First Mover Advantage Essay

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What. exactly, are first-mover advantages? Under what conditions do they arise, and by what specific mechanisms? Do first-movers make above-average profits? And when is it in a firms interest to pursue first-mover opportunities, as opposed to allowing rivals to make the pioneering investments? In this paper we examine these and other related questions. We categorize mechanisms that confer advantages and disadvantages on firstmover firms, and critically assess the relevant theoretical and empirical literature.

The recent burgeoning of theoretical work in industrial economics provides a rich set of models that help make understanding of first-mover advantages more precise. There is also a growing body of empirical literature on order-of-entry effects. Our aim is to begin to provide a more detailed mapping of mechanisms and outcomes, to serve as a guide for future research. We define first-mover advantages in terms of the ability of pioneering firms to earn positive economic profits (i. e. profits in excess of the cost of capital).

First-mover advantages arise endogenously within a multi-stage process, as illustrated in Figure 1. In the first stage some asymmetry is generated, enabling one particular firm to gain a head start over rivals. This firstmover opportunity may occur because the firm 0143-2095188/050041-18$09. 00 1988 by John Wiley & Sons. Ltd. possesses some unique resources or foresight, or simply because of luck. Once this asymmetry is generated a variety of mechanisms may enable the firm to exploit its position; these mechanisms enhance the magnitude or durability (or both) of first-mover profits.

Our discussion is organized as follows. We first consider theoretical models and empirical evidence on three general categories in which first-mover advantage can be attained: leadership in product and process technology, preemption of assets, and development of buyer switching costs. We then examine potential disadr~atztages of first-mover firms (or conversely, relative advantages enjoyed by late-mover rivals). These include free-rider problems and a tendency toward inertia or sluggish response by established incumbents. The next section addresses a series of basic conceptual issues.

These include the endogenous nature of first-mover opportunities, and various definitional and measurement questions. We conclude with an assessment of opportunities for additional research and a discussion of managerial implications. MECHANISMS LEADING TO FIRSTMOVER ADVANTAGES First-mover advantages arise from three primary sources: (1) technological leadership, (2) preemp- 42 M. B. Lieberman and D. B. Montgomery Environmental Change .. ,, . , b ,,. >.. .,. I ,.. I .( 1. First-Mover Opportunity I, 1 I (1 Mechanismsfor Enhancing First-Mover Advantage 1 ,{ .

(I 111 I Profits I Figure 1. Endogenous generation of first-mover advantages. tion of assets, and (3) buyer switching costs. Within each category there are a number of specific mechanisms. In this section we survey existing theoretical and empirical literature on these three general categories of first-mover advantages. The theoretical models surveyed in this section assume the existence of some initial asymmetry among competitors that can be exploited by the first-mover firm. This initial asymmetry is critical; without it, first-mover advantages do not arise.

Ways in which this asymmetry may come about are considered later in the paper. Technological leadership First-movers can gain advantage through sustainable leadership in technology. Two basic mechanisms are considered in the literature: (1) advantages derived from the learning or experience curve, where costs fall with cumulative output, and (2) success in patent or R&D races, where advances in product or process technology are a function of R&D expenditures. Rumelt (1987) refers to these as isolating mechanisms, since they protect entrepreneurial rents from imitative competition.

Learning curve In the standard learning-curve model, unit production costs fall with cumulative output. This generates a sustainable cost advantage for the early entrant if learning can be kept proprietary and the firm can maintain leadership in market share. This argument was popularized by the Boston Consulting Group during the 1970s and has had a considerable influence on the strategic management field. In a seminal paper, S ~ e n c e demonstrated that when learning can be kept First-mover Advantages proprietary, the learning curve can generate substantial barriers to entry.

Fewer than a handful of firms may be able to compete p r ~ f i t a b l y . Despite high seller concentration, ~ incentives for vigorous competition remain. Firms that d o enter may initially sell below cost in an effort to accumulate greater experience, and thereby gain a long-term cost advantage. Such competition sharply reduces profits. Empirical evidence of learning-based preemption is given by Ghemawat (1984) in the case of DuPonts development of an innovative process for titanium dioxide, and by Porter (1981). who discusses Procter and Gambles sustained advantage in disposable diapers in the U.

