***Standardization in***

***Technology-Based Markets***

**Gregory Tassey**

**Senior Economist**

**National Institute of Standards and Technology**

(<gtassey@nist.gov>)

**June 1999**

**\[Forthcoming in *Research Policy*\]**

***Standardization in Technology-Based Markets***

**Gregory Tassey**[^1]

Senior Economist, National Institute of Standards and Technology

**Abstract**

The complexity of modern technology, especially its system character,
has led to an increase the number and variety of standards that affect a
single industry or market. Standards affect the R&D, production, and
market penetration stages of economic activity and therefore have a
significant collective effect on innovation, productivity, and market
structure. Standards are classified into product-element and nonproduct
categories because the two types arise from different technologies and
require different formulation and implementation strategies. Because
standards are a form of technical infrastructure, they have considerable
public good content. Research policy must therefore include
standardization in analyses of technology-based growth issues.

Keywords: standardization, innovation, R&D, economic growth, industry
structure

Through R&D-performing industries and the effect of new technologies on
other parts of the economy, technology accounts for one-third to more
than one-half of U.S. GDP growth and at least two-thirds of productivity
growth. However, the so-called "high-tech" sector only contributes
approximately 7 percent of U.S. GDP.[^2] This relatively small direct
contribution implies substantial leverage by this sector on the overall
economy, but also that extensive diffusion of new technology must take
place if adequate productivity growth rates are to be achieved by the
entire economy.

Standardization affects both innovation and technology diffusion. It
also can influence industry structure and thereby help determine which
firms benefit and which do not from technological change. Thus, a
concern of R&D policy should be the evolutionary path by which a new
technology or, more accurately, certain elements of a new technology
become standardized. Over a technology's life cycle, standardization can
affect economic efficiency. However, these effects can be both positive
and negative. For example, standardization can increase efficiency
within a technology life cycle, but it also can prolong existing life
cycles to an excessive degree by inhibiting investment in the
technological innovation that creates the next cycle.

Standardization can and does occur without formal promulgation as a
"standard." This distinction between *de facto* and promulgated
standards will be made apparent and discussed in the following sections.
In one sense, standardization is a form rather than a type of
infrastructure because it represents a codification of an element of an
industry's technology or simply some information relevant to the conduct
of economic activity. On the other hand, the selection of one of several
available forms of a technology element as "the standard" has
potentially important economic effects.

1\. Economic Functions of Standards

A standard can be defined generally as a construct that results from
reasoned, collective choice and enables agreement on solutions of
recurrent problems. Looked upon in this way, a standard can be viewed as
striking a balance between the requirements of users, the technological
possibilities and associated costs of producers, and constraints imposed
by government for the benefit of society in general (Germon \[1986\]).

More functionally, an *industry standard* is a set of specifications to
which all elements of products, processes, formats, or procedures under
its jurisdiction must conform. The process of *standardization* is the
pursuit of this conformity, with the objective of increasing the
efficiency of economic activity.

1.1. Nature and Scope of Impacts

Standards played an important role in the industrial revolution. They
allowed factories to achieve economies of scale and enabled markets to
execute transactions in an equitable and efficient manner.
Standardization of parts made supplier specialization possible and
increased efficiency over the entire product life cycle by facilitating
part repair or replacement.

In a modern economy, standards constitute a pervasive infrastructure
affecting the technology-based economy in a number of important and
relatively complex ways. Some of these impacts even appear
contradictory. For example, whereas the traditional economic function of
standards in production can restrict product choice in exchange for the
cost advantages of economies of scale, other types of standards common
to advanced production and service systems can actually facilitate
product variety and hence choice for the customer.

Fig. 1 depicts the multiple functions performed by standards. These
functions transcend the three major stages of technology-based activity
 R&D, production, and market penetration, and are difficult to
construct and implement because many important technologies have both an
intrinsic complexity and a \"systems\" character. Such characteristics
demand more sophisticated technological foundations for standards and
imply the need for technically competent standards setting processes.

The greater complexity of technologies and the associated networks of
firms and supporting infrastructure that develop and disseminate these
technologies mean that supply chains ![](media/image1.wmf)are becoming
the most important level of policy analysis. Greater distribution of R&D
among materials and equipment suppliers, manufacturers of products, and
providers of services increasingly characterize high-tech supply chains.
The consequent increase in market transactions involving technology also
demands standards to reduce the associated transaction costs.

Technology consists of a number of discrete elements that tend to evolve
in different institutional settings. These elements have distinctly
different character and require different types and combinations of
standards to effect efficient development and utilization (Tassey
\[1992, 1997\]). Many variations exist but broadly defined they fall
into the three major categories shown in Fig. 1:

(1) The fundamental or ***generic technology*** base of the industry on
    which subsequent market applications (products and services) are
    based

(2) A set of ***infratechnologies*** that provide a varied and critical
    technical infrastructure to support for development of the generic
    technology and subsequent market applications

(3) The market applications (***proprietary technologies***)

Because the type of R&D required for each element differs significantly,
so do private-sector investment incentives with the result that
underinvestment varies across the different elements of an industrial
technology. The greater the infrastructural character of a technology,
the more underinvestment is likely to occur. Standards and thus their
technical underpinnings have a strong infrastructure character, so that
underinvestment is common.

1.2. Basic Functions of Standards

To analyze the economic functions of standards in a technology-based
economy, a taxonomy is required that classifies standards by functions
having unique economic characteristics. For the purpose of economic
impact assessment, the functions of standards are classified into four
categories.[^3] The positive effects of each of the four functions are
described below. However, as discussed in later sections, standards also
can have negative economic consequences or simply fail to achieve their
maximum potential economic benefit.

