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Network Effects in Office Suites

Source: http://www18.georgetown.edu/data/people/maccartm/publication-43095.pdf

 

This paper talks about the value of having a single, open standard for document formats in office suite programs.  It also talks about some of the history of how the landscape of office suite programs became what it is today.  I will mostly focus on the history aspect in this post.

There is a very large network effect consideration when people decide what office suite they are going to use.  One of the most important uses that consumers have for documents created with office suite programs is to share them with others.  This requires that the both users are using programs that support a shared document format.  This type of situation often results in a format war, such as what happened between Blue Ray and HDDVD.  Some markets, such as the video game market, have been able to reach equilibrium where several formats share the market.  However, the market for video games is fundamentally different from the market for office suites.  In the video game market, people are happy as long as they have some people to play with; they don’t need everyone they know to own the same console.  They know that if there are only a few formats, they will be able to find a format that supports the games that they like and can enjoy themselves within the network of that format.  They also have relatively little problem working with multiple formats; it is not a requirement that all formats work on the same console.  In contrast, in the market for office suite programs does not lend itself well to a few standards in equilibrium.  The more people with whom it is possible to share a document with, the more value everyone on the market gets.  At first it may seem that it is only necessary for highly connected segments of the network of human users to share the same standard, such as a group of friends or a company.  However, upon further inspection it becomes clear that one person could share a document with a friend, who shares a document with another friend, and so on.  As this pattern continues, the document will soon reach people to whom the original person has no connection.

This results in a push towards the emergence of a single winner in the standard war.  Microsoft had an advantage in this battle, as it was also making the leading operating system.  All of its competitors for office suite programs had to ensure that their programs were compatible with Microsoft Windows.  Microsoft had control over when to provide information to its competitors before each Windows update, and thus gave its own software an advantage.  As the percentage of the population using Word, Excel, and PowerPoint grew, the network effect made those goods more and more valuable to consumers.  Additionally, Microsoft decided to offer this software as a bundle at a significant discount, cornering even more of the market share.  As businesses felt the increasing need to be able to send their documents to other business, Microsoft reached a critical mass and eventually nearly everyone began to switch to the Microsoft office suite, even those users who found that they preferred a different product in a vacuum.  Finally, Microsoft solidified its place as the dominant office suite provider by making sure that its products could accept the format of other products.  This meant that users of the Microsoft Office suite could enjoy the benefits of having a network that includes many of the competitors of office programs, while users of those programs were left out of a large part of the network.  In the end, network effects played a huge role in helping the Microsoft office suite become the dominant software in the industry.

The article also argues that this dominance is neither necessary nor helpful.  It points out that the strong network effects should make it very difficult for multiple formats to compete in the market; it should not inhibit multiple vendors all working under a standard format.  It calls for a standard format to be made open, so that there can be multiple companies competing.  This will help lower prices and increase innovation.  At the same time, all users can enjoy the network effects of being able to share documents with each other because each vendor will be using a standardized document format.

Microsoft’s rise to dominance in the industry of office suite programs illustrates the power of network effects.  Once there is a critical mass of consumers using the same program, consumers will gain enough benefit from using the same product as others that this will override any small or even large differences between the products.  This story also shows how a company can use network effects to its advantage.  Instead of all companies agreeing on a standard format, Microsoft was able to benefit from a format war where it held a distinct advantage because of the popularity of its operating system.  This paper illustrates both the power of network effects and how they can sometimes stifle innovation by making it difficult for other companies to compete with a dominant company.

-TW

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