S. Similarly, Shaw and Shaw (1984) argue that late entrants into European synthetic fiber markets failed to gain significant market shares or low cost positions, and many ultimately exited. Learning-based advantages are also evident in the case of Lincoln Electric Company (Fast, 1975); the firms early market entry with superior patented products, coupled with a managerial system promoting continued cost reduction in an evolutionary technological environment, has enabled the company to maintain high profitability for decades.

Inter-firm diffusion of technology, which diminishes first-mover advantages derived from the learning curve, is emphasized in theoretical papers by Ghemawat and Spence (1985) and Lieberman (1987~). is now generally recognized It that diffusion sccurs rapidly in most industries, and learning-based advantages are less widespread than was commonly believed in the 1970s. Mechanisms for diffusion include workforce mobility, research publication, informal technical communication, reverse engineering, plant tours, etc.

For a sample of firms in ten industries, Mansfield (1985) found that process technology leaks more slowly than product technology, but competitors typically gain access to detailed information on both products and processes within a year of development. Lieberman (1982, 1987b) shows that diffusion of process technology enabled late entry into a sample of 40 chemical product industries, despite strong learning curve effects at the industry level.

In a related setting where learning depends on accumulated investment rather than output, Gilbert and Harris (1981) show that a first-mover will preempt in the construction of new plants over multiple generations. 43 R&D and patents When technological advantage is largely a function of R & D expenditures, pioneers can gain advantage if technology can be patented or maintained as trade secrets. This has been formalized in the theoretical economics literature in the form of R & D or patent-races where advantages are often enjoyed by the first-mover firm.

Gilbert and Newbery (1982) were the first to develop a model of preemptive patenting, in which a firm with an early head-start in research exploits its lead to deter rivals from entering the patent-race. Subsequent papers by Reinganum (1983), Fudenberg et al. (1983) and others show that successful preemption by the leader depends on assumptions regarding the stochastic nature of the R & D process and on the inability of followers to leapfrog ahead of the incumbent. One general defect of the patent-race literature is the assumption that all returns go exclusively to the winner of the race.

As an empirical matter, such patent-races seem to be important in only a few industries, such as pharmaceuticals. In most industries, patents confer only weak protection, are easy to invent around, or have transitory value given the pace of technological change. For a sample of 48 patented product innovations in pharmaceuticals, chemicals and electrical products, Mansfield et al. (1981) found that, on average, imitators could duplicate patented innovations for about 65 percent of the innovators cost; imitation was fairly rapid, with 60 percent of the patented innovations limited within 4 years.

Imitation appears relatively more costly in the pharmaceutical industry, where imitators must go through the same regulatory approval procedures as the innovating firm. Levin et al. (1984) found wide inter-industry variation in the cost and time required for imitation. They also found interindustry differences in appropriability mechanisms, with lead-time and learning curve advantages relatively important in many industries, and patents important in few. In a study using the PIMS data base, Robinson (1988) found that pioneer firms benefit from patents or trade secrets to a significantly greater extent than followers (29 percent vs.

13 percent). However, he also found that patents accounted for only a small proportion of the perceived quality advantages enjoyed by pioneers. 44 M. B. Lieberman and D. B. Montgomery turing locations. Here, the returns garnered by the first-mover are pure economic rents. first-mover with superior information can (in principle) collect all such rents earned on nonmobile assets such as resource deposits and real e ~ t a t eThe firm may also be able to appropriate . ~ some of the rents that accrue to potentially mobile assets such as employees, suppliers and distributors.

The firm can collect such rents if these factors are bound to the firm by switching costs, so that their mobility is restricted. One empirical study of first-mover advantages in controlling natural resources is Main (1955). Main argues that the concentration of high-grade nickel deposits in a single geographic area made it possible for the first company in the area to secure rights to virtually the entire supply, and thus dominate world production for decades. Several case studies have examined the role of patents in sustaining first-mover advantages.

