STRUCTURAL MODELS OF TECHNOLOGY ADOPTION by Botao Yang A thesis submitted in conformity with the requirements for the degree of Doctor of Philosophy Joseph L. 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Rotman School of Management University of Toronto ABSTRACT This dissertation consists of two essays, studying technology adoption decisions from both the demand/consumer side and supply/firm side by using structural models. Essay 1 investigates consumers' ATM card adoption decisions and Essay 2 examines firms' 56K modem adoption decisions in 1997. The first essay, "Dynamics of Consumer Adoption of Financial Innovations: the Case of ATM Cards", offers a new explanation to a stylized fact - seniors' low technology adoption rate. Previous literature tries to rationalize this fact by arguing that seniors have psychological resistance toward technology, or they have more difficulties in learning new technologies. However, one potential explanation has been neglected: the elderly have shorter life horizons than the young, and consequently they have smaller discounted adoption benefits. To capture this, we model consumers to be forward-looking and solve a finite-horizon dynamic programming problem when making adoption decisions. We apply this framework to the case of ATM cards. To measure monetary benefits from ATM card adoption, we also model how consumers make cash withdrawal decisions. We estimate the structural parameters by using a ii micro-level panel dataset. We find evidence that the elderly may not have larger monetary adoption costs for ATM cards. The second essay, "Are All Managers Created Equal", explores the idea that managers have different strategic thinking levels when playing a simultaneous entry game. Based on the cognitive hierarchy framework of Camerer, Ho and Chong (2004), we develop a structural model that estimates the level of strategic thinking. In the model, firms with a high level of strategic thinking are more likely to correctly conjecture the expected actions of their competitors. We apply this model to decisions by 2,233 Internet Service Providers to offer their customers access through 56K modems in 1997. The model is validated by showing that firms with a higher probability of strategic thinking were more likely to have survived through April 2007. The estimation results show considerable heterogeneity in the degree to which firms behave strategically and suggest that strategic ability affects marketing outcomes: a simulated increase in strategic ability means that fewer firms offer the technology to their customers. in To my parents IV ACKNOWLEDGEMENTS I am deeply grateful to my dissertation committee members, Andrew Ching, Sridhar Moorthy, Avi Goldfarb, and Victor Aguirregabiria, for their exceptional guidance and help on this dissertation. Without your help, writing my dissertation could never have been such a rewarding experience. I want to thank all faculty members in the Marketing area at the University of Toronto for their numerous help along the way. In particular, I would like to thank Andy Mitchell, Mengze Shi, Dilip Soman, Nitin Mehta, Ron Borkovsky, Claire Tsai, Min Zhao, David Soberman, and Sergio Meza. 1 also appreciate the comments from Ignatius J. Horstmann, Kenneth Corts and other seminar participants at the University of Toronto. Many thanks to my fellow PhD students and friends in Toronto. Their friendship made my PhD life more enjoyable and memorable. My special thanks goes to my parents and my fiancee Lori Qingyuan Yue. This dissertation was made possible by your unconditional love and encouragement. Finally, I want to say "thank you" to all those who ever helped me in one way or another during my PhD life. Although I am not able to list all your names here, I will never forget your help. v TABLE OF CONTENTS INTRODUCTION 1 ESSAY 1 5 1 INTRODUCTION 6 2 LITERATURE REVIEW ll 3 INSTITUTIONAL DETAILS 13 4 DATA 16 5 MODEL 21 6 EMPIRICAL STRATEGY 29 7 ESTIMATION RESULTS AND COUNTERFACTUAL EXPERIMENTS 32 8 LIMITATIONS 40 9 CONCLUSION 41 APPENDIX 43 REFERENCES 44 ESSAY 2 85 1 INTRODUCTION 86 2 A REVIEW OF THE Two KEY BUILDING BLOCKS 90 3 MODEL AND EMPIRICAL STRATEGY 94 4 RESULTS 101 5 LIMITATIONS 107 6 CONCLUSION no REFERENCES 112 APPENDIX 126 VI 1 Introduction 2 The diffusion of a new technology usually requires adoption decisions from both the supply side and the demand side - firms should carry the new technology products or provide the new services; consumers should decide to either buy the new technology products or use the new services. Consequently, it is important to study adoption decisions from both sides. This dissertation fulfills this task - it studies both consumers' technology adoption decisions and firms' technology adoption decisions by using structural models. Specifically, Essay 1 investigates forward-looking consumers' ATM card adoption decisions in a dynamic discrete choice model, and Essay 2 examines firms' 56K modem adoption decisions in 1997 in a static simultaneous entry game framework. Essay 1: Dynamics of Consumer Adoption of Financial Innovations: The Case of ATM Cards (coauthored with Andrew Ching) Consumer technology adoption has long been a research topic in Marketing and Economics. One interesting stylized fact is that usage of new technologies by the elderly is consistently much lower than that by other age groups. Previous literature tries to rationalize this fact by arguing that the elderly have psychological resistance toward new technologies, or it is relatively more difficult for them to learn and use new technologies. If one estimates individuals' adoption costs in a static choice model, this stylized fact would translate into higher adoption costs for the elderly. However, there is one potential explanation that has been neglected in the previous literature: the elderly have much shorter life horizons than the young, and consequently their total discounted benefits from adoption could also be much smaller. In order to capture this factor, we explicitly model consumers to be forward-looking and solve a finite horizon dynamic programming 3 problem when deciding whether to adopt a new technology. We apply this framework to the case of ATM cards. To measure monetary benefits per period from ATM card adoption, we also explicitly model how consumers make cash withdrawal decisions. We estimate the structural parameters of our model by using a micro-level panel dataset, which consists of detailed demographic information, individuals' adoption decisions of ATM cards and cash withdrawal patterns, and the number of ATM machines and interest rates over time, as provided by the Bank of Italy. The estimation results allow us to measure the relative importance of adoption costs and total discounted benefits in influencing consumers' ATM card adoption decisions. We find evidence that the elderly may not have larger adoption costs for ATM cards in Italy - the lower ATM card adoption rate among the elderly can be explained in terms of differences in total discounted benefits of adoption across age groups. Since we can infer consumers' adoption benefits per period from observing their usage patterns, then combining this with the dynamic model of adoption decisions, we are able to measure adoption costs in monetary terms - this is another important contribution of this paper. By conducting counterfactual experiments, we quantify how consumers' ATM adoption decisions would be affected by changing (i) the amount of sign-up bonuses, (ii) number of ATMs, and (iii) interest rates. Essay 2: Are All Managers Created Equal (coauthored with Avi Goldfarb) Some managers are better than others. Based on the cognitive hierarchy framework of Camerer, Ho and Chong (2004), we develop a structural econometric model that estimates the level of strategic thinking. In the model, firms with a high level 4 of strategic thinking are more likely to correctly conjecture the expected actions of their competitors. We apply this model to decisions by managers at 2,233 Internet Service Providers to offer their customers access through 56K modems in 1997.