Users Dvprs Providers Sponsor Watch for new control points closer to customer. See: Eisenmann, Parker, Van Alstyne (2006). “Opening Platforms: How, When & Why” Ch 6 in Platforms, Markets and Innovation (ed Gawer).

71. 63 Danger! Users Dvprs Providers Sponsor Watch for new control points closer to customer. See: Eisenmann, Parker, Van Alstyne (2006). “Opening Platforms: How, When & Why” Ch 6 in Platforms, Markets and Innovation (ed Gawer).

72. When should you close (absorb) parts of a platform ecosystem? Openness &Time: Having opened its platform, does Microsoft (or Cisco or Google or Apple) kill its ecosystem by bundling developer value into Windows? Windows: Multithreading, Disk Compression, Internet Browsing, Streaming Media, Instant Messaging, … iPhone: Flashlight, Voice Memo, shake-to-shuffle, iBooks, Voice Control, … © 2011 Parker & Van Alstyne

73. Should Apple have opened the iPod? 65 Most firms can only concentrate on most valuable apps Profits increase when others add to platform’s “Long Tail” No! It does 1 thing only, so make it “insanely great” and own it.

74. Should Apple have opened the iPhone? Most firms can only concentrate on most valuable apps Profits increase when others add to platform’s “Long Tail” Of Course! It has video, wifi, camera (scanner), accelerometer, mobile, MP3, web browsing, etc. Platforms benefit from broad contributions. But control the top several complements.

75. Which applications to absorb? Apps offered by Platform Sponsor Apps offered by Developers Rule 1: Absorb the highest value applications from the ecosystem. This adds value for users and mitigates threat of disintermediation. Example: Apple iPad absorbed e-books Example: Microsoft Windows absorbed web browsing

76. Anything else to absorb? Apps offered by Platform Sponsor Apps offered by Developers

77. Anything else to absorb? Rule 2: Absorb features that emerge in multiple places in the ecosystem. This increases compatibility, ensures efficient implementation, and benefits other apps. Examples: Operating systems support for (i) spell check (ii) cut & paste (iii) PDF.

78. We have explored the platform strategies of many firms How will you build IBM’s platform strategy?

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