Bresnahan (1985) discusses Xeroxs use of patents as an entry barrier. In addition to key patents on the basic Xerography process, Xerox patented a thicket of alternative technologies which defended the firm from entry until challengers used anti-trust actions to force compulsory licensing. Bright (1949) argues that GEs longterm dominance of the electric lamp industry was initially derived from control of the basic Edison patent, and later maintained through the accumulation of hundreds of minor patents on the lamp and associated equipment.

R&D and innovation need not be limited to physical hardware; firms also make improvements in managerial systems and may invent new organizational forms. Organizational innovation is often slow to diffuse, and hence may convey a more durable first-mover advantage than product or process innovation (Teece, 1980). Chandler (1977) describes managerial innovations that enabled producers to exploit newly available scale economies in manufacturing and distribution in the late nineteenth century. Many of these firmse. g. American Tobacco, Campbell Soup, Quaker Oats, Procter and Gamble-still retain dominant

positions in their industries. Preemption of locations in geographic and product characteristics space First-movers may also be able to deter entry through strategies of spatial preemption. In many markets there is room for only a limited number of profitable firms; the first-mover can often select the most attractive niches and may be able to take strategic actions that limit the amount of space available for subsequent entrants. Preemptable space can be interpreted broadly to include not only geographic space, but also shelf space and product characteristics space (i. e.

niches for product differentiation). The theory of spatial preemption is developed in papers by Prescott and Visscher (1977), Schmalensee (1978), Rao and Rutenberg (1979) and Eaton and Lipsey (1979, 1981). The basic argument is that the first-mover can establish positions in geographic or product space such that latecomers find it unprofitable to occupy the interstices. If the market is growing, new niches are filled by incumbents before new entry Preemption of scarce assets The first-mover firm may be able to gain advantage by preempting rivals in the acquisition of scarce assets.

Here, the first-mover gains advantage by controlling assets that already exist, rather than those created by the firm through development of new technology. Such assets may be physical resources or other process inputs. Alternatively, the assets may relate to positioning in space, including geographic space, product space, shelf space, etc. Preemption of input factors If the first-mover firm has superior information, it may be able to purchase assets at market prices below those that &ill prevail later in the evoiution of the market.

Such assets resource deposits and prime retailing or manufac- The basic argument is standard economic analysis. and can be traced back to Ricardos analysis of rents capturcd b landowners (first-movers) in the market for wheat i n nineteenth-century England, Note that, with complete markets, a first-mover with superior information need not actually own or control such assets to capture economic rents. Hirshleifer (1971) argues that if futures markets exist. the firm can simply assume forward market positions that exploit its superior information. First-mover Advantages becomes profitable.

Entry is repelled through the threat of price warfare, which is more intense when firms are positioned more closely. Incumbent commitment is provided through sunk investment costs. Empirical evidence suggests that successful preemption through geographic space packing is rare. In their study of the cement industry, Johnson and Parkman (1983) found no evidence of successful geographic preemption even though structural characteristics of the industry suggest that such strategies would be likely. In a study of local newspaper markets, Glazer (1985) found no difference in survival rates between first- and second-mover firms.

One explanation for these findings is that all firms in cement and newspaper markets have similar technologies and entry opportunities, so preemptive competition for preferred sites drives profits to zero. In other words, there were no initial asymmetries in timing or information to be exploited. One counter-example illustrating effective geographic preemption is a case study of the WalMart discount retailing firm (Ghemawat, 1986b). Wal-Mart targeted small southern towns located in contiguous regions that competitors initially found unprofitable to service.

By coupling spatial preemption at the retail level with an extremely efficient distribution network, the firm has been able to defend its position and earn sustained high profits. Schmalensees (1978) model of product space preemption was developed in the context of a lawsuit brought by the Federal Trade Commission against the three major U. S. breakfast cereal companies. The FTC alleged that these firms had sustained their high profit rates through a strategy of tacit collusion in preempting supermarket shelf space and product differentiation niches.

