Economic lessons of video games

The ravages of a certain sexy academic trend in economics, and its enthusiastic application in the business world, could have been easily avoided if the people involved had only looked to the world of video games, which would have handily disproved their silly little theories. I'm referring to the academic school of thought that believes in the lock-in of inferior technologies due to network effects -- even though any evidence for them is lacking. The application to the management culture was to sacrifice just about everything, including quality, to gain the all-important "first mover advantage" -- even though any evidence for this advantage is lacking.

Primarily academics and other smarties did not grasp how implausible these ideas were, and did not accept the evidence showing so, because they sprang from one of the unofficial religions among nerds -- hating on Microsoft. Every tribe needs its devil, and sub-billionaire nerds will always use Microsoft and Bill Gates for this purporse. Really, much of the seemingly unrelated pieces of their worldview and codified behavior patterns derive from a gut aversion to Microsoft. In reality, Microsoft dominated the markets that it has because its products are consistently rated as better than the others. Read Winners, Losers, and Microsoft (featured in my Amazon box above) for more data, or visit Stan Liebowitz's webpage.

Realizing that they will never snap out of this, I've thought of what other types of evidence we could show them that would not offend their religious sensibilities. It so happens that if we use examples from the hardware and software of video games rather than personal computers, they would recognize right away what the evidence shows, and would at least tone down their ranting about the spread of inferior Microsoft products.

The key idea behind inferior lock-in due to network effects is that adopters of a technology consider not only its utility to the adopter, but also the benefit the user gets from being part of the network of adopters. For example, you should buy something that plays VHS tapes rather than Betamax tapes if the former has a larger installed user base -- say, because you figure that producers of tapes will offer a wider variety in the format that's more common. The worry is that this network effect could overwhelm the intrinsic quality effect, so that an inferior technology became (nearly) fixed just because it got the snowball rolling in its direction early on.

For the same reason, real-life managers fought hard to get the "first mover advantage" during the tech bubble because they believed this theory. After all, if it was possible for an allegedly inferior keyboard design to become the standard, or an allegedly inferior videotape format to become standard, due to network effects, we shouldn't worry so much about quality that we sit on our asses and somebody else beats us to getting the snowball rolling. Get to the market first, and while it may not be a lock, we've at least got the positive feedback loop of network effects started for us.

Again, all of this was nonsense, but it was hard for the proponents to see because it validated their geek tastes for exotic keyboard and videotape formats, making them feel superior. But take another geek hobby like playing video games. The near impossibility of dethroning an entrenched incumbent would have meant that Atari would have reigned through the 8-bit era, leveraging its dominant market share and huge installed user base from the previous era of video games. Instead, the Atari 7800 went nowhere, while Nintendo -- who before had not even produced a home console at all -- readily swept them aside.

What led to this no-name newcomer stealing Atari's thunder? -- quite simply, the games for the Nintendo were better than for the Atari 7800. There are surely ratings data from the late 1980s that would support this claim, but this isn't a data-mining blog anymore, so I'll put that confirmation exercise aside for the moment.

Nintendo continued to dominate through the 16-bit era, so now we have another test of the lock-in due to network effects idea -- namely, that they would continue to do so into the next generation. But that didn't happen at all. Once more, a complete newcomer -- Sony -- easily tossed Nintendo off a cliff when it released its PlayStation, whose games appealed to people more than did the games for the Nintendo64. As Nintendo had before, Sony continued to dominate the following generation of consoles with its PlayStation 2.

So, Sony's locked in their consoles for good, right? Wrong -- in the current generation of home consoles, Sony's PlayStation 3 is in a distant third place among the big three, while Nintendo has completely reversed its beat-down years and come out on top with its Wii.

I could surely go on, but the point is that it was as clear as day that lock-in (whether of inferior or superior products) due to network effects was a silly idea, just looking at video games. Instead, it was the hardware that offered the best software that sold the most units -- sometimes it was the incumbent company (Super Nintendo, PS2), sometimes just the opposite (NES, PS1, Wii). This allows a complete virgin in the video game business to utterly annihilate the reigning giant, as Nintendo did with Atari, Sony did with Nintendo, and now Nintendo has done with Sony in turn.