1.2.1. Quality/Reliability

*Standards are developed to specify acceptable product or service
performance along one or more dimensions such as functional levels,
performance variation, service lifetime, efficiency, safety, and
environmental impact.* A standard that specifies a minimum level of
performance often provides the point of departure for competition in an
industry. For example, a case study by Putnam, Hayes and Bartlett
\[1982\] points out that when an automobile manufacturer develops a new
engine, the company specifies the minimum acceptable lubrication
attributes. This specification then becomes the basis for competition
among petroleum companies, who either compete on price at the minimum
specified level of quality or by offering motor oil with a level of
performance above the minimum.

1.2.2. Information Standards

*Standards help provide evaluated scientific and engineering information
in the form of publications, electronic data bases, terminology, and
test and measurement methods for describing, quantifying, and evaluating
product attributes.* In technologically advanced manufacturing
industries, a range of measurement and test method standards provide
information, which, by virtue of being universally accepted, greatly
reduce transaction costs between buyer and seller. In their absence,
especially for complex, technology-based products, considerable
disagreement will often ensue over verification of performance claims.
These disputes raise the cost of consummating a marketplace transaction,
which is reflected in higher prices charged. The economic impact is to
slow market penetration.

Measurement methods are also essential to conduct state-of-the-art
research. In today's semiconductor R&D, scientists and engineers must be
able to measure the distances between individual atoms (dopants) that
are added to silicon to achieve the desired millions of high-density
electronic functions on a single chip. Standardization of some of these
methods is essential for the efficiency of R&D itself. For example,
being able to replicate and verify research results is often critical to
obtaining follow-on research funding or commitment to commercialization.
Standardized scientific and engineering data (in the sense of having
been critically evaluated and verified for accuracy) and standardized
equipment calibration techniques are also essential for efficient R&D.

Finally, the typical manufacturing process is increasingly measurement
intensive because of growing demands for quality and real-time process
control. Traditional manufacturing processes tested products after a
production run. The inefficiency of this approach is large, not only
because of the wasted material and labor when a production run must be
scrapped, but also because of down time and hence unused capacity
incurred while a problem is identified and fixed.[^4] The availability
of computers makes possible the real-time monitoring and control of a
process, potentially enabling instant adjustment of process variables.

When fully implemented, real-time control can virtually eliminate waste
and increases product mix flexibility. However, real-time control of a
production process is a complex systems technology, requiring large
numbers of sensors, computers, and software. Standardization of certain
performance measurements for, say, a sensor facilitates design of the
equipment. Equally large efficiency gains can occur from standardization
of certain elements of the actual methods or techniques of process
control, as adherence to these standards often removes the need for much
of the post production testing. Finally, whatever production strategy is
adopted, the equipment that helps execute the strategy must be
periodically calibrated by standards in order to ensure maximum
efficient performance.

1.2.3. Compatibility/Interoperability

*Standards specify properties that a product must have in order to work
(physically or functionally) with complementary products within a
product or service system.* This function of standards has been the most
intensively studied by economists.[^5] Compatibility or interoperability
is typically manifested in the form of a standardized interface between
components of a larger system. An effective interface standard does not
affect the design of the components themselves, such as numerically
controlled machine tools or the components of these tools, including
controllers. In fact, interface standards provide "open" systems and
thereby allow multiple proprietary component designs to coexist --- that
is, they enable innovation at the component level by being competitively
neutral with respect to design. In effect, competitors can innovate on
\"either side\" of the interface, while the consumer of the product
system can select the particular components that optimize system design.
They also allow substitution of more advanced components as they become
available over time, thereby greatly reducing the risk of obsolescence
of the entire system. Widespread factory automation as it is currently
evolving in advanced economies likely will not proceed without these
standards.

Without interface standards, large companies often supply "turnkey"
systems where proprietary interfaces link components. However, the cost
to the user can be high because the system is not optimized for the
user's particular needs (competitors will typically offer components
that are superior to some of those in the turnkey system) and price
competition will not be a factor when system components need
replacement.

In such situations, system design can still be optimized. However, the
cost of modifying physical and functional interfaces to allow components
from different vendors to work together (i.e., to "interoperate") is
usually prohibitive. Moreover, full functionality is often not obtained
by reengineering proprietary (nonstandard) interfaces.

1.2.4. Variety Reduction

*Standards limit a product to a certain range or number of
characteristics such as size or quality levels.* The fourth function of
standards is the traditional one of reducing variety to attain economies
of scale. The majority of standards perform this function. However,
variety reduction is no longer simply a matter of selecting certain
physical dimensions of a product for standardization (such as the width
between threads of a screw). Variety reduction is now commonly applied
to nonphysical attributes such as data formats and combined physical and
functional attributes such as computer architectures and peripheral
interfaces.

The process of setting variety reduction standards also varies
significantly. Many standards of this type are viewed as infrastructure
and thus adopted by an industry consensus process. However,
standardization of some attribute or element of a product is just as
often achieved through the marketplace by one firm gaining control of
the underlying technology and using this control to force other
manufacturers with whom that firm competes to adopt its version of the
technology. The product element then becomes a de facto (non-consensus)
standard.[^6]

Conceptually, the variety reduction function is the most difficult
category of standardization to analyze because of its ability to either
enhance or inhibit innovation. Variety reduction typically enables
economies of scale to be achieved, but larger production volumes tend to
promote more capital-intensive process technologies. This common
evolutionary pattern of a technology over a number of product life
cycles usually reduces the number of suppliers and increases their
average size. Such trends may or may not reduce competition, but often
progressively exclude small, potentially innovative firms from entry due
to increased minimum efficient scale thresholds.