Although the lawsuit was dismissed, the cereal firms have continued to sustain exceptionally high profit rates. Robinson and Fornell (1985) found that new consumer product pioneers initially held product Incumbents fill these niches in order t o sustain monopoly profits at nearby locations: these profits may be dissipated if new entry occurs. Judd (1985) argues that sunk costs are not sufficient: exit costs are required as well. Of course, these profits may be derived from sources other than spatial preemption. 45

quality superiority over imitators and subsequently developed advantages in the form of a broader product line. Thus, there is evidence that pioneers try to reinforce their early lead by filling product differentiation niches. Preemptive investment in plant and equipmen1 Another way in which an established first-mover can deter entry is through preemptive investment in plant and equipment. Here, the enlarged capacity of the incumbent serves as a commitment to maintain greater output following entry, with price cuts threatened to make entrants unprofitable.

In these models the incumbent may successfully deter new entry, as in Spence (1977), Dixit (1980), Gilbert and Harris (1981) and Eaton and Ware (1987). Alternatively, preemptive investment by the pioneer may simply deter the growth of smaller entrants, as in Spence (1979) and Fudenberg and Tirole (1983). These investment tactics d o not seem to be particularly important in practice. Gilbert (1986) argues that most industries lack the cost structure required for preemptive investment to prove effective. Lieberman (1987a) shows that preemptive investment by incumbents was seldom successful in deterring entry into chemical product industries.

One exception was magnesium, where Dow Chemical maintained a near-monopoly position for several decades, based largely on investments (threatened or actual) in plant capacity (Lieberman, 1983). The role of scale economies is intentionally deemphasized in the above-mentioned models of preemptive i n ~ e s t m e n t When scale economies . ~ are large, first-mover advantages are typically enhanced, with the limiting case being that of natural monopoly. However, outside of public utilities, scale economies approaching the natural monopoly level are seldom observed in U. S. manufacturing industries.

In a theoretical treat- We have also ignored the possibility that network externalities may enhance the position of the first-mover firm. These externalities arise if there are incentives for interconnection o r compatibility among users (see, for example, Farrell and Saloner, 1986 and Katz and Shapiro. 1986). For example, see Weiss (1976). This finding applies to manufacturing operations only: greater scale economies may arise in distribution and advertising. Also. many retailing markets are geographically fragmented. leading to the possibility of spatial preemption of the sort described above.

Such preemption requires the presence of some scale economies in the form of fixed costs. 46 M . B. Lieberman and D. B. Montgomery brand they encounter that performs the job satisfactorily. Brand loyalty of this sort may be particularly strong for low-cost convenience goods where the benefits of finding a superior brand are seldom great enough to justify the additional search costs that must be incurred (Porter, 1976). In such an environment, earlymover firms may be able to establish a reputation for quality that can be transferred to additional products through umbrella branding and other tactics (Wernerfelt, 1987).

Similar arguments derived from the psychology literature suggest that the first product introduced received disproportionate attention in the consumers mind. Late entrants must have a truly superior product, or else advertise more frequently (or more creatively) than the incumbent in order to be noticed by the consumer. In a laboratory study using consumer products, Carpenter and Nakamoto (1986) found that the order-of-entry influences the formation of consumer preferences. If the pioneer is able to achieve significant consumer trial, it can define the attributes that are perceived as important within a product category.

Pioneers such as CocaCola and Kleenex have become prototypical, occupying a unique position in the consumers mind. Their large market shares tend to persist because perceptions and preferences, once formed, are difficult to alter. More traditional marketing studies confirm the existence of such perceptual effects. In a study of two types of prescription pharmaceuticals-oral diuretics and antianginals-Bond and Lean (1977) found that physicians ignored me-too products, even if offered at lower prices and with substantial marketing support.

l o Montgomery (1975) found that a products newness was one of the two key variables necessary to gain acceptance onto supermarket shelves. These imperfect information effects should be greater for individual consumers than corporate buyers, since the latters larger purchase volume justifies greater investment in information acquisition activities. Using the PIMS data base, O One explanation of these findings is that physicians are price-insensitive because they d o not actually pay the prescription costs.

