HW 6 Solution Set

due November 8 (yes, you really have two weeks this time)

Last modified 11/8/99 --PR
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Chapter 8

Recommended: for those interested in understanding the material in chapters 7 and especially 8 in more depth, you might want to peruse a very readable book that's gotten a lot of attention recently. Information Rules: A Strategic Guide to the Network Economy, by Carl Shapiro and Hal Varian.

Check the syllabus for the readings for November 8.

Text exercises

  1. (2) E7.10 Suppose there is an industry effort to create a standard user interface for word processing programs, so that all programs would provide a common set of features, with the same look and feel (e.g., the menus for invoking formatting features would be identical). Following the open-closed principle of interfaces, individual vendors would be free to add features, so long as they preserved the common way of performing the operations specified in the standard.
    1. What might motivate Microsoft, Corel, or Red hat to participate in this process? (If you don't know what these companies do, find out about them by searching on the Web).

    2. Users might prefer the standard interface, for ease of learning and companies to please users. There would be one combined "network" to gain network effects from, possibly increasing the total number of word processing users.
    3. Why might they choose not to participate?

    4. It might inhibit innovation. Perhaps more importantly, it reduces customer lock-in, and thus makes it hard to charge premium prices.
    5. Are the answers to a and b different, based on the companies' current market share in the word processing or operating systems market?

    6. A company with greater market share in word processing (e.g., Microsoft) would get less benefit from the larger combined network, and would lose more from losing the lock-in. A company with less market share would be less concerned about lock-in and more concerned about having a chance to lure away its competitors' customers. Market share in the operating systems market should not make much difference.
  2. (2) E8.3 Concisely answer the following questions:
    1. Does vertical integration make it easier or harder for a company to achieve customer lock-in?

    2. Actually, vertical integration of the company doesn't make any difference. A stovepipe product architecture does make it easier to achieve customer lock-in, because the customer has to replace the entire integrated product in order to switch, rather than being able to replace a component at a time.
    3. Does product diversification make it easier or harder for a company to achieve customer lock-in?

    4. Diversification can make it a little easier to achieve customer lock-in. If customers have high coordination costs for shopping from multiple companies, and hence prefer buying from a single diversified company, those coordination costs help to lock the customer in to the diversified company. A customer has to overcome those coordination costs initially in order to buy from a non-diversified company, and hence is less  locked in after purchase.
    5. Does the presence of a widely used open horizontal interface between two layers make vertical integration more or less attractive to a company?

    6. A popular, open horizontal interface between two layers make vertical integration less attractive. A  company that sells products at both layers will need to compete separately in the market for each layer (customers can buy from the company in one layer's market, and from a competitor in the other layer), and coordination between the product development teams is easy with the open interface, so there is little advantage to vertical integration.
    7. The text describes lock-in as resulting from complementary assets. Suppose that a vendor sells a single product for which there are no complementary products (though there may be some near substitutes). Is there any way for a vendor to create consumer lock-in for such a product?

    8. Network effects can create lock-in even in the absence of complementary products. If a vendor establishes a large customer base, customers may not want to switch to a competitor's substitute product, because they would not be using the same product as the other customers.
  3. (2) E8.6 What pricing and versioning strategies would be most advantageous to the seller for each of the following products or services sold over the network? Briefly justify your opinion.
    1. Restaurant reviews and recommendations

    2. Frankly, it's hard to see how you'd get consumers to pay directly for these, even wealthy consumers. You might consider charging the restaurants, or getting advertising revenue.
    3. A software application for managing investment portfolios

    4. The people with the largest portfolios would probably be willing to pay more, so you could have a pricing structure that charged more based on the size of the portfolio.
  4. (2) E8.8 For each of the following, what form of intellectual property protection would be suitable for preventing appropriation by other suppliers
    1. A new technique, using cryptographic methods, for protecting information content (e.g., music and videos) from piracy

    2. Patent.
    3. The name of a new word processing application

    4. Trademark
    5. The specification of an internal module for an application

    6. Trade secret (you want to keep this functionality encapsulated by keeping it secret)
    7. A song commemorating the anniversary of the invention of the computer

    8. Copyright.
  5. (2 bonus points if you actually come up with a good alternative; I'm not expecting that you will)  Suppose you have been hired as a political lobbyist by the American Library Association (ALA). Congress has expressed a desire to keep so-called harmful-to-minors materials from reaching children over the Internet and has proposed legislation that includes a requirement that libraries install software filters on at least some of the  public access terminals in order to receive federal funding. The ALA has taken a strong position against use of software filters on Internet terminals in libraries: one of the fundamental values of librarianship has been to promote access to information, and any content-based restriction on what patrons access calls that fundamental value into question. Your political advisors, however, tell you that it's unwise and ineffective to just be against the legislation, that you need to propose some alternative(s) that will make Congress and the ALA look good while still preserving the values that the ALA holds dear. What alternative(s) would you suggest?
      This is a tough one that the ALA and civil liberties groups haven't adequately solved. There are lots of  possibilities that would increase children's positive uses of the Internet and/or reduce their access to controversial materials, but few of them both give the U.S. Congress a role and at least arguably fit within the core values of librarianship.

      Some of the possiblities include:

Explanation exercise (2)

Explain the concept of network externalities to someone, and why it is so important to understanding the evolution of the computer and communications industry.