Information and Communication Technology Policy and Strategy

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Lecture 2

Physical Networks: Technology and Economics

How is technological advance converted into market developments?

Step One: Introducing connectivity and system integration

Improvements in technology over time open new opportunities – (seems obvious)

Slightly more subtle is the idea that these improvements are influenced by past success – so past technological success fuels more intensive search/discovery which may or may not generate new opportunities

The ‘trends’ we considered last week are all examples of this process and we call them ‘technology trajectories’

However, whether these new potentials are exploited is a question rather than a certainty. To reap the economic and social potential of technological trajectories

requires meaningful new applications.

Sometimes these application ‘stand alone’ – e.g. one may make a digital thermometer for use in the kitchen to replace thermometers based on mechanical technologies

More often, new applications involve connection with other devices or software in one or both of the following senses:

Connectivity – ability to ‘send’ or ‘receive’ data

System integration – ability to function as a component in a larger system typically involving some sort of ‘programmed control’

The Early Years of Semiconductor-Based Electronics

Some applications, e.g. the telephone network, were built on the principle of centralised planning – technocratic or techno-socialist approaches to large technical system applications predominated until relatively recently (see T. Hughes Networks of Power)

If we look at the world of ICT in 1968, we see the dominance of large system companies like AT&T, Siemens (Germany), IBM, Bull (France), Fujitsu (Japan), ICL (UK)…

These and similar large companies produced systems using ‘discrete’ (individual) electronic components for telecommunication and computing applications.

A somewhat larger collection of large and medium sized companies built other electronic devices ranging from televisions and radios to hearing aids and scientific instruments.

The components used by these companies were very elementary and hence circuits for complicated applications were very complex…

Motivation (2) – How is technological advance converted into market developments?

A small part of a circuit constructed with ‘discrete components’

Motivation (3) – How is technological advance converted into market developments?

The Early Years of Semiconductor-Based Electronics: Consequences

The complexity of discrete based systems meant each system involved substantial design and construction cost – systems had to be comparatively simple if they were to be affordable or very valuable in application in order to justify their cost…

A System 360 installation costing

in excess of £15 million pounds in

current £s and having capacities

similar to a medium priced laptop of today (e.g. £600)

A 1970 era consumer transistor radio

advertising ‘17 transistors’ and having

the capacity to receive a wide range of

radio signals

For this device to be affordable, many units

had to be produced to justify the design costs

and each unit was affordable but relatively costly due to the costs of construction (which increasingly used labour from low wage countries)

Even then, Sony was forging ahead in design with the first integrated circuit

Radio (14 transistors)

(these images are approximately

correct in relative size)

The Revolutionary Technological Transformation and its Consequences

Beginning in 1961 with the integrated circuit and accelerating in the 1970s with the

microprocessor the components used to construct systems embedded the complexity

of the entire circuit which had previously required individual customised designs.

It became possible to build very complex systems with only a few of these components.

However, this opened a very big question…

Would the dominance of earlier technological era (valves/tubes and discrete transistors) companies persist?

To understand what happened we need to compare two different methods of organising the design and production system…

Centralised planning, a good way to achieve rules for connectivity, is a particularly bad way to support innovative initiatives for exploiting the technological opportunities that emerged from the technological revolution

In the military competition between the Soviet Union and the West one of the most conspicuous shortcomings of the Soviet military was military electronics for command, control, communication and intelligence.

Was this due to an absence of rules or an absence of technological variety?

Systematic European plans to employ ISDN (a consensus plan) in upgrading data communication networks was not successful because of the emergence of alternative digital technologies such as dial-up modems.

The rules were not technologically flawed, but they did constrain the speed of innovation by limiting variety.

Variety is not necessarily good – but when it comes to innovation, variety offers the potential to SELECT better outcomes. Notice the conflict with (some) engineering approaches – the best or optimal solution – suggesting only one best way.

Shortcomings of centralised planning

The shortcomings of centralised planning suggest a market solution.

However…

Individual design initiatives (market-led initiatives) do not necessarily support connectivity.

There is a fundamental tension between the variety generation needed to exploit technological opportunity and the standardisation needed to achieve connectivity.

In addition, there are incentives are to create proprietary interfaces and data structures because of the possibility to have market power and high profits if they are successful.

Angry orphans – buying the wrong technologies creates orphans

Blind giants – efforts to regulate variety generation by government is dangerous because despite their size and power, governments are not well informed about technological issues

Ways of resolving these tensions are examined in this session.

