Market Share Shifts May Be Caused by Incompatible Standards

Sudden shifts in market shares are likely to happen in industries with competing, incompatible standards, said Guenter Hitsch, associate professor of marketing. This can occur when an industry is characterized by “indirect network effects” – the positive feedback loop where increased hardware sales result in more software titles which, in turn, increase hardware sales.

Indirect network effects can cause a market to “tip” quickly in favor of one standard, Hitsch said during the Quantitative Marketing and Economics Conference, sponsored by James M. Kilts Center for Marketing, at Gleacher Center October 12.

In the market for video game consoles, this tipping depends on consumers’ valuations of software and on consumer expectations, according to a study by Hitsch; Pradeep Chintagunta, Robert Law Professor of Marketing; and
Jean-Pierre Dubé, Professor of Marketing and Neubauer Family Faculty Fellow. Hitsch, Chintagunta, and Dube developed a model, calibrated with data from the video game console market that generates predictions that can be used to measure the extent of tipping, Hitsch said.

Two important conditions must exist for tipping to occur, he said after the conference. “The first is that you need to have consumers who base their adoption decisions on a sufficiently long, detailed forecast of which standard is going to win,” Hitsch said. “They make this forecast because they care about the availability of the software that complements their hardware.”

Second, the consumers’ forecasts must agree on which standard will win.  “If these two conditions are met, you will find that markets with indirect network effects can become very concentrated,” Hitsch said. “Within possible short periods of time, the market tips strongly toward one standard.”

A more commonly known example of competing standards was the battle between VHS and Betamax videocassettes about 30 years ago, he said. “Initially they were battling with each other,” Hitsch said. “In the end, the Sony standard, Betamax, lost out. VHS got a sufficiently large market share and drove Betamax out of the market.”

In the video game console market, Xbox competes against PlayStation, he said. Consumers have to choose a standard but don’t want to be left with the system that loses the market battle, Hitsch said. “Your initial investment is for a console or player,” he said. “But they are mostly completely useless by themselves. You only get value if your console’s manufacturer makes a good investment in software titles, or games.”

For those reasons, consumers follow market trends, Hitsch said. “Indirect network effects means in the end I care about how many people have adopted Xbox or PlayStation, not because I care, per se, but because if more other people adopt or will adopt a particular standard, that means there will be lots of titles for that particular standard,” he said.

Such markets create two interesting business issues, Hitsch said. “The first is that below-cost pricing is a crucial element of success,” he said. “You want to do it even though if it creates a loss on your current consoles, because you get momentum towards your standard that allows you to make up for your early losses.”

The second issue raises the specter of antitrust violations, Hitsch said. “This was a big deal in the Microsoft antitrust case, where they were accused of engaging in bad acts to kill Netscape essentially,” he said. “Our research says these markets have the potential of becoming very concentrated, close to monopoly-like, without the firms engaging in anything illegal. That’s just the nature of the markets.”

- Phil Rockrohr