However, the Carpenter and Nakamoto (1986) experiments found that more typical consumers are also unwilling to switch to objectively similar me-too brands, even at subtantially lower prices. Moreover, switching costs in industrial markets often dissipate over time as buyers become more knowledgeable about competing products (Cady, 1985). ment, Schmalensee (1981) shows that in most realistic industry settings, scale economies provide only minor entry barriers and hence potential for enhanced profits. Switching costs and buyer choice under uncertainty

Switching costs First-mover advantages may also arise from buyer switching costs. With switching costs, late entrants must invest extra resources to attract customers away from the first-mover firm. Several types of switching costs can arise. First, switching costs can stem from initial transactions costs or investments that the buyer makes in adapting to the sellers product. These include the time and resources spent in qualifying a new supplier, the cost of ancillary products such as software for a new computer, and the time, disruption, and financial burdens of training employees.

A second category of switching costs arises due to supplierspecific learning by the buyer. Over time, the buyer adapts to characteristics of the product and its supplier and thus finds it costly to change over to another brand (Wernerfelt, 1985). For example, nurses become accustomed to the intravenous solution delivery systems of a given supplier and are reluctant to switch (Porter, 1980). A third type of switching cost is contractural switching cost that may be intentionally created by the seller. Airline frequent-flyer programs fit in this category (Klemperer, 1986).

Theoretical models of market equilibrium with buyer switching costs include Klemperer (1986) and Wernerfelt (1986, 1988). Switching costs typically enhance the value of market share obtained early in the evolution of a new market. Thus they provide a rationale for pursuit of market share. However, first-movers with large market shares do not necessarily earn high profits; early competition for share can dissipate profits; and under some conditions the inertia of an incumbent with a large customer base can make the firm vulnerable to late entrants, who prove to be relatively more profitable (Klemperer, 1986).

Buyer choice under uncertainty A related theoretical literature (e. g. Schmalensee, 1982) deals with the imperfect information of buyers regarding product quality. In such a context, buyers may rationally stick with the first First-mover Advantages Robinson (1988) and Robinson and Fornell (1985) found that pioneers had larger market shares than followers in both consumer and industrial markets, but the effect was much greater for consumer goodsorder of entry explained 18 percent of the variance in market share in consumer goods markets.

but only 8 percent in industrial markets. For a sample of 129 consumer packaged goods, Urban er al. (1986) found a strong inverse relation between order-of-entry and market share. Brand positions remain remarkably durable in many consumer markets. Ries and Trout (1986) noted that of 25 leading brands in 1923, 20 were still in first place some 60 years later. Davidson (1976) found that two-thirds of the pioneers in 18 United Kingdom grocery product categories developed since 1945 retained their market leadership through the mid-1970s. 47

FIRST-MOVER DISADVANTAGES The mechanisms that benefit the first-mover may be counterbalanced by various disadvantages. These first-mover disadvantages are, in effect, advantages enjoyed by late-mover firms. Latemovers may benefit from: (1) the ability to freeride on first-mover investments, (2) resolution of technological and market uncertainty, (3) technological discontinuities that provide gateways for new entry, and (4) various types of incumbent inertia that make it difficult for the incumbent to adapt to environmental change.

These phenomena can reduce, or even completely negate, the net advantage of the incumbent derived from mechanisms considered previously. Free-rider effects Late-movers may be able to free-ride on a pioneering firms investments in a number of areas including R&D, buyer education, and infrastructure development. As mentioned previously, imitation costs are lower than innovation costs in most industries. However, innovators enjoy an initial period of monopoly that is not available to imitator firms.

The ability of follower firms to free-ride reduces the magnitude and durability of the pioneers profits, and hence its incentive to make early investments. The theoretical literature has focused largely on the implications of free-rider effects in the form of information spillovers in R&D (Spence, 1984; Baldwin and Childs, 1969), and learningbased productivity improvement (Ghemawat and Spence, 1985; Lieberman, 1987~). mentioned As previously, empirical studies document a high rate of inter-firm diffusion of technology in most industries.

Guasch and Weiss (1980) assess free-rider effects operating in the labor market. They give a theoretical argument that late-mover firms may be able to exploit employee screening performed by early entrants, and thus acquire skilled labor at lower cost. This is in addition to the fact that early entrants may invest in employee training, with benefits enjoyed by later entrants who may be able to hire away the trained personnel. Teece (1986a,b) argues that the magnitude of free-rider effects depends in part on ownership of assets that are complementary or co-specialized with the underlying innovation.

