The Standardization Problem in Networks - A General Framework

Abstract

Every interaction and all coordination in economic processes is based upon communication. The exchange of information necessarily requires both the sender and receiver of a message to use a mutual language or set of communications standards. Communications standards can be generally defined as rules which provide the basis for interaction between actors (man, as well as machine). These rules must be known or determined ex ante, i.e. before communication begins. If n actors bilaterally agree to a set of communications standards, then n•(n-1)/2 rules must be defined. Such a Babylonian cacophony of languages rarely leads to an efficient exchange of information, however. The uniqueness of communications standards lies in their solely bilateral functionality; they work only when both the sender and the receiver of a message use identical or at least compatible standards. This basic principle for the use of communications standards applies to natural languages as well as to EDI (Electronic Data Interchange) for the electronic transfer of business documents or to network protocols like TCP/IP, for example. Thus, the decision to implement a standard is necessarily tied to the standardization decision of the communications partners. The user’s benefit from a given standard generally increases with the number of other users. This phenomenon— the increase of utility derived from a good as the number of users increases—is known as a positive network effect, or demand-side economies of scale, in economic terms. See for example Katz & Shapiro (1985) or Farrell & Saloner (1988). Network effects lead to the interdependence of decisions regarding communications standards by otherwise completely independent actors. This interdependence results in coordination problems because actors, such as firms, do not know in advance when which standards will be implemented by other firms, if at all. Our research focuses on the examination of alternative forms of coordination and their impact on the selection of communications standards. We have developed two models for evaluating different coordination designs, differentiating between centralized and decentralized coordination of standardization decisions. These models can also be used to analyze and evaluate further cooperation forms between participants in communication networks. We based the economic parameters of the models and the discussion of their implications on empirical research. To gain information about the use of software standards in enterprises, we conducted a comprehensive empirical survey, both in Germany and the U.S.A. It focuses on the corporate adoption and use of various Information Technology (IT) standards, including Internet and electronic commerce standards, business software and EDI.