The Lock In Effect And Its Causes

This paper has the purpose to explain the lock-in effect and its causes through the most famous example in history. We will start describing the concept of lock-in and then we’ll try to explain the theory behind path-dependences and increasing returns. In the second half of the document we will undertake a trip between the most famous cases of lock-in in history and we’ll discuss their main causes.

In the corporate field one of the most important strategic choice is technological change, this is connected with technology management, organizational learning and industrial organization economics. In this case we can have a strategic dilemma, where we can have two different possibilities. First the firm can exploit an existing and well known technology or it can explore a new technology that can give more advantages in the long period. Huge firms usually decide to invest in their core business where they have more possibilities and returns. This produce a strategic problem where they prefer to stay in their old technology indeed to develop a new one. So new and alternative technologies meet big difficulties to develop in the market. Lock-in occurs when an alternative and maybe better technology can’t increase its market share because there are some predominance and maybe worst technology. The emergence of a dominant technology starts when some new and alternative inventions compete to accomplish the demand and the needs of consumers. In the beginning there is a uncertainly period called “era of ferment” (Unruh 200), in which all technologies fight each other for performance improvements and market share. This period of competition ends when one technology obtain enough market share and becomes a standard. To underline is that the initial choice is arbitrary. This causes a change in the policy of the firms that move innovation from the development of new products to the improvement of standard product’s process. The superior technology not necessary win the war for the market share. An inferior one can win thanks to path-dependent processes; where time, strategy and historic circumstance are more important than optimality. During development and commercialization of this technology we can see the presence of increasing returns to scale that are the main reason for winning.

Path dependence implies that a lower advantage or a temporary lead for some technology, product of standard provoke huge and irreversible pressure on the allocations of resources in the market. Also when in the market there are voluntary decisions and individually maximizing behavior. There are three types of path dependent (Liebowitz and Margolis 1995). First is an irreversible path because to be left require some cost, but at the same time it appear optimal and so doesn’t provoke a market failure. Second and third paths occur when there is imperfect information. Second path happens when a non optimal decision is taken in the beginning. This decision is taken because information aren’t known and when they are discovered is too late to change the path. In this case we can identify inferiority of path and results are unpleasant, hard and expensive to change. Third case introduce the same hypothesis of the second path but the path should be remediable while not done. Besides in this case outcomes cannot be predicted and we can find the Lock-in effect, because we have a market failure indeed there is the persistence of certain choices. Like in the paper from Liebowitz and Margolis (1995), path dependences can be easily explain as a mathematical probability. We need to consider two different choice (A1 and A2). Those are mutually exclusive and are taken like a sequence. We have two probabilities indicate with Pn and (1-Pn) where letter n indicate the number of attempt. At the attempt number i correspond an event Ei. The probability P(n+1)= f(Pn,En,En-1,…,E1). The response probability is said to be “d-trial path dependent” where the probability function can be written f=f(Pn,En,En-1,…,En-d). In the special case where d=0, the process is “path independent”. All of this concept are connected with the concept of memory; in fact today’s decision are constrain by past decision.

Increasing return

As Brian Arthur (1989) said, path inefficiency and market failure can occur only when there are some kind of increasing returns. Increasing returns and lock-in effect can be easily explain by an example. Like in the Table 1, we can see benefits for adopters according to the total number of adoption of technology. In this example there are two alternative technology: A and B. The first adopters will have more benefits adopting the technology A, but on the long term technology B lead more benefits than A. if we choose technology A we can’t return or switch to Technology B thanks to externalities and network effects, and this is Lock-in effect.

Table 1: Adoption payoffs, Source adapted from Arthur Table 2 (1989).

This is a banal example where we have agents at the same level and events can make no different. First person choose best and most profitable technology and this cause the increasing of adoption this technology (in our example Tech. A). This can continue and all agents prefer Tech. A to Tech. B that lead to a dominance of Tech. A and an failure of Tech B. This result can be easily predictable, but we can see in table 1, if returns increase at the same rate, that adoption process can become path-inefficient. We can see that at thirty choice of adoption Tech. A have a similar adoption of Tech. B. Then if the process proceeded and the number of adoption increase we can see that market became more “locked-in”.

The effect of increasing returns to lock-in can be also explained by the use of the graph in Figure 1 taken from the paper of Unruh (2000): the horizontal axis represent the degrees of adoption while the vertical measure the increasing of relative benefits for adopters. The curve in the graph show that returns of scale are not linear with the increasing of the number of adopters. First there is a period in which there are increasing returns than follow ones in which the returns of scale decreases. It is important to notice that fundamental is the view of the curve and not only the first part. Nonetheless when there are path dependences the increasing return of the beginning of the curve can lead to the market failure because they could catch wrong decisions about the choice of the correct technology. This is provoked by a variety of factors: increasing returns in the first part of the graph are generated by expectations, the improving of processes and the development of networks; decreasing returns in its place arise when market is near to saturation.