2\. Types of Standards

Standards have been classified by the form they take. To varying degrees
all four functions of standards specified above can be described
alternatively in terms of design specifications or performance levels.
Design-based standards are much more restrictive and can inhibit
innovation to a greater degree than performance-based standards. The
latter type allows flexibility in product or service design while still
meeting the performance requirements of the standard. Thus, standards
generally work more efficiently when they are performance based.

The economic functions of standards aggregate into two basic categories
 product and non-product  delineated by their relationship to product
(or service) structure and their public good content. Distinctions
between the two types are important because their economic roles are
distinctly different and hence so are the processes by which they are
set. The differences in public good content have important implications
for policy because the rationales for government intervention are very
different in the two cases.

Simply put, standardization of one or more attributes of a product (or
service) can convey direct competitive advantage to the owner/controller
of the technology producing those attributes. They therefore get
considerable attention from economic growth strategists. Conversely,
non-product standards tend to be competitively neutral, at least within
an industry or trading block. Hence, they tend to get less attention.
Yet, this latter category can be critical to the entire industry's
efficiency and its overall market penetration rate.

2.1. Product-Element Standards

Product-element standards typically involve one of the key attributes or
elements of a product, as opposed to the entire product. Government,
especially where large economies of scale are present or when early
market entry is considered an essential part of a national economic
strategy, mandates some product-element standards.

In most cases, at least in the U.S. economy, market dynamics determine a
*de facto* standard. Alternative technologies intensely compete until
the dominant version gains sufficient market share to become the single
standard. Market control by one firm can truncate this competitive
process. Such control is particularly effective in cases of increasing
returns and can quickly force acceptance of the monopolist's proprietary
technology element as the standard. However, the globalization of
high-tech markets with shorter product life cycles is making single-firm
dominance more difficult. In response, various combinations of vertical
and horizontal consortia are promulgating product-element standards by
consensus, at least within a single large economy or trading block.

One of the more visible examples of the competitive effects of *de
facto* standardization is the \"architecture\" of personal
computers.[^7] Elements of computer architecture such as the operating
system, the \"bus,\" the graphical user interface, and the applications
programming interface, have been the focus of intense competition by
firms seeking to gain sufficient market control to "set" the *de facto*
standard for the particular product element.[^8]

In this regard, Apple Computer made a brilliant move when it forced
third-party software developers to adopt a standard \"graphical user
interface\" so that all programs running on Apple\'s computers presented
the user with the same screen format and command structure.[^9] However,
Apple kept its hardware operating system proprietary (i.e., it did not
adopt an open systems architecture strategy) and thus it had no chance
to become the industry standard. This decision explains Apple's initial
prosperity and subsequent competitive decline. In contrast, Sun
Microsystems opened the microprocessor architecture for its workstations
in order to obtain help in gaining market share. It was willing to share
its markets in return for the increased probability that its
architecture would become a standard and thereby create a large and
stable customer base.

The policy issue is thus: To the degree that certain product elements
must become standardized to enable economies of scale and network
externalities to be realized, the potentially large benefits that accrue
to the firm owning the technology element are acceptable. However, this
is the case as long as competition is not constrained in the other
elements that make up the overall product or system technology.

This caveat with respect to economic efficiency was the basis for
charges by software firms that Microsoft was using its monopoly position
as owner of the dominant operating system standard to gain unfair
advantage in marketing its own versions of new operating system elements
(such as a web browser) and applications programs that run on that
operating system. Such charges were pursued in a 1998--1999 U.S.
government antitrust lawsuit.

In contrast, the Japanese PC industry has never been able to establish a
single standard operating system. Reasons for this include (1) an
oligopolistic industry structure (*keiretsu*), which has resulted in
factionalism within the industry and thereby prevented a single standard
(domestic or foreign) from gaining dominance; (2) a mainframe computer
orientation, which for a long time relegated PCs to basically terminal
status, thereby slowing market growth; (3) a reluctance to move away
from customized software; and (4) a language barrier---the inability to
export kanji-based software (Cotrell \[1994\]).

Over a technology's life cycle, additional elements of the product's
technology become standardized so that the product takes on a
"commodity" character. Competition among suppliers of the "standardized"
product then becomes increasingly based on price and service-related
aspects of the product's acquisition and use. Dell Computer, for
example, has succeeded in the PC industry by being the low-cost producer
and offering excellent before and after sales service. This evolutionary
pattern was noted decades ago by the famous Austrian economist Joseph
Schumpeter \[1950\], who observed that one of the essential dynamics of
capitalism is assuring that the \"silk stockings\" initially purchased
only by the rich would eventually be items of mass consumption.

2.2. Nonproduct Standards

Nonproduct standards, as the name implies, derive from a different
technical base than that upon which the attributes of the product itself
depend. Industry organizations often set these standards using consensus
processes. The technical bases (infratechnologies) for such standards
have large, although not total, public good content, so that their
provision frequently depends upon a combination of industry and
government investment. Examples of infratechnologies frequently embodied
in nonproduct standards include measurement and test methods, interface
standards, scientific and engineering databases, and artifacts such as
standard reference materials (Tassey \[1997, Chaps. 8 and 9\]).

Most infratechnologies and therefore the resulting industry standards
are derived from basic standards. Basic standards represent the most
accurate statements of the fundamental laws of physics and have such
diverse applications that they qualify as pure public goods and hence
are provided entirely by government. Basic standards are relatively few
in number and are not easily transported to or used by industry. Thus,
as indicated in Fig. 2, such standards are converted into working and
transfer standards that convey the standardized information to industry.
Large numbers of industry standards are based on (traced back to) basic
standards. With respect to form, most industry standards are either
method, procedural, or normative.[^10]

![](media/image1.wmf)Fig. 2 provides an example of the hierarchy through
which basic standards are utilized to develop infratechnologies upon
which semiconductor industry standards are based. The production of
semiconductor components is a highly demanding process. The densities of
today\'s circuits are such that each conducting path (\"line\") on a
chip is a small fraction of the width of a human hair. These widths must
be consistent with respect to design specifications to avoid thermal,
electrical, and other problems. The semiconductor producer therefore
needs to be able to measure the widths of circuit lines that make up a
"chip." Particularly important are line widths on the masks that are
used to inscribe the multiple layers of circuit patterns on the chip
itself. Such masks are used to make tens of thousands of chips. Their
quality greatly affects performance of the chips produced and hence a
semiconductor manufacturer\'s production yield.

