This is a presentation I’m preparing for “Tech Startup Conference: Artificial Intelligence” being held on September 26, 2017.
1. Issues Covered
- Adoption of New Technology Systems: What does it take for new technologies to become successfully adopted in the marketplace? Why do some technologies become adopted while others do not?
- Value Creation: How do the components of the system combine to create value for the different players? Can the environment be changed so that the system will create more value?
- Value Extraction: How much value does each player extract? In particular, are players extracting as much value from the system as they can?
2. Game Theory Basics
You and I are in a Game if what you do affects what I get. More technically, a Game consists of a set of:
- Players: The entities whose payoffs depend on the actions of the other players;
- Actions: The actions available to each of the players in the game; and
- Payoffs: How much each player gets under each set of actions available to each of the players in the game.
Game Theory helps us understand
(i) How players are interconnected, that is, how exactly their actions affect the outcomes that other players get;
(ii) What the expected outcome will be under the current environment; and
(iii) How to change the environment to get "better" outcomes for a particular player.
I will discuss what constitutes an “environment” in more detail later (Section 7).
3. Smartphone Game
Let’s consider a specific example of a game: the Smartphone Game. There are three sets of players in the Smartphone Game (see Figure 1):
1. OS Developers: The technology that drives the smartphones systems is the operating system, developed by Apple and Google.
2. Software Providers: To create value for Users, smartphones must be used in conjunction with other products and services, namely
Carriers to provide voice and data services (e.g., AT&T or Verizon),
Apps provided by Apps Developers, and
Accessories provided by Accessory Providers.
3. Users: Smartphone handsets, services, and accessories are purchased by Users, who use them jointly to consume voice and data services.
Note that all the different components must be used together at the same time for Users to be able to generate the user experience provided by the smartphone system. That is, all the Players’ components work together to jointly create value for Users.
The amount of value created by the system overall, and for each of the Players individually, will depend on the environment and the actions each Player chooses. It is generally up to the primary technology system developers, in this case Apple and Google, to create an environment that will optimize the amount of value created by the system overall and extracted by each of the players individually.
4. Hardware-Software Game
Now let’s consider the more general case of the Smartphone Game: The Hardware-Software Game. The Hardware-Software Game applies to most any situation in which Users must combine components from multiple, independent Providers to be able to enjoy the “consumption experience” provided by the technology system (see Figure 2).
Specific applications include, for example,
- Communications Systems: Cell/smart-phones, TVs, gaming systems, electronic medical records (EMR) systems, etc.
- Transportation Systems: Cars, trains, ships, planes, etc.
- Platforms: Vendors, social media, matchmakers, etc.
- Devices: Fitbit, industrial machinery, etc.
Hardware Manufacturers (HW)
I use the term “Hardware Manufacturer” to refer to an entrepreneur who introduces the primary component of a new technology system. The “new technology system” must be different enough from currently used systems so as to be incompatible with current “software,” as defined below.
Hardware Manufacturers choose a time path of prices and strategies to
(i) optimize the provision of software by Software Providers and
(ii) encourage adoption by Users.
Software Providers (SW)
I use the term “Software Providers” to refer to Providers other than the Hardware Manufacturer who provide any type of complementary software, content, or accessories (jointly referred to as “software”) that Users combine with the Hardware Manufacturer’s component to generate value from the technology system.
I assume that at the time that the Hardware Manufacturer’s technology is introduced into the marketplace, Software Providers are deploying their resources in other uses, such as generating content for other technology systems.
Software Providers must choose the timing (how long to wait) of redeployment of their resources away from their current activities and towards providing software for the Hardware Manufacturer’s system.
Users are the potential consumers who generate “consumption experiences” from the Hardware Manufacturer’s new technology system.
When the Hardware Manufacturer introduces his new technology system into the marketplace, Users generally have some other way of doing what the Hardware Manufacturer’s system does, though perhaps not as well. Users must choose if and when to switch from the system they’re currently using and adopt the Hardware Manufacturer’s new system.
Notably, in today’s world, old systems generally entail some sort of
(ii) network effects, or
(iii) switching costs
which deter both Users and Software Providers from switching out of their current systems into the Hardware Manufacturer’s new system. In these cases, Hardware Manufacturers must overcome the lock-in, network effects, or switching costs to convince Users and Software Providers to switch to the new systems.
5. HW-SW Game Key Issues
There are three key issues to note in the Hardware-Software Game.
