Business Dynamics and System Modeling

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Chapter 10: Path Dependence and 
Positive Feedback
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Pard Teekasap
Pard Teekasap
Southern New Hampshire University
 Outline
1. Path Dependence
2. VHS VS BetaMax
VHS VS BetaMax
3. Positive Feedback of Corporate Growth
4. Positive Feedback and Economic Growth
5
5. Modeling Path Dependence and Standard
Modeling Path Dependence and Standard 
Formation
 Path Dependency
Path Dependency
A pattern of behavior in which small, random 
events early in the history of a system 
y y y
determine the ultimate end state, even when 
all end states are equally likely at the
all end states are equally likely at the 
beginning
E.g. the clockwise movement of the clock, VHS 
f
Vs BetaMax, QWERTY Vs Dvorak keyboard
 Stable Vs Unstable Equilibrium
Stable Vs Unstable Equilibrium

P*

P*

Equilibrium
q Position of Equilibrium
Position of + P iti
Position
+ Ball (P) Position Ball (P)
(P*) (P*)

+ R +
B -
- Force on Discrepancy
Force on Discrepancy
Ball (P - P*) Ball (P - P*)
+
-
Black & White Stone: Polya Process
Black & White Stone: Polya
+
Black Stones
Added per
R Period
+
Proportion of Black
Bl k St
Black Stones Stones
+
-
B
+
Total Stones Random
Number of Added per
Stones Period Draw
+
B

- +
White
Proportion
P ti off
Stones
White Stones
R +
White Stones
Added per
+ P i d
Period
 Result from 10 runs
Result from 10 runs

1.0
Stones

0.8
portion of Black S

0.6

0.4

02
0.2
Prop

0.0
0 50 100 150 200
Time (periods)
 The Diffusion of VCRs in US
The Diffusion of VCRs in US
Sales of VCRs and Prerecorded Tapes in the US
100

12

Tape Sales (million/year)

VCR Sales (million/year)

75
VCR Sales
(left scale)
8
50

4 Prerecorded Tape Sales Fraction of US Households with at least One VCR

(right scale) 25 100

0 80

ent of Households
s
0
1975 1980 1985 1990 1995
60

40
Average Price of VCRs

Perce
2500
20

2000
0
1975 1980 1985 1990 1995
1500
$/Uniit

1000

500

0
1975 1980 1985 1990 1995
 Share of BetaMax Vs VHS
Share of BetaMax
US Sales of VCRs by Format

12
on Units/Year

Total VCR Sales

8

VHS
Millio

4 US Sales of Prerecorded Tapes by Format

100
Beta

Total
80

e Sales
0
1975 1980 1985 1990 1995

ar)
Prerecorded Tape
(million/yea
60
VHS

40

Market Share of VHS Format VCRs and Tapes 20

100
B t
Beta
VHS Share of VHS Share of
Sales 0
80 Tape Sales
1975 1980 1985 1990 1995
Share (%)

60
Market S

40
VHS Share of
Cumulative Sales
20

0
1975 1980 1985 1990 1995
 BetaMax Vs VHS
Vs VHS
• 1975; Sony introduced BetaMax
• 18 months later; VHS was introduced
18 months later; VHS was introduced
• 1988; Sony abandon BetaMax
• Based on your idea, which factors affect the 
results of the competition?
p
• Draw a CLD to explain the dominance of VHS 
i th h
in the home VCR market
VCR k t
 Positive Feedback of the Corporate 
Growth
• There are many feedback loops for the 
corporate growth
p g
• The following diagrams present loops in a 
highly simplified format without considering 
highly simplified format without considering
the competitors and omitting many negative 
feedbacks
 Product Awareness
Product Awareness
• Customers become aware of firm’s products 
through
g
– Advertising
– Direct sale
– Word of mouth
– Media attention
Advertising and Direct Sales
Advertising and Direct Sales
Word of Mouth and Media
Word of Mouth and Media
 Unit Development Cost
Unit Development Cost
+
+
Sales
Expected
p Fixed Costs of
+ Market Size Development and
Production
-
Industry Market Unit Fixed +
R10 R11
Demand Share Costs
Demand from Share from
+ Spreading + Spreading
Fixed Costs Fixed Costs
+
Unit Costs
Product Unit Variable
Attractiveness + Costs
Price
- +
Production Cost
Production Cost
Network and Compatibility Effect
Network and Compatibility Effect
 Product Differentiation
Product Differentiation
+
Price

+
R20
Sales + +
Price Premium +
Effect
Revenue

Industry R19 Market

Demand Share R18
Product +
Price Premium + Differentiation +
(Total Demand Product Investment in
f Superior
for S i Effect) Differentiation
(Share Effect) Product
Technology
Features
Product
+ Attractiveness

+ Product +
Features:
• Functionality
• Suitability to Customer Needs
• Quality and Reliability
• Service and Support
• Other Attributes
 New Product Development
New Product Development
Price
+ +
+
Revenue

Sales
R22 +
+
R21
Price Premium Product
for Uniqueness
New U
N Uses,
Development
New Needs Capability
Industry and Effort
Price Premium for Demand
Unique New
+
Products
New +
+ Products
 Market Power
Market Power