The line-width measurement equipment must be calibrated against a
physical standard, which has a pattern of lines whose thickness and
spacing have been determined to a specified level of accuracy. This
determination is done by an authoritative source, such as the National
Institute of Standards and Technology (NIST) in the United States. The
physical or \"transfer\" standard used by industry must be easily
transportable (a reticule in the above example) in order to ensure
widespread and accurate transfer of the infratechnology.

The information transferred by a physical standard is itself determined
or certified by a so-called working standard, which is laboratory based
and more accurate but not readily transportable. In this example, the
working standard is a laser interferometer, which measures and certifies
the physical dimensions of the line reticule prior to transfer to
industry. Finally, the laser interferometer is itself dependent for
calibration on a \"basic\" standard for length. [^11]

The four basic functions of standards are all represented in the range
of standards for a single industry like semiconductors. Many standards,
like line-width measurement, provide information, while others affect
variety reduction, quality, reliability, or compatibility. The
collective economic impact of these standards is greatly magnified when
an entire supply chain is considered. Semiconductors are a component of
computers and communications equipment, which, in turn, constitute an
information network. Each level in the supply chain requires an
elaborate infrastructure of standards.[^12]

3\. Market Structure Effects of Standards

The market structure effects of standardization have important effects
on the achievement of economic growth objectives. "Open systems" allow
small and medium companies to participate in markets for system
technologies by supplying components in which they have a comparative
advantage. This diversification on the supply side of the market makes
system optimization by users (the demand side) possible and increases
price competition.

Decisions by large companies to enter systems markets at the component
level are also affected by the availability of interface standards.
These firms typically target larger markets where they can benefit from
economies of scale. A strategy of selling into markets characterized by
proprietary turnkey systems requires a high degree of product
segmentation in order to service each turnkey system integrator. This
situation increases costs and constrains market growth projections, even
with a superior technology. The more distributed the participants in a
market, the more critical to technological innovation are open systems.

A good example is medical services, which has traditionally suffered
from excessive customization. Moreover, healthcare environments are
becoming extremely distributed. In every local community there are
multiple sites  hospitals, labs, clinics, pharmacies, home-care
settings, and so on  that conduct numerous clinical and administrative
activities. Currently, the operational computing infrastructures across
these organizations are rarely the same. In this environment, incomplete
standardization is an increasingly serious problem. User-defined
attributes for specific applications make plug-and-play data interchange
impossible. Even where two applications are built according to an
existing standard, frequent user-defined modifications to the
applications often prohibit "seamless" communication between them.

The solution to such a problem, where standards exist but customization
of applications creates incompatibility with the existing standardized
interface, is to develop and reach agreement on true open systems.
Achieving complete interoperability eliminates levels of complexity in
implementing limited or partial standards. In the healthcare area,
Hewlett-Packard took the lead in organizing an industry consortium (The
Andover Working Group) to build an "enterprise communication framework
(ECF)" that provides a common interface for data communications. HP was
motivated by its desire to sell multiple products into a single large
market. With interoperability among system components, such a market
retains the advantage of diversification at the component and system
levels and also achieves the efficiency advantages of interoperability.

Such interoperability is a demanding challenge. It is achieved by
encapsulating existing standard message profile specifications into
software objects called enterprise communicators. These communicators
provide a comprehensive set of rules that make it possible for
developers to achieve interoperability for their applications without
having to completely understand the existing complex standards and
rewrite them into their applications. This software code is packaged
within the ECF and embedded into third-party applications as a software
component.

In practice, attaining truly open computer systems has been extremely
difficult, with achievement of compatibility being partial at best. One
of the major reasons for this difficulty is the complexity of systems
technology. Each one of a number of layers in the hierarchical structure
of a typical information system must have its own architecture and these
architectures must be integrated into a larger network. Today, systems
technologies not only have complex hardware and software platforms, but
require rules and protocols to introduce, process, store, move, and
retrieve information.

The existing systems architectures are typically controlled by a handful
of firms. Vendors often claim to conform to open systems\' requirements,
but in reality they conform only to a portion of the set of standards to
which compliance is necessary to sell their systems. Moreover, even when
true open systems compatibility is offered, users often find that
mobility from their current proprietary system to the open system does
not exist, even when the same vendor provides both. That is, mobility
products are not made available, leaving the user with a severe
transition problem. Such partial conformity standards tend to segment
the market structure.

In summary, lack of conformity to interface standards by the supply side
of a market can be a conscious strategy or a reflection of the poor
quality of the standard.[^13] Large firms with market strategies
focusing on turnkey systems have an incentive to resist open systems to
protect the market shares resulting from their horizontally integrated
strategy. In cases of increasing returns, such strategies may result in
a monopoly position being attained by one supplier or prolonged market
segmentation by several competing suppliers. Either situation has the
potential to constrain economic efficiency.

Conversely, large users are likely to want to have access to several
different classes or brands of a particular product, or at a minimum
have a second source of supply for a critical component. Such product
users have substantial need for effective interfaces. The ability to
integrate equipment and software from different vendors (or even to
integrate different classes of equipment from a single multi-product
vendor) has several economic benefits: system costs can be reduced and
performance optimized thereby increasing productivity, competition among
vendors for each element of the system lowers prices, and responding to
technological or functional obsolescence is facilitated by replacing
individual components at relatively low cost.