Motivation (3) Market solutions do not necessarily work either

A Tool for Thought – Evolutionary Theory

Evolutionary theory provides a useful metaphor for thinking about the interplay between

‘variety’ and ‘selection’

In biological evolution, ‘mutation’ is the variety generation process, while in socio-economic evolution it is ‘innovation’

In biological evolution ‘sex and death’ are the selection methods, while in socio-economic

evolution the selection methods at the ‘meso’ (industry and market) level are institutional

re-combination (merger, acquisition, networks of co-operative agreements, etc.) and market failure. At the ‘micro’ level (among firms) selection involves competition for customers and the potential for failure (‘death’).

Biological selection methods are usually believed to be ‘hard.’ Mutations are either

confirmed as adaptive and resilient to environmental conditions by the processes of survival and reproduction or they are rejected by failure to reproduce and death.

Socio-technical selection is ‘soft’ (by comparison) since organisations can often achieve some measure of control over their environment. It is difficult to make general statements about whether this ability to influence the environment favours more rapid or ‘better’ evolution.

Comparing Evolutionary Theory and Rational Planning

Both conventional economics and other ‘positivist’ disciplines associated with rational

planning (e.g. industrial engineering) assume that choices are made among competing alternatives based upon ‘best available’ information and with a clear ‘objective’

Engineering designs, especially those involving digital electronics, involve a multiplicity

of design choices and many ‘arbitrary’ decisions about how to solve certain problems

It is often the case that many different design decisions will be equally effective in

achieving a design purpose

These alternative designs are still likely to involve different levels of ‘performance,’ or

‘quality’ or other attributes that would influence economic competition.

Available resources are most often too limited to explore all of the economically relevant attributes of design alternatives. Therefore the ‘best’ alternative cannot even be identified.

Under these conditions, what governs the selection process?

One possibility is that selection is just about luck…If this were true, however, the selection

process would not only be ‘hard’ but it would be very arbitrary – it would destroy capabilities

that might be useful in future design competitions.

Economic and engineering theory argue for optimality, the real world allows something less. Designs have more than a single attribute and customers differ in their preferences for these multiple attributes.

In the real world, therefore, the problem could be too much variety because the selection process is too ‘soft’ (too many alternatives are viable). This could be costly to both firms and society – too much money spent on implementing similar, but distinct, designs.

Against this is customers desire to have ‘compatibility’ – to reduce their costs of learning about the features of multiple products or services. The desire for compatibility creates ‘band wagon’ effects in which everyone chooses the same implementation. Now, again, we have a ‘hard’ and ‘arbitrary’ selection process

In the electronics industry, unlike the toothpaste or breakfast cereal industry, firms have chosen a governance process to preserve some variety and to reduce the force of bandwagon effects from pure market competition

This governance process is ‘technical compatibility standardisation’

Fitness is not the same as Optimality

Technical Compatibility Standards

Technical compatibility standards are an alternative to using market competition to select technical designs

Technical compatibility standards are an extension of ‘reference standards’ such as

units of measure or chemical purity that have a long history

Standards may be achieved through deliberative process and we call these standards de jure. De jure standards-making may involve either voluntary processes (managed by suppliers) or mandated processes (typically established by governments, but also by larger users)

In cases where de jure standards-making is not employed (typically due to strong

competing interests among profit-seeking firms) the process of market competition may, nonetheless, produce a de facto standard. De facto standards may be endorsed or regularised by voluntary or mandated standards-making processes.

Public standards making organisations face difficult problems because their processes may be more deliberative (slower) than either private consortia or de facto standards.

The problem is that non-public or ‘sponsored’ standards are not necessarily pro-competitive – they may favour market concentration and power

USB 1.0

USB 2.0

USB OTG

Certified Wireless USB

(competes with Bluetooth)

USB 3.0

1.5/12 mbps

280 Mbit/s

3.2 Gbit/s

Case Study: USB Standards

A fairly neutral standard

Competitive Strategy and Standards

The gains from conforming to a standard are that a larger market for ‘inter-operable’

components is formed

The cost from the viewpoint of the supplier is the creation of greater competition. At

the limit, producing a ‘standard’ component can be like producing a simple commodity

like nuts and bolts. The consequence is very low profit

A firm that is able to produce at a lower cost or is able to deliver greater quantities to

the market than rivals will seek to establish a standard.

If other firms are not able to benefit from ‘one’ standard they are likely to create

alternative and competing standards

The ideal position is to be in a position to define the standard and prevent imitation.