Figure 1: Trend of return of scale, source from Unruh (2000).

Barriers to adoption

When it is recognized that there are better alternative technologies to another, the main causes of non-adoption are barriers to adoption. They are originated, as Unruh (2000) said, by myopic microeconomic decisions. This is influenced also by the interdependence in the technological systems and by decisions from private and public institution.

When a technology prevails the firms who have chosen alternatives are forced out of the market and the market become more concentrated. Firms who remain in the market tend to move innovation from products and the research of alternatives to the development of the processes connected with the winner technology. Usually this technology became the core business of the firm. Also they don’t invest their time and money to different alternatives and they stay on the existing competencies because they not incentive the development of technologies that could make obsolete their core one. Another cause connected to the firm’s behavior is the irreversibility of investment; more they are huge specialized and durable more an firm is blocked on his old technology.

Another cause of lock-in is the development of a network around a certain technology. More a technology spread, more are the firms who decide to support it and invest on it and so the network grows and the circle restart. If instead there is a sort of uncertain around a new alternative technology, firms could not accept the risk to make irreversible network investment on that technology, so it never diffuse and firms remain locked-in with the old technology. Financial system also can be consider responsible for lock-in. financial institutions prefer to finance firms with well consolidated business and not to finance the develop of business based on new unripe technology. Development of new technology so is often given to joint venture or public research that have higher cost and less chance to move the technology successful on the market.

Lock-in cases

Fossil fuel

One case of lock-in in history is the advent of fossil fuel (Unruh 2000) it happens thanks to the diffusion of two other technologies: the internal combustion engine in the cars and the AC standard for electricity. They are also cases of lock-in.

Internal combustion engines fight for the monopoly of the market with two other technologies: the steam-engine and the electric engine. In the beginning no one considered the internal combustion engine the best option for the market: it was the louder, the more harmful, the more complex and the more unsafe. Nonetheless it prevails thanks to lower cost of petrol who at that time was only a waste of kerosene and it was cheap and easy to find. It conquer the market thanks to his initial superiority on others technologies: it has more power than steam engine and it won in a race of prototypes built up to compare the technologies. Ones the internal combustion engine got enough market share it entered in a period of increasing returns in which networks and advantages of the technology increased and lock-in the world on the internal combustion power and in consequence on fossil fuels.

The other reason to the advent of fossil fuels was the diffusion of the AC standard for the distribution of electricity because it bring to the building of big power station fed with fossil fuels. The first electric standard used was the DC standard sponsored by Edison, the rival standards was the AC sponsored by the “Westinghouse” electrical company. Both technology had pro and cons. DC had less loss during transportation but it had a limit of distance of 2 km. it has been thought to be used with local stations even build inside houses. AC instead was less efficient but permitted transportation for long distances. Edison tried to prove that AC was much more dangerous than DC and build up the electric chair powered by AC, but it instead was a success as “dead machine” and it was adopted in many of the United States, giving to the AC standard lot of advertisement and popularity. In the end The AC standard won and thanks to its characteristics lead to the development of a network of big centralized power station that used a huge quantity of fossil fuels.

This two episodes are the main responsible for the fossil fuel diffusion and for the development of networks of subsidiary technology who locked the world to the use of oil and derivatives. The most important point in this case is the presence of path dependences that influenced the initial choice. Then we can find the influences of networks externalities and increasing returns.

Betamax and VHS

Competition between Betamax and Vhs (Park 2004) in the market of VCR was one of the most interesting example of Lock-in model. This two different technology of home video was discovered and developed by Sony and Matsushita Corporation. In 1976 Sony introduced Betamax format for American VCR market, in 1977 Matsushita launched VHS model on the same market. An important point was that this two format was incompatible. American VCR market evolution can be divided in two different phases. First one (1976-1980) where VHS reach immediately a huge part of the market (Betamax sold 140.000 VCR in a year, instead VHS over 80.000 in only 5 month in 1977). In this case the consumer prefer the better usability of VHS format and his additional time available for recording (over two hour that was necessary to record movies, TV shows and sport events), instead the better quality who characterized the Betamax format. Then in 1978 VHS outsold Betamax, after that both companies tried to increasing the time of recording and also to move the competition on the field of reduction of price and of increasing the performance of recording supports. Second phase (1981-1988) is characterized by the constitutions of joint venture between firms to support one or the other format. For example RCA form an alliance with Magnetic Video Corporation of America (MV), at the same time (1979) Sony connected with Video Corporation of America. During this period there were also a big diffusion of shop in which where possible to rent a movie, most of which adopted VHS format. With the expansion of the network of rental shop, the number of movie rentals start to increase exponentially. In this second phase there weren’t lot of difference between two formats: they were similar in price, features and performance. Nonetheless Like in the paper from Sangin Park (2004), in this period there were a dramatic movement from Betamax adoptions to Vhs like it can be seen in the Figure 2.