At the product or component level, increasing returns can result in a
monopoly position for one supplier. If the product happens to be
critical in some way, that monopoly can be extended into related
component markets. In other cases, multiple standards exist for extended
periods of time resulting in a segmented market structure. The latter
situation is caused by high switching costs relative to perceived
benefit gains by users. These switching costs can be increased when
suppliers with monopolistic control of portions of the market for the
main product (such as a minicomputer) fail to agree on a single standard
for a complementary product (such as the operating system). The UNIX
operating system is an important example.

4\. "Systems" Aspects of Standards

Product and nonproduct standards within a product or service system
interact with each other to create a systems character to the overall
economic effects of standardization. The interactions among different
types of standards that affect a single industry are summarized in Fig.
3. Each of the two industries shown here depends on standardized formats
and evaluations of scientific and technical information from supporting
science and technology infrastructures. They use this information to
select and conduct R&D projects.

These industries then set additional standards specific to their
internal needs for production efficiency. Finally, each industry must
also be concerned with standards that affect their ability to sell their
products in specific markets. Meeting procurement specifications in
domestic markets or complying with certification requirements for
exporting to foreign markets are examples. Moreover, as many products
now become components of larger product systems, part of meeting
specifications is demonstrating compatibility with the performance
attributes of other products.

Interaction among interface standards occurs because of the need to
optimize product systems. For example, a numerically controlled machine
tool is a system of components such as the controller and numerous
sensors. Link and Tassey \[1987, pp. 88−96\] point out that the multiple
interface standards involved in a machine tool allow modularization of
the product, which permits custom design and prevents obsolescence.
However, these standards must be linked by a common data format, if all
components are to function together as an efficient system.

![](media/image1.wmf)Moreover, the structure of the components affects
the interface standards. The technical difficulty and hence cost of
constructing an interface standard increases when all components are
completely proprietary. A frequent solution is to standardize certain
attributes or elements of key components. In the case of the machine
tool, a standard architecture for the machine tool controller has been
agreed upon. This step has significant efficiency advantages, such as
allowing upgrades to the controller without costly reengineering of the
interfaces between the controller and other hardware and software
components.

As Tassey \[1997, pp. 172−175\] points out, industries that have
complex, measurement intensive production processes must reengineer
multiple standards simultaneously for each new generation of the generic
product technology. The semiconductor industry is an excellent example.
In the past, a single dominant integrated circuit supplier has
undertaken the development of standards associated with transitions
between generations of semiconductor process technology (usually
revolving around wafer size).

However, accomplishing the transition now requires a complex and
integrated standards development process, involving a large number of
different standards. The huge estimated cost of next generation
fabrication plants and shorter product life cycles finally have made the
risk too great for individual IC manufacturers to incur the considerable
burden of undertaking the standards development efforts alone. As a
result, an international consortium of semiconductor firms is
undertaking the development of standards for the generation of
semiconductors based on a 300 millimeter wafer.

5\. Potential Negative Impacts of Standardization

Both types of standardization described here can greatly increase
overall economic efficiency and hence rates of growth in
technology-based industries. However, through their structure or through
the timing of their implementation, they can also have negative economic
impacts.

1.  Product-Element Standards

Once a product-element standard is set, network externalities are
typically realized. However, the marketplace dynamics that result in one
firm's version of the technology becoming the standard do not guarantee
that this version is the optimal one. A "lock-in" effect ensues, whereby
many developers of related products conform to the standard and
purchasers of the standardized technology invest substantial resources
in learning to absorb and use it as well as complementary technologies
and infrastructures. These sunk costs create a reluctance to switch to a
new standard and related cluster of technologies. Considerable resources
are then allocated to an inferior technology, which can extend over long
periods of time.[^14]

As pointed out by a number of economists, the controller of the
product-element standard captures increasing returns to scale as initial
market penetration begets dominance. This may be an acceptable price for
rapid market growth from an economic welfare perspective, as long as
either the standardized version of the technology element is the best
one or sufficient opportunity exists for market forces to periodically
replace the standard.[^15]

The tendency for modern technologies to have systems structures
increases the economic importance of the lock-in phenomenon. In
particular, most technologies today have clusters of standards embedded
in them. One, however, is frequently the dominant or driver standard.
Thus, the controller of that standard can have even greater impact on
the evolutionary development of the overall technology and related
markets.

While the lock-in effect works on the demand side, the "installed base"
effect impacts the supply side. Dominant suppliers of a technology, who
either control or adhere to the standard, have invested substantial
resources in developing and servicing the markets based on this
standard. Their established market positions promote evolutionary as
opposed to revolutionary migration of customers, who demand backward
mobility to existing technology. Mobility is more difficult and
expensive, the more radical the new technology. If Microsoft, Apple, and
IBM were freed from maintaining compatibility with existing hardware
software, new generations of systems software would likely evolve at a
faster pace.

5.2. Nonproduct Standards

Because this class of standards consists of a set of "tools" that make
the process of developing, producing, and marketing the core technology
more efficient, they do not have the dominant or controlling effects of
product-element standards. Thus, the potential negative impacts are not
as obvious. However, negative economic effects can occur. They typically
result from three problems: (1) multiple standards for the same
infratechnology, (2) poorly designed standards, and (3) poorly timed
standards.

Multiple standards usually arise in the early phases of a technology's
development when innovating firms are intent on achieving market
penetration. At this point, the market is often not large enough to
warrant investment in infratechnologies such as sophisticated test
methods. Consequently, innovators rely on off-the-shelf or contrived
methods that hopefully convince customers to try the new technology.

