The next-gen DVD war between HD-DVD and Blu-ray is over, and Blu-ray won. Now Engadget reports that Blu-ray player retail prices are increasing. This is not really surprising. In a market like this that is dominated by network effects, there is typically strong competition for the market in the early stages. Then a dominant standard emerges and can raise prices to make profits until the next new technology comes along.

If you only focus on the latter stages, it can look like a bad deal for consumers. However, taken as a whole (over time), competition may be no less intense than in other markets. When making an assessment of consumers’ welfare, we should consider those who bought early at a low price as well as those who buy later at a higher price. On the other hand, those who buy early also run the risk of picking the wrong standard and getting stranded. Anyway, my point is that to make a judgment about intensity of competition and consumer welfare in these markets we need to take a long-run perspective.

Check out this Google horror story, about a guy who was using Google services for his email, blog, calendar, etc. He fell victim to a phishing attack, and Google deleted his account — all his data gone. At first Google said they weren’t willing to restore it; eventually they did thanks to publicity and connections.

This is exactly the kind of thing that makes me cautious about using online services for anything important. There are currently fourteen web-based spreadsheet services available, and I’m not using any of them. It’s not because they’re no good, but because I worry about whether I’ll be able to access my data a few years down the track. One advantage of having a long-lived de facto monopoly like Microsoft is that, 13 years later, I can still easily open a file I created in Excel 95.

I think I’m not the only person who cares about being able to access his data in 10 or 20 years’ time. Hopefully the online applications providers will realise this and support open document standards, as well as letting me download my data and keep my own copy.

Many people are familiar with the “tragedy of the commons”. This is the idea that a common resource will be overused by its users, to their detriment. The classic example is a common field in a village that farmers can use for grazing sheep for free. When deciding how many sheep to graze on the field, each farmer will ignore the negative effect that his sheep have on the sheep of the other farmers that use the same field. Too many sheep on a fixed amount of grass means skinny sheep, which is bad for the farmers. Unless they can somehow coordinate their actions, the joint value to them of the field will be less than its maximum possible value. They could solve this problem by getting together and allocating quotas for using the field, or given ownership of the field to someone and let them charge a price for using it. Either way (in theory) it’s possible to achieve the optimal usage of the field, to the benefit of all.

The tragedy of the anticommons doesn’t get as much airtime, but it’s equally important, especially in high-tech industries. This is where a common resource has too many owners. Imagine the farmers’ field had three separate gates that you have to pass through to access the field. Each gatekeeper sets his own price to use the field independently of the other gatekeepers. When setting prices, each gatekeeper will realise that if he raises his price, fewer sheep will be grazed on the field. This is the normal demand response, and how strong it is will determine whether it’s profitable to raise his price or not. What he fails to take account of, however, is the fact that raising his price reduces the demand that all the gatekeepers receive. Since all will behave in this way, each will have a tendency to set a higher price than would prevail if all the gatekeepers got together and set a single joint price for grazing.

Thus the tragedy of the anticommons has the opposite effect of the tragedy of the commons. With a commons, a lack of ownership means it is over-used. With an anticommons, too many owners means the resource is under-used. Why is the anticommons important in high-tech industries? The answer is intellectual property rights. Many high-tech innovations, as well as standards, are based on multiple intellectual property rights, like patents. If the patents have different owners, an anticommons problem can result. In that case, the ‘field’ is the innovation that makes use of the patents, and the ‘gatekeepers’ are the patent owners. Each patent owner effectively controls access to the innovation, and so there are multiple ‘gates’ that have to be passed through to use it.

This problem can easily come up in the process of standards formation. For example, the patents that define the DVD format standard are owned by a number of different firms. Without some sort of coordination, it’s likely that royalties for DVD technology would be very high. The way around this problem is joint setting of the royalties by the relevant patent owners. In this case, ‘collusion’ among patent owners is actually beneficial. Without coordination, royalties end up being too high which hurts not only the patent holders but the downstream users of the technology. Joint royalty setting will result in lower royalties that are beneficial for all.

As innovation progresses and the number of patents or other intellectual property rights increases, it becomes more likely that further innovations or standards will depend on multiple rights held by different owners. Thus centralisation and coordination of royalties will become more important considerations in standards-setting processes and other forms of innovation.

Standards are becoming ever more important in IT, communication and entertainment industries. The very fact that you can view this web page is thanks to standards. Your browser knows how to display the standard known as hypertext markup language (HTML), which is a set of rules for specifying how text and other elements display in your screen. My web server communicates with your browser thanks to the HTTP standard, and other standards are used for the pictures and the font formatting, and so on.

Standards are useful because they allow competition. Different web browser programs are available and can compete with each other because they all understand the HTML standard and other important web standards. Without these standards, we would have competing proprietary systems for web servers and browsers that would only work together in specific pairs. Either one proprietary system would emerge as dominant, destroying the benefits of competition, or a number of separate incompatible systems would exist, making life difficult for web publishers and web surfers.

On the other hand, standards themselves exhibit network effects. A standard becomes more useful the more potential users of the standard adopt and support it. This means that it’s often the case that a single standard dominates in a given area. HTML is the only dominant standard for displaying web pages. Similarly there’s one standard format for CD-ROMs and DVDs. Because of these network effects, ‘owning’ a dominant standard can be a profitable thing for firms. This means that firms tend to compete hard to establish their preferred standard in the first place. At the moment there’s hot competition between Blu-ray and HD-DVD to become the dominant next-generation DVD standard. Because of this intense competition ‘for the market’, the fact that a single standard eventually dominates might not be so bad. Consumers might benefit from the intense competition in the beginning, even if there is a lack of competition later. Also, history has shown that standards tend not to be dominant forever. Technological improvements mean that standards become obsolete and get replaced.

To me, the process of standards formation is quite interesting, especially when a standard involves multiple parties. Such standards are known as ‘consortium standards’ and depend on more than one key technology. Establishing such standards requires cooperation among firms that normally compete. They do so because they recognise the benefits of standardisation even if it means that competition between them once the standard is established will be intense. In other words, intense competition within a market can be preferred to winner-takes-all competition for the market.

ConsortiumInfo.org is an interesting website and blog about the process of forming consortium standards. They discuss in detail the events in standardisation processes and how the various parties use different strategies to try to manipulate the process. There are a number of strategic considerations that come up when establishing a standard requires the agreement of multiple parties. Essentially, the inputs of the parties are complements in the production of the resulting standard. What each does affects the outcome for the others. In the next post I’ll discuss some of the important strategic considerations.