First, Entrepreneurs’ technologies are part of larger systems that contain multiple components that must be combined for Users to jointly generate value. More specifically, Hardware Manufacturers’ payoffs (profits) are dependent upon the actions of other players, namely Software Providers and Users. This means that the actors who participate in technology systems, together with their actions and payoffs, form a Game.
The second key issue in the Hardware-Software Game is that User adoption requires (i) that a minimum set of components be available in the market to be used to generate a consumption experience, and (ii) that the system components available at the time of User adoption provide sufficient value to users to justify their switch to the new system.
Taken together, these first two requirements generally lead to a chicken-and-egg problem between Software Providers and Users:
- Software Providers won’t provide content for the new system unless or until there are enough Users to make it profitable to switch over their resources from their current uses, while at the same time
- Users won’t adopt the new system unless or until there is enough content available from Software Providers to generate a sufficient amount of value for Users.
In the case of a chicken-and-egg problem, the Hardware Manufacturer must encourage “premature” adoption by convincing
(i) Software Providers to redeploy resources toward the new system earlier than they would otherwise do, and
(ii) Users to adopt the new system earlier than they would otherwise do.
The key is to look at the existing alternatives available to the other players and find a way to make the Hardware Manufacturer’s new system more attractive to the other players than their current systems are.
The third key issue is that technology system “success” requires harmony, that is, coordination of actions, across elements of the environment. It is generally up to the Hardware Manufacturer to choreograph pricing and strategies to achieve success, where “success” includes,
(i) successful system adoption,
(ii) an optimal pattern of system-wide value creation, and
(iii) an optimal pattern of value extraction (by the Hardware Manufacturer).
For example, Amazon, Apple, and Walmart all do tremendous jobs of choreographing the vast multitudes of components that make up their systems. As a result, these systems all create a fantastic amount of value for their owners. In stark contrast, sub-systems within both the healthcare industries (e.g., hospitals, clinics, etc.) and education industries (schools, colleges, etc.) have been cobbled together from the bottom up in completely ad-hoc manners. And as a result, while these systems generate a tremendous amount of activity, it’s wholly uncoordinated and unsynchronized, leading to massive amounts of unproductive activity and downright waste. And as a consequence, these systems fail to achieve anything close to their potential values.
6. Recent HW-SW Games
- Movies (2014): 35mm ® Digital
- 2009 Slumdog Millionaire 1st shot mainly in digital
- HW: Movie Studios
- SW: Movie Theaters
- Carrot Strategy: HW financed the purchase of new video equipment by SW
- Visa (Oct 2015): Mag Strip ® Chip-n-PIN
- Changeover announced 2011
- HW: Credit Card Companies
- SW: Merchants
- Stick Strategy: HW shifted liability for fraud to SW unless they adopted new terminals
7. Social Environment of Technology Systems
When I defined what Game Theory is in Section 2, I said that I use game theory to understand what the expected outcome will be, given the current environment, and how to change the environment to get "better" outcomes. Well, let’s unpack what the environment consists of. The Social Environment is the collection of Technology Ecosystems and Market, Government, and Cultural Environments – associated with a technology system.
In Section 5, I indicated that system success requires harmony, or coordination of actions, across all the elements of the current environment. I also indicated that it is generally up to the Hardware Manufacturer to achieve this harmony through his pricing and adoption strategies.
Well, in the full Social Environment context, it’s not just the Technology Ecosystem that the Hardware Manufacture must consider, but the Market, Government, and Cultural Environments as well (see Figure 3).
- The Technology Ecosystem consists of all the resources, hardware, software, services, accessories, and know-how needed for the technology to provide value to Users.
- The Market Environment consists of the resources, products and services, together with the mechanisms used
(i) to allocate those resources to producers,
(ii) to generate products and services, and
(iii) to allocate those products and services to customers
- The Government Environment consists of the people, together with the mechanisms available to them
(i) to generate taxes, subsidies, laws, regulations, and transfers, and
(ii) to provide for public works, that is, infrastructure, to facilitate the smooth flow of social and market activities in society.
- The Cultural Environment consists of the norms, beliefs, attitudes, practices and customs, values, stigmas and professional standards that guide people in their actions and establish trust and comfort among members of society.
8. Technology System Dynamics: Key Take Away Points
>> Technologies are systems of interdependent components that combine to jointly provide value to Users.
>> Maximization of
√ System adoption
√ Value created by the system
√ Value extracted by key players
requires strategic alignment across all elements of the environment, generally required and provided by Hardware Manufacturers in successful systems.
>> Mapping the game helps you understand the dynamics and how to change them.