However, as the market expands, imitators enter with their own versions
of the required test methods. Confusion among buyers soon takes over, as
different vendors provide test methods that produce different results.
The cost to buyers of determining what test method most accurately
measures performance rises as their purchases increase. Moreover,
because these multiple measurement and test methods are typically
adapted from previous generations of the underlying infratechnology,
they are frequently inaccurate and sometimes markedly so.

These first two problems can be resolved by additional research to
develop better infratechnologies, which can then be adopted as single
industry standards. However, because a consensus process involving
numerous industry stakeholders promulgates most standards of this type,
developing the needed infratechnology and reaching a consensus on the
standard often encounters substantial obstacles.[^16] The resulting
delays can create significant costs in executing market transactions,
which raise prices and thereby retard market penetration.

The problems of multiple standards and the timing of standardization
also arise at the interface between components of a system of
technologies. The increasingly important objectives of compatibility and
interoperability are implemented through interface standards. Interface
standards typically have both physical and functional elements and can
be extremely complicated to design, especially in systems technologies
where multiple components must interoperate.

The timing of interface standards is not only important, but also often
essential for small firms that supply a single component to a larger
system. Often, a standard interface must be in place for small firms to
even contemplate entering the market. Thus, poorly designed or delayed
interface standards can have decidedly negative effects on market
structure.[^17]

3.  Cost

The economic cost of inadequate standardization (either no standard or a
poorly designed one) can be very high. A study by Brunnermeier and
Martin \[1999\] estimated that interoperability problems associated with
sharing product and engineering data impose annual costs on the U.S.
automotive supply chain totaling approximately \$1 billion. Resources
expended to correct or re-create data files because of software
incompatibilities account for more than 80 percent of the total. Delays
in the introduction of new vehicles are responsible for almost 10
percent of the cost. Other expenses include purchases of several
vendors\' versions of software designed to perform similar tasks and
spending for data-exchange services. Other large U.S. industries, such
as aerospace, have similarly large electronic data transmission
requirements within their supply chains, so the total cost to the U.S.
economy of inadequate interoperability standards is much greater than
the estimate for the automotive supply chain alone.

One potential solution is the evolving international Standard for the
Exchange of Product Model Data (STEP), or ISO 1303. STEP is a neutral
file format intended to support computer-to-computer exchanges of all
types of product data, from initial design to maintenance requirements.
However, this standard is itself very complex and is requiring a huge
investment worldwide to develop the generic set of standards. In
addition, infratechnologies such as test methods and software tools must
be developed to facilitate industry\'s adoption and implementation of
interoperability standards.

6\. Degrees of Standardization

From both the corporate strategy and public policy points of view,
standardization is not an all-or-nothing proposition. In complicated
system technologies, such as distributed data processing,
telecommunications, or factory automation, standardization typically
proceeds in an evolutionary manner in lock step with the evolution of
both embodied and disembodied technology. The pattern of evolution is
determined by several factors: the pace of technological change embodied
in each component category; disembodied technology development, which
determines the overall system architecture and organization; and changes
in market structure (and, with it, the incentives and ability to force
the standardization process).

In the case of numerically controlled machine tools, early total
standardization of data formats would have severely compromised the
range of performance attributes desired by different users in the
machine tools they purchased. Thus, a degree of standardization has been
optimal, at least up to this point in the technology\'s evolution. In
other words, complete standardization too early in the technology life
cycle can constrain innovation.

As technology-based systems become increasingly important and \"windows
of opportunity\" for making successful investments in the associated
markets continue to shrink, the relevant standards will have to be
managed. If a standard is fixed, even if it is competitively neutral, it
will eventually act to stifle the introduction of new technology into
the system. Alternatively, if the standard is updated frequently, then
version consistency (upward mobility of current system components) can
become a problem.

For example, efficient data processing and communications networks are
possible only if standard interfaces are provided on all the
communication paths in the network. Such interfaces need to be defined
between application programs, data formats, network protocols, printer
control codes, human/machine interfaces, and so on. But, these system
elements are all evolving at different rates and thus need updated
interfaces at different points in time.

Thus, with new technologies continuously being introduced into ever
expanding networks, the pressure on the standards infrastructure to
adapt is substantial. One reason is the need to reflect changes in the
core distributed processing technology. Another is the requirement to
adapt system management technologies such as toleration of faults, rapid
(real time) response to multimedia inputs and outputs (voice, image,
text, and others), and human friendly interfaces to a constantly
changing network structure as nodes are added, removed, or replaced by
different systems.

7\. Policy Implications

In most cases, market dynamics seem to affect standardization of product
elements that drive network externalities. As long as the private-sector
originator and hence controller of the standard does not use this
control to gain advantage in related products, long-run efficiency seems
attainable. On the other hand, if monopoly control by a single firm
becomes entrenched or, conversely, if no standard emerges (i.e.,
multiple standards persist) to the detriment of economic growth, some
policy action may be required.

Cottrell \[1994, pp. 163--164\] discusses how the Japanese government
tried in several ways to remedy the multiple PC standards problem in its
domestic industry. The SIGMA (Software Industrial Generalization and
Maintenance Aids) Project and a subsequent five-year extension
(SuperSIGMA) were major government efforts to achieve a Unix operating
system standard and thereby deal with the economic inefficiencies of a
heterogeneous (nonstandardized) product structure. The project attempted
to promote automated software development and create standardized
Unix-based data structures, communications interfaces, and applications
platforms.

An important policy implication is that research projects can be funded
with a pure "technology development" objective or a combined "technology
and standardization" objective. The TRON project in Japan is an example
of the latter.[^18] R&D projects that involve horizontal cooperation
between suppliers of system components (e.g., computer hardware and
software firms) can promote standardization of key product elements at
an earlier point in the technology life cycle. Such joint research
ventures with standardization as an objective are occurring more
frequently, especially in IT industries.

