Overcoming the penguin problem

Most platform networks are asymmetric, and in most cases, service providers (such as app developers) will have a high initial cost (both monetary and private network cost), but copying (also called marginal cost) will be low, and that is, there is great scalability after making the initial investment. 

Even a new platform with a good idea and great potential for network effects, no one will be the first to invest. Farrell and Saloner identified this problem in their research, where they saw reluctance to take chances early on investing in a good business idea, also called the "Penguin" problem.

In new markets, uncertainty is high, and it is difficult to predict the long-term effect of new technology. As a result, you may risk a wrong investment, but on the other hand, you also know that being a first-mover could be a significant gain. Hence the name penguin problem, where all the penguins stand on the ice edge waiting to jump out to catch all the fish, but no one dares to be the first for fear of being eaten by the sharks that also may be lurking in the water. But when the first one takes the chance, everyone else will follow, as they know that the risk is significantly reduced. Economic literature often refers to this phenomenon as "the bandwagon effect." 

Fighting network effects

Penguin dilemma can often explain why a superior new solution fails to make it through the adoption phase, where it loses to another platform that solves the penguin dilemma better. In theory, there should always be a demand for new, better solutions. But according to Farrell and Saloner, the existing standard has often built up a network effect, often also called an exit barrier, that prevents potential customers from switching to a new and better solution. If, as a new challenger, you cannot obtain benefits with their functionality and promises of similar network effects as the existing standard, adoption will be slowed. (excess inertia).

This situation can also be referred to as a "lock-in effect" where network effects is significant, and switching will involve lower network power (high exit barriers). Examples of this can be found, among other things, in the software industry with Microsoft's standard with its Office products, substantial direct and indirect network effects are achieved. For example, even though others had better spreadsheets than Microsoft Excel, the higher switching cost hinders sharing. Farrell and Saloner argue that an established standard prevents the adoption of a new and better solution due to a lack of information flow and communication problems.

Compatibility lowers the network effect.

Farrell and Saloner offer several approaches to this challenge that can be helpful insights for building a multi-sided platform. Considering the compatibility of the existing user group, with the facilitation of interoperability, complementarity, straightforward communication, and cost savings by not investing in entirely new solutions, the switching cost will be lower. This means to continue some of the network effects from the "market standard." 

When you can license a market standard into your solution, the customers' switching cost (network cost) will be lower, as they can bring the network value to the new solution. Some firms (e.g., IBM, General Motors, 3M, Toyota, and Tata group) adapt to new market conditions. In contrast, others stagnate and die, suggesting that the capacity for change is an organizational capability. David Teece and his colleagues introduced the term dynamic capabilities, referring to a firm's ability to integrate, build and reconfigure internal and external competencies to address rapidly changing environments.