+
Sales
+ +
+ +
IIndustry
d t Market Market Market Market
Demand Share Power Over
R23 R24 Power Over R25 Power over
+ Suppliers Labor Customers
+ Power over Power over Power over
Suppliers Workers Customers
-
Product -
Attractiveness Unit
Costs
- Price
+ -
 Mergers and Acquisitions
Mergers and Acquisitions
+
+ Financial
Sales Resources
+ + +
Industry Market Acquisition of
Demand Sh
Share Acquisition of
R26
Suppliers and
R27 Rivals
+ Customers
+
Vertical Monopoly
Integration Power
Product +
Attractiveness Economies +
of Scale Market Power over
-
Suppliers,
pp , Workers,,
Price Unit - Customers
Costs
+ -
 Workforce Quality
Workforce Quality

+ +
Sales
Revenue
+
+
+
Industry Market Growth
R28 Profit R29
Demand Share Rate
+ Wage
g Career
+ Premium Growth
+
Product Wages and +
Attractiveness Benefits Perceived
P i d Career
C
Quality of Opportunities
+ +
Workforce
+
 Cost of Capital
Cost of Capital
+
Recent
+ Revenue
+ Revenue
+ -
Sales +
+ R33
- Recent
Profit
G th Growth Rate
Growth
Premium
Industry
Demand Market
+ Share R31
+
+
Effect of Cost Expected
Reduction R30
on Sales Future +
Effect of Cost Earnings
Reduction
Product on Profit
Attractiveness +
Stock Price
+ -

Cost of -
Price Unit
+ Costs Capital
p
R32
+

Effect of Cost
Reduction on
Investment

Investments in
Innovation,
-
Quality, and
Differentiation
 Golden Rule
Golden Rule
+ Business
Success

R34

The Golden Rule +

Favorable
Organizational Size
Rules of the
and Influence
Game

+
 Motivation

Level of
+ Achievement
Stretch
R35
+ + Factor
Stretch Desired
Objectives
Achievement
B -
Motivation, Performance Shortfall
Effort, (Gap between
Investment Aspiration and
A hi
Achievement)
t) +
+
 Synergy between loops
Synergy between loops
• All the loops work together
• However, not all positive feedbacks that drive 
However, not all positive feedbacks that drive
corporate growth are compatible with one 
another
 Positive Feedback and Economic
Growth
• Specialization and productivity
• Adam Smith stated that as a process is divided 
p
into a larger number of routinized operation, 
productivity grows because specialization enables 
productivity grows because specialization enables
people to learn faster
• Krugman: Even though two countries have 
K E th ht ti h
identical resources, they should produce only one 
thing and trade because specialization boosts 
hi d d b i li i b
productivity, hence total output increases
 Economy Lock In to Inferior 
Technologies?
• If a dominant determinant of product 
f d i d i f d
attractiveness is compatibility and the availability 
of complementary goods, a firm might become 
f l t d fi i ht b
the market leader even though its technology is 
inferior
• The likelihood of locking into an inferior
technology increases with the strength of the 
h l i ih h h f h
positive loops that confer advantage to the 
market leader independent of the attributes of 
k tl d i d d t f th tt ib t f
the technology
 How to reset the lock in
How to reset the lock in
• It happens when the system in which the 
standard is dominant becomes obsolete or is 
itself overthrown
• The mass extinction event removed all the 
The mass extinction event removed all the
market share so the selection of new thing is 
once again strongly influenced by random 
f
events
Model Structure for Path Dependence
Model Structure for Path
 Effect of the sensitivity of 
attractiveness
1.00
ess)
hare (dimensionle

0.75

0.50

s=1 Share 1 = A1/(A1+A2)

Market Sh

0.25 s=2 A1 = EXP(s*Installed Base 1/Threshold)

s=4 A2 = EXP(s*1)
s=8
M

s = 20
0.00
0.0 0.5 1.0 1.5 2.0
Installed Base of Product i
Threshold for Compatibility Effects
(dimensionless)
 Simulation of the installed base
Simulation of the installed base
1 00
1.00
et Share, Firm 1

0.75

0.50
Marke

0.25

0.00
-1 0 1 2 3 4 5 6 7 8 9 10
Years
Evolution of the distribution of market 
share 0.50

t=0
0.50 0
0 1

t=2
0.50 0
0 1

t=4
0.50 0
0 1

t=6

0.50 0
0 1

t=8

0.50 0
0 1

t = 10
0
0 1
Market Share,
Firm 1
Hypothetical phase plot
Hypothetical phase plot
1

Unstable
Equilibrium
e Productt 1
(dimensionless)

Stable
Equilibrium
Marrket Share

Stable
Equilibrium
0
0 1
IInstalled
t ll d Base
B off Product
P d t1
Total Installed Base
(dimensionless)
Phase plot at different installed based 
of product 2
1.00
et Share Product 1

0 75
0.75
dimensioonless)

0.50 B2 = 0.1

B2 = 0.5
(d
Marke

0.25
B2 = 1

B2 = 2
0.00
0.00 0.25 0.50 0.75 1.00
Installed Base of Product 1
Total Installed Base
(dimensionless)
 Policy Implication
Policy Implication
• When a new product is first introduced
h d f d d to a 
market where no prior standards have been 
established, the network effect is likely to be 
quite week. Market share will be determined 
primarily by other product attributes
g
• As the installed base grows and the network 
effects become stronger, the chance that a 
late entrant can overcome the advantage of
late entrant can overcome the advantage of 
the first mover declines rapidly