Finally, government R&D can establish and demonstrate a backbone
infrastructure, which in turn promotes private-sector R&D investment in
standards to enable effective use of this infrastructure. No private
entity would have funded several decades of the Internet's development,
as it slowly evolved to its current state where enormous private
investment is now taking place. Industry standards such as Java are
enabling a host of applications to be developed and implemented, but
Java would not have been possible without the U.S. government's
persistent funding of the Internet's predecessors.

This last example exemplifies a key issue for government R&D policy.
Success as an innovator manifests itself in a large installed base. The
lock-in effect that results from the role of increasing returns to scale
can be accepted as a natural and even desirable attribute of many
technology-based markets. However, this characteristic along with the
installed-base effect can combine to prolong technology life cycles at
the expense of newer, more efficient technologies. The standard setter
can maintain control by migrating the installed base through several
incremental generations of the technology within a longer life cycle.
This supply-side incentive to resist major technological change is
reinforced by the fact that, once a large customer base is attained,
user demand for backward mobility further promotes an evolutionary
rather than a revolutionary approach to change. This phenomenon is a
major reason why smaller firms appear more innovative, especially with
respect to radical innovations; they are not encumbered by the installed
base.

One possible policy response is to require, through regulation, equal
access to applications markets so that the firm controlling the
infrastructure standard does not use this advantage to restrain
competition (Arthur \[1996, p. 106\]). Government funding of new
generations of technology-based infrastructure is another response to
dealing with the negative effects of this type of standardization.

The Internet provides a great example of the basis for a new technology
life cycle that may eventually replace the "Wintel" standards of the
current PC technology life cycle.[^19] In fact, the "open systems"
nature of the Internet may preclude the type of lock-in strategy
observed so often in the 1980s. Netscape gave away its Internet browser
and attained 70 percent of the market. Its objective was to obtain
potentially larger and more lasting profits from the substantial value
added available from software applications accessed through the browser.
Similarly, America Online gained an initial substantial lead of more
than 4.5 million subscribers by giving away free services. In these and
other similar cases, however, ease of entry implies achieving lock-in is
problematic at best.

Policy implications for non-product standards and investment in the
associated infratechnologies are subtler. Public sector infratechnology
investment is not resource intensive. The semiconductor industry, for
example, spends \$4-5 billion per year on measurement equipment (Finan
\[1997\]). However, the government support for the infratechnologies
(measurement and test methods, for example) and associated standards
required to attain the productivity goals of this investment is
considerably less. Nevertheless, tight R&D budgets in most
industrialized nations during the 1990s have constrained infratechnology
research support.[^20]

The critical point is that a range of infratechnologies and associated
standards are needed by industry over the technology life cycle.
Individual standards may have modest economic impact, but the large
number of standards required by the typical high-tech industry means
that the collective impact is substantial. Government research program
management and associated funding must be sufficient to provide this
complex technical infrastructure in the time frames dictated by industry
R&D strategies in response to competitive trends.

8\. Conclusions

Over the past decade, the infrastructure roles of standards have
increased in importance because (1) many new technologies are systems or
networks so that increasing returns to scale can generate huge economic
rewards for the version of a technology that becomes the standard, (2)
the demand for quality and reliability in technologically complex
products and systems requires a range of standards based on
sophisticated infratechnologies, (3) the systems nature of critically
important technologies means that competition is greatly affected by the
degree of standardization within product structures and at the
interfaces between components of these systems, and (4) the shortening
of the average technology life cycle has on average increased the
pressure on the standards setting process with respect to timing.

The central strategic problem of managing the timing and content of
standards is a difficult one because (1) many types of standards are
needed in today\'s typical technology-based industry, (2) they interact
to varying degrees with one another, and (3) nonproduct standards, as
one type of technology infrastructure, derive from different sources
than the industry\'s core technology and thereby often conflict with
corporate strategies.

Because the U.S. domestic market is large with considerable internal
competition in most industries, American economic philosophy has allowed
the competitive dynamics of the marketplace to set product-element
standards. Issues of unfair advantage in related markets for the firm
whose technology eventually wins out as the industry standard are raised
periodically. In other cases, several competing "local" standards
coexist for some time, resulting in complaints of inefficiency. In
Europe, more coordinated standardization efforts in areas such as
wireless communications have been undertaken to gain first mover
advantages. This latter approach is causing U.S. industry and government
managers to rethink their laissez faire standards strategies.

More generally, industry structures and hence long-term economic
efficiency can be significantly affected by which firms' technologies
become industry standards and the degree to which standardization
enables or inhibits access to the markets for a technology. To the
extent that monopolistic control of a standard or the existence of
multiple standards produces economic inefficiency, the globalization of
technology-based competition can accentuate these problems.

More national economies are now capable of competing for the dominant
product-element standard in technology-based industries. National
governments often support the domestic industry's standard over
alternatives. Moreover, multinational alliances of firms frequently
pursue their versions of a product-element standard in emerging
technology-based markets. Thus, multiple standards can arise and persist
for some time. In such cases, multilateral efforts should be undertaken
to at least harmonize these competing standards, if not to select one as
a single international standard at an appropriate point in the
technology life cycle.

In contrast, nonproduct standards have a more persuasive infrastructure
character and thus, unlike product-element standards, evolve largely
through non-traditional market processes. Such standards are themselves
based on infratechnologies, which often derive from a different science
and engineering base than does the industry's core technology. If
correctly configured, they are competitively neutral and have their
economic impact by increasing efficiency for all domestic suppliers and
customers in the particular market for the product or service.

