Coordination versus differentiation in a standards war: 56K modems

• Author: Angelique Augereau,Shane Greenstein,Marc Rysman
• Date: 01 December 2006
• DOI: http://doi.org/10.1111/j.1756-2171.2006.tb00062.x
• Published date: 01 December 2006

mss # Augereau et al.; art. # 07; RAND Journal of Economics vol. 37(4)

RAND Journal of Economics

Vol.37, No. 4, Winter 2006

pp. 887–909

Coordination versus differentiation in a

standards war: 56K modems

Angelique Augereau∗

Shane Greenstein∗∗

and

Marc Rysman∗∗∗

56K modems were introduced under two competing incompatible standards.We show the impor-

tance of competition between internet service providers in the adoption process. We show that

ISPs were less likely to adopt the technology that more competitors adopted. This result is par-

ticularly striking given that industry participants expected coordination on one standard or the

other. We speculate about the role of ISP differentiation in preventing the market from achieving

standardization until a standard setting organization intervened.

1. Introduction

We study the adoption of 56K modems by internet service providers (ISPs). Introduced

in 1997, 56K modems allowed for data transfer off of the Internet at up to twice the speed of

the previous technology at a time when the demand for large files such as graphics became

increasingly important. Originally, there were two competing specifications for the standard from

two competing consortia, one led by the equipment manufacturer US Robotics, the other by

Rockwell. The technologies were functionally identical in the sense that they had the same

performance characteristics. However, the technologies were incompatible. If a consumer used

one technology and the consumer’s ISP used the other, data transfer speed diminished to that of

the previous technology, only 33K or 28K.

We focus on understanding the role of competition in adoption by an ISP. We show that

ISPs differentiated across technologies rather than coordinating on one technology or the other.

Specifically, we show that ISPs were less likely to adopt a technology as more of their local

∗Archetype Solutions; aaugerau@archetype-solutions.com.

∗∗ Northwestern University; greenstein@kellogg.northwestern.edu

∗∗∗ Columbia University; bs2237@columbia.edu.

Wethank seminar audiences at the SED 2002 meetings in New York,the Wharton School, the University of Toronto,

Brown University,the Department of Justice, the University of Illinois, and Pennsylvania State University,the AEA 2003

meetings in Washington, D.C., the Federal Reserve Bank of Chicago, Northwestern University, Syracuse University, the

NBER Winter IO Meetings of 2005 in Palo Alto, California, MIT, LSE, UCL, and the Graduate School of Business at

Stanford University.We also thank Tim Bresnahan, David Dranove,Phil Haile, Mike Mazzeo, Ariel Pakes, Greg Rosston,

Katja Seim, VictorStango, and two anonymous referees and the Editor for helpful comments. Martino De Stefano provided

excellent research assistance. This research was supported by NSF grant no. SES-0112527 and a grant from NET Institute.

Copyright ©2006, RAND. 887

mss # Augereau et al.; art. # 07; RAND Journal of Economics vol. 37(4)

888 / THE RAND JOURNAL OF ECONOMICS

competitors adopted that technology. This differentiation is particularly important because, as

we discuss below, it hindered coordination on a single standard technology, which could have

provided important benefits.

Theories about standardization discuss the role of competitive choice between standards, but

few prominent cases everpermit researchers to garner a close look at behavior during deployment,

which we get here. Also, there is very little empirical research to examine how competitive

behavior shapes demand for competing standards or vice versa. Data needs are the primary

impediment. We rarely observe competition between two comparable technologies played out in

more than one market. Even when that occurs, it is often difficult to disentangle the effects of

competition from other important effects.

This study’s setting is uniquely well suited to meet these requirements. An important feature

of the ISP market is that consumers almost always connect to ISPswithin their local telephone call-

ing plan. This creates numerous geographically distinct or partially overlapping markets, which

leads to geographically dispersed decision making and a variety of competitive interactions. We

study over 2,200 ISPs in 2,300 calling areas. Thus, we are able to compare decisions across mar-

kets, where a variety of factors shape decision making, such as the competitive and demographic

environment and ISP size.

We employ a series of empirical approaches. Simple statistics illustrate a prevalence toward

“even splits” in local markets. That is, adopting ISPs were more likely to be evenly split between

the two technologies than would be predicted by independent random choice. We also estimate

a structurally motivated model of each ISP’s choice over adoption of the two technologies as a

function of the competitiveenvironment, local demographics, ISP characteristics, and ISP decision

making across multiple markets. We capture the influence of an ISP’s adoption decision on its

rivals in a discrete game of imperfect information as suggested in Seim (2004).

Estimating a discrete game has well-known problems with endogeneity and multiple equilib-

ria. Fortunately,our data contain a great deal of useful variation. ISPs have different technological

characteristics and face different demographic characteristics due to imperfectly overlapping cov-

erage areas. Weuse this exogenous variation to predict the number of competitors that a given ISP

faces. The great asymmetry in the data means that our models typically have a unique equilibrium.

Throughout we conclude that an ISP is less likely to adopt a technology as more of its competitors

do so. We are particularly sensitive to the robustness of our inferences to unobservable errors at

ISPs or at locations, so we pursue a variety of strategies for estimation in the presence of such

errors.

Understanding the deployment of 56K modems is also interesting because the “standards

war” for 56K was well publicized. While many contemporary press reports discussed howmodem

makers competed fiercely for adoption by the earliest choosers, few had substantial data. Citing

such accounts, Shapiro and Varian (1999, pp. 267–270) feature the case prominently in their

discussion of strategic behavior and consortia development prior to deployment, but, again, they

do not present any evidence about actual adoption. Similarly,contemporary press accounts tend to

cover announcements from firms, not the deployment in each local area. No research has closely

examined the deployment decision of service providers, as we do.

The events are also interesting because they end in intervention from the International

TelecommunicationsUnion, a quasi-government agency. Before ITU intervention, this experience

appeared to be an example of “coordination failure.” That is, there was a benefit to coordinating

ISPs and consumers on a single standard as quickly as possible, but market actors failed to quickly

standardize. Market participants expected that standardization would arise because it was in users’

interests to do so. The popular standard would have more ISPs servicing it, which ensured con-

sumers of high-quality, low-hassle, low-price service into the future. However, coordination did

not arise in the first year of competition. Not only did the two technologies maintain relatively

similar levels of ISP commitments, but overallsales to consumers and ISPs were well below what

the market could have supported. Sales increased only after the ITU introduced a third incompat-

ible standard as a new focal point. The new standard quickly gained market acceptance, and high

industry sales followed.

© RAND 2006.