For example, EM1 developed the first CT scanner but lost in the marketplace because the firm lacked a technology infrastructure and marketing base in the medical field. Pilkington, by comparison, was able to profit handsomely from its pioneering float glass process due to its assets and experience in the glass industry. In other instances latemover firms have been successful largely because they were able to exploit existing assets in areas such as marketing, distribution, and customer reputation-e. g. IBM in personal computers and Matsushita in VCRs (Schnaars, 1986).

Resolution of technological or market uncertainty Late-movers can gain an edge through resolution of market or technological uncertainty. Wernerfelt and Karnani (1987) consider the effects of uncertainty on the desirability of early versus late market entry. Entry in an uncertain mark2t obviously involves a high degree of risk. They argue that early entry is more attractive when the firm can influence the way that uncertainty is resolved. For example, the firm may be able to set industry standards in its favor.

Firm size A related point is that a late-mover may be able to take advantage of the first-movers mistakes. For example, when Toyota was first planning to enter the U. S. market it interviewed owners of Volkswagens, the leading small car at that time. Information on what owners liked and disliked about the Volkswagen was incorporated in the design process for the new Toyota. 48 M. B. Lieberman and D. B. Montgomery Honeywell, IBM and Burroughs, all of whom offered computer systems to meet the emerging need for electronic funds transfer (Abell, 1978). Incumbent inertia

may also be important-large firms may be better equipped to wait for resolution of uncertainty, or to hedge by maintaining a more flexible investment portfolio. In many new product markets, uncertainty is resolved through the emergence of a dominant design. The Model T Ford and the DC-3 are examples of dominant designs in the automotive and aircraft industries. After emergence of such a design, competition often shifts to price, thereby conveying greater advantage over firms possessing skills in low-cost manufacturing (Teece, 1986b). Shifts in technology or customer needs

Schumpeter (1961) conceived of technological progress as a process of creative destruction in which existing products are superseded by the innovations of new firms. New entrants exploit technological discontinuities to displace existing incumbents. Empirical studies which consider these technological discontinuities or gateways for new entry include Yip (1982) and Bevan (1974). Foster (1986) gives practical advice on how such discontinuities can be exploited by entrants, who might be defined as first-movers into the next technological phase.

Scherer (1980) provides a list of innovative entrants who revolutionized existing industries with new products and processes. He also cites numerous examples of dominant incumbents that proved slow innovators but aggressive followers. Since the replacement technology often appears while the old technology is still growing, it may be difficult for an incumbent to perceive the threat and take adequate preventative steps. Cooper and Schendel (1976) provide several examples, such as the failure of steam locomotive manufacturers to respond to the invention of diesel.

Foster (1986) cites American Viscoses failure to recognize the potential of polyester as a replacement for rayon, and Transitrons inattention to silicon as a substitute for germanium in semiconductor fabrication. This perceptual failure is closely related to incumbent inertia considered below. Customer needs are also dynamic, creating opportunities for later entrants unless the firstmover is alert and able to respond. Docutel, as the pioneer, supplied virtually all of the automatic teller machine market up to late 1974. Over the next 4 years its market share declined to less than 10 percent under the onslaught of

Vulnerability of the first-mover is often enhanced by incumbent inertia. Such inertia can have several root causes: (1) the firm may be lockedin to a specific set of fixed assets, (2) the firm may be reluctant to cannibalize existing product lines, or (3) the firm may become organizationally inflexible. These factors inhibit the ability of the firm to respond to environmental change or competitive threats. Incumbent inertia is often a rational, profitmaximizing response, even though it may lead to organizational decline. For example, Tang (1988) presents a model that rationalizes the decisions of most U.

S. steel producers to continue investing in open-hearth furnace technology even after it had become clear that basic oxygen furnaces were superior. A firm with heavy sunk costs in fixed plant or marketing channels that ultimately prove sub-optimal may find it rational to harvest these investments rather than attempt to transform itself radically. MacMillan (1983) suggests that in the rapidly changing environment of health care, old health care systems may currently be harvesting from their initial investments