The unavailability of standards at different points in a technology's
life cycle can result in large economic inefficiency. Both types of
standards can also cause economic losses if they are poorly structured.
Multiple standards may exist for prolonged periods of time, limiting
economies of scale or network externalities and hence total market
growth, although market growth may be greater in the long run if this
situation allows superior technology to eventually dominate. Therefore,
especially because the process of standardization within a technology
life cycle is often irreversible, these and other elements of the
dynamics of this process are key policy variables.

Finally, standardization over a technology life cycle has a dynamic
character, in that different degrees of standardization are optimal at
different points in both the technology's and the industry's evolution.
Moreover, because standards interact with each other in imparting their
economic impacts, the process of standardization frequently must be
managed as a system.

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[^1]: Email: <tassey@nist.gov>. The author is grateful to Albert N. Link
    for comments on previous drafts.

[^2]: Tassey \[1997\]. The high-tech sector is defined here as
    consisting of four major categories: high-tech manufacturing
    (IT-related plus industrial electronics), communication services,
    software and computer-related services, and pharmaceuticals). For
    alternative definitions of IT-related high-tech industries, see
    American Electronics Association \[1997, p. 128\] and Department of
    Commerce \[1998, Appendix p. A1--2\]. The AEA definition results in
    a 6.1 GDP estimate for 1996 and the Commerce definition yields about
    8 percent for 1998. To either of these definitions should be added
    pharmaceuticals, which brings the AEA-defined high-tech sector's GDP
    contribution to 7 percent.

[^3]: This taxonomy follows Tassey \[1982, 1992, 1997\] and Link and
    Tassey \[1987\]. David \[1987\] proposes a similar taxonomy based on
    three kinds of standards (reference, minimum quality, and
    compatibility). Other taxonomies have been developed based on the
    process by which a standard comes into existence. For example, David
    and Greenstein \[1990\] provide a framework to classify standards as
    *de facto* ("unsponsored" or "sponsored") or promulgated (voluntary
    or *dejure*).

[^4]: Scrap can result when periodic testing of product reveals an
    attribute flaw. All units produced between the sample product tested
    and the previous test are equally defective.

[^5]: See, for example, David and Steinmueller \[1994\], Kahin and
    Abbate \[1995\], and Link and Scott \[1998\].

[^6]: Intel's microprocessor architecture and Microsoft's operating
    system are well-known examples.

[^7]: Architecture is the scheme by which the function of a product is
    allocated to physical components (Ulrich, \[1995, p. 419\]).
    Architecture is important because it provides a set of standardized
    product attributes and the rules or protocols for their interaction
    with other product elements.

[^8]: The business literature continues to debate the efficacy of
    competition to supply the product elements that constitute an
    architecture. See Morris and Ferguson \[1993\].

[^9]: The term *graphical user interface* refers to the use of \"menus\"
    of images instead of characters to indicate instruction options for
    the computer user. Apple pioneered this much-preferred format and
    also made this approach even more attractive to users by sticking to
    a standardized format for all application programs.

[^10]: A normative standard is one in which a particular value (size,
    performance, quality, or design) is selected from a range of
    alternative values.

[^11]: Line-width measurement is just one of many infratechnologies that
    a competitive semiconductor industry must utilize. For example,
    current state-of-the-art chips consist of multiple layers of
    circuits. The circuits in each layer must be connected to adjoining
    layers. Accomplishing this very difficult manufacturing step
    requires a precise alignment of the "mask" (circuit pattern) for
    each layer. Until recently, the alignment process required
    multimillion-dollar optical equipment. NIST, however, developed a
    procedure that allows semiconductor manufacturers to ensure proper
    alignment of successive layers of an integrated circuit with a
    precision better than ten nanometers. This new calibration standard
    represents a more than fivefold improvement over current alignment
    calibration methods and is much less expensive. The cumulative
    economic impact of such advances in infratechnologies/standards is
    substantial and can greatly affect price as well as quality, and
    hence competitive position for the domestic industry.

[^12]: In communication networks, for example, there are published
    standards and interface protocols that allow hardware components and
    software from many vendors to operate as a single product or as a
    system of products (i.e., as a network). To achieve efficient or
    \"seamless\" integration, the standards and protocols define what
    rules hardware components must adhere to in order to exchange
    signals between applications software and operating systems at
    different levels in the network.

[^13]: See David and Greenstein \[1990\] for an excellent review of the
    early literature on these topics.

[^14]: For more than a decade, DOS --- a clearly inferior operating
    system to alternatives such as Apple Computer's system --- dominated
    the personal computing market because the Microsoft/IBM combination
    was able to lock in the PC market.

[^15]: Arthur \[1996\] provides an excellent analysis of the increasing
    returns-to-scale phenomenon that characterizes many technology-based
    industries and the consequent motivation for firms to set and
    control product-element standards.

[^16]: See U.S. Congress, Office of Technology Assessment \[1992\].

[^17]: Delays can also occur simply because all component technologies
    do not evolve at the same rate. Laggard components of the system are
    often characterized by chaotic entry and exit as well as by rapid
    technological change, which prohibits consensus being reached on
    needed standards.

[^18]: The TRON Project has been an ongoing effort between Japanese
    industry and universities since 1981. It seeks to develop
    standardized operating systems, which in turn will drive compatible
    hardware development. However, the installed base effect of the
    dominant U.S. industry standards has at least partially thwarted
    this effort, as one of the largest Japanese computer firms, NEC, has
    invested so much effort in marketing MS-DOS/ WINDOWS/UNIX machines
    that the company has not participated in TRON. See Cottrell \[1994,
    p. 166\] and Kahaner \[1991\].

[^19]: "Wintel" refers to the dual hardware and software standards
    controlled by Intel and Microsoft, respectively.

[^20]: For example, NIST infratechnology research funding relative to
    U.S. industry R&D spending, which NIST is charged with supporting,
    is one half the level of 25 years ago.