Since electronics markets are following Moore’s law and other trajectories of

improvement, the supplier also needs to periodically introduce new products that

re-define the standard in ways that are favourable to its interest

This is what Microsoft, Intel, and a number of other companies do.

Regulation of Inter-Operability

Governments may choose to accelerate standards-making processes by subsidising standards making or organising the process

Another approach is to require ‘inter-operability’ or to eliminate barriers to achieving inter-operability

Producers of telephone equipment have typically been required to follow particular compatibility standards to safeguard and improve telecommunication networks

In Europe and the US, the copyright law on software explicitly allows imitators to ‘reverse engineer’ the interfaces in existing software products computer interfaces for the purpose of achieving inter-operability

Governments may also set standards through procurement requirements

These are all complex and difficult decisions because:

1) the time at which a standard may be set is short

(delay may allow competing standards to emerge),

2) it may be difficult to avoid locking users into an ‘inferior’ standard

(e.g. US television picture standards) and

3) users of alternative standards may be orphaned by the decision

(creating a political protest)

Are Technical Compatibility Standards Pro-Competitive?

Ideally, yes. But several things can go wrong…

Technical compatibility standards create a larger market and encourage faster market

development. Both are likely to enhance competition by encouraging investment.

A standard may, however, favour a single company or a small group of companies

and enhance its/their market power

Windows, an operating system standard, is owned by one company

Implementing GSM or CDMA technology requires patent licenses that are held by

a small group of companies or one company

Standards tend to suppress alternatives and may lock users into an inferior standard

or one that is expensive to improve. These problems can be ameliorated through policy:

1) standards can be required to be ‘open’ (access to the technologies required to

use the standard must be in the public domain or equally costly to all players)

2) the formation of new standards should not be blocked so that competing

alternatives are designed

It is important to keep in mind that ‘sunk costs’ have transitory or no effect on

business decisions. Similarly user ‘lock-in’ is often transitory.

BROADCOM CORPORATION,

Plaintiff,

QUALCOMM INCORPORATED,

Defendant.

…international and United States standard-setting bodies only adopted UMTS as a mobile telephone standard after Qualcomm represented in writing that it would license its WCDMA patents on fair, reasonable and non-discriminatory (that is, so-called "FRAND") terms. The adoption of the UMTS standard led mobile telephone services carriers to invest billions of dollars in developing UMTS phone systems.

But after the UMTS standard was adopted, giving Qualcomm monopoly power in the WCDMA technology markets, Qualcomm disregarded its FRAND commitments. Qualcomm has instead leveraged its WCDMA patents in an attempt to expand its monopoly power into the separate market for the sale of the UMTS chipsets that provide basic operational functionality for UMTS phones. Indeed, Qualcomm is now employing with respect to WCDMA and UMTS the same types of unlawful and anticompetitive tactics that Qualcomm has already used to gain tight monopoly control of the markets for technology and chipsets applicable to another third-generation mobile phone standard based on Code Division Multiple Access ("CDMA") technology.

A Legal Dispute Over Standards

and Patent Issues…

Qualcomm and Broadcom announced Sunday that they have agreed to end patent litigation between the companies worldwide, with Qualcomm paying Broadcom $891 million, according to the announcement.

A Legal Dispute Over Standards

and Patent Issues…the second outcome

Brooke Crothers

26 April, 2009

http://news.cnet.com/8301-13924_3-10227815-64.html

18 February 2009

http://arstechnica.com/gadgets/2009/02/qualcomm-hedges-standards-bets-with-new-35g4g-chip/

A Legal Dispute Over Standards

and Patent Issues…the first outcome

Platforms – What are they?

Platforms are systems comprised of component products

and/or services that must be integrated to become useful.

Platform integrators are companies that have the knowledge to perform the integration when the final user is not willing or able to do so.

Component suppliers are the companies with the knowledge to produce the components integrated into the system.

Knowledge is required to integrate components into platforms – in particular, reliable knowledge of the interface between components

Examples

Source: Microsoft Encarta

http://encarta.msn.com/media_461520476/Personal_Computer_Components.html

The Generic Personal Computer Platform

Leading Mobile Phone Platforms

iPhone

Samsung

Multi-Supplier Stereo Component Platform – Not the Platform we have in mind!

Why not?

Source: Tampa Cabinets

http://www.tampacabinets.com/residental.html

Creating a Platform

Platforms are a kind of innovation

Their acceptance by the market is uncertain

First implementations will later appear crude

Their success often involves adoption network externalities (the value of the platform increases with greater numbers of users)

Each type of standardisation process has advantages and disadvantages in the design of a platform