Figure 2: Relative sales and relative installed bases of Betamax and VHS, source from Park (2004) Figure 1.

Like in the figure many firms of Vhs entry in the market and many producer of Betamax close and exit (for example Zenith, Emerson, Sanyo e Toshima that stop to produce Betamax in 1983-1986). In 1987 Vhs became dominant (87,6% of the market share in 1985 and 90,5% in 1986). Sony was be the last producer to Betamax that close his production and leaves victory to Vhs in 1988.

In this example the main cause of lock-in is the high presences of increasing returns perceived by consumers. They give more importance to time of recording than quality of the product.

Qwerty

The story of keyboards, taken from the paper of David (1985), starts more than a century ago when Carlos Glidden and Samuel W. Soule invented the typewriter (October 1867). This model of typewriter had some problem and many defects, instead this was designed with the specific aim of not allow fastest typing because an excessive speed of beating could block the hammers plate. In 1873 Qwerty’s model evolves with Remington’s mechanism, in which was changed the disposal of some letters ( for example the “R”). They tried to arrange the letters in a better way designed specifically for the salesman, but this new machine, born during the economic downturn in 1870, had a precarious destiny and touches the edge of bankruptcy. In 1881 there was a revival: the production of qwerty by Remington had a big diffusion between typists which they used it in some typing schools, and doing so they contributed a lot on its diffusion. Next many other firms adopted the qwerty typewriter and soon the diffusion became global. During the last fifty years someone tried to change the disposition of the keys, but this innovation wasn’t use by none and today we still use the qwerty even though there is no longer the problem of overlapping hammers This is the Qwerty Phenomenon where the winning system isn’t the best one. Usually in this cases the first product available with a new technology takes most of the market and tends to dominate. This is use by Stephen Jay Gould in his theory where not always adoption of a product implies a future better adaptation to the environment, this can be caused by casual events that modify circumstances. This case is a good example of lock-in caused by dynamics that go beyond the behaviors of individuals and show that when a new technology is introduced and spread so largely and quickly, like Qwerty, is quite impossible to come back to the old one. The only solution it’s anticipate the choice when the alternative are still on the same level.

We can find the influences of path dependences when the qwerty keyboard was adopted in typing school and in consequence was developed the network and was given the bases for the diffusion of the standard.

Nuclear power reactors

Another case of lock-in which one possible inferior technology dominates the market is the history of nuclear power technology (Cowan 1990). Today Most important centrals in the U.S. and all reactors installed in the US Navy for the propulsion use light water technology that is the main tech in the power market. The history of nuclear reactor has characterized by different technologies but all need big investments to be developed and to be competitive and are also subjected to dynamics of increasing returns. So most of the countries collaborate with each other to share the costs. The study of nuclear reactors start from the first years after Second World War, where only in the U.S. there were LWR (light water reactor), until now where 80% of all reactor in the world use the old American technology. The nuclear reactor competition was highly influenced by three events: first in 1946 when Hyman Rickover supplied U.S. naval ships with LWR propulsion , second the introduction in Russian of nuclear in 1949, third the subsides given by US government to move this technology to Europe (1950). These three points gave a huge advantages to LWR on the other technologies (like graphite and heavy water). This events switch the reactor from the military to the civilian world. In 1970 there were a huge step in the adoption of this technology and a reduction of uncertainly about benefits of light water. For example in UK they decided to use light water because this technologies was already studied and cost less than graphite or heavy water reactor. In the three decades after first nuclear reactor, light water was been dominant in the market.

Main characteristic of the case are the barriers for adoption of alternatives technologies: very high costs of R&D and huge irreversible investments already done make impossible the switch to new reactor technologies and so we are locked-in.

Conclusion

In our paper we have discussed about the lock-in effect that influence or have influenced some technologies of our daily life. We have done a panorama on the main causes of lock-in and we have analyzed which were more present in the different cases we have summarized. The lock-in effect, we discovered, is a result of many factors: it starts with dynamics and events that are interdependent and it diffuse thanks to increasing returns and networks externalities. But it is not enough, it remains because alternative and maybe better technologies are maintained out of the market by strong barriers of adoption.