The first mover advantage was equally obviously illusory, even during the tech bubble of roughly 10 years ago. Take the CD-ROM format for games -- it looked like this was the future, rather than the ROM cartridges that the Nintendo or Sega Genesis used. According to the first mover advantage idea, the first -- or at least one of the very first -- systems to use CD-ROMs should have become the standard. However, it wasn't until the PlayStation (released in 1995) that a system using CDs really took off.

Was the PlayStation the first mover into the CD-based console market? Not by a long shot. Fully three years earlier, Sega released the Sega CD attachment to the Genesis. So, not only did the Sega CD have such a huge lead in launching, but they could tap into the huge installed user base that Sega had built with the Genesis, whereas Sony had no fans to work with, as they had no previous system. But again, everyone thought the games for the Sega CD sucked, so it went nowhere.

Even before that, in the late 1980s and early 1990s NEC released a CD-ROM attachment for their TurboGrafx-16 system, as well as a combined cartridge-cum-CD-ROM system. Also, the Neo Geo CD debuted in 1994, the 3DO in 1993, and the Philips CD-i in 1991. Once again, there weren't enough superstar games to draw people into buying these CD-based systems.

Or we could look at what are called generations of video game consoles -- did the first entrant win? The Super Nintendo came out years after Sega Genesis and the TurboGrafx-16. The Sega Saturn came out four months before the PlayStation but got destroyed by it. In the next generation, Sega's Dreamcast enjoyed more than a one-year lead over the PlayStation 2, and a two-year lead over Nintendo's GameCube, although it too was quickly eclipsed by both of them. In the current competition, Microsoft's Xbox 360 should have benefited from its one-year lead over the Wii, but instead it has been leapfrogged by the Wii.

In all of these cases, the reason that the first mover advantage failed to materialize is that there is no such thing in the first place. Consoles sell based on how appealing its games are to the target audience, period. So it didn't matter that the Sega Saturn came out before the PlayStation -- it didn't as attractive of a library of games, so consumers steered clear of it. Product quality matters, not when you enter the market.

Finally, what if a company were not merely the first mover but the only mover -- in the fantasy world of geeks who lament the spread of QWERTY keyboards and Microsoft software, this would surely mean the company would have a lock on the market and in short order establish a monopoly, fleecing the powerless consumers. Rewind to the mid-1990s when everyone figured virtual reality was the future of video game-like experiences. Its hype extended to popular movies and music videos, its intrinsic appeal is easy enough to grasp, so the demand for a virtual reality toy was certainly there. Maybe it wouldn't be as cool as what the military used, but it would still be cool, and you get what you pay for.

Against this background of massive hype for virtual reality, Nintendo released the Virtual Boy in 1995, which offered something of a VR experience. Again, not the most high-tech thing you'd ever seen, but if you wanted virtual reality, it was the only game in town, and it wasn't even expensive at $180. However, the games for it were awful, and instead of passively giving in to a piece of shit technology, consumers refused to buy it -- and therefore, any virtual reality system -- altogether. Imagine it: no competition at all, plus the first mover advantage, plus benefiting from the virtual reality craze of the time -- and yet, this was Nintendo's most pathetic selling system of all, and it was discontinued the year after its release. This result is the exact opposite of what we'd expect if the inferior lock-in and first mover advantage ideas held any water at all.

It could be that the mostly Baby Boomer academics and managers who ran with these nutty ideas couldn't have drawn on video game evidence first-hand. But now that most nerds and managers are Generation X or younger, it should be much easier to offer evidence that they won't reject. They'll probably carve the universe in two, as most religions do -- the laws of supply and demand, and so on, apply to video games, sure, but anything related to Microsoft is described by inferior lock-in, bla bla bla, because they are the devil, not a real-life company like Nintendo or Sony. But as long as manage to chip away at the religions of academia and the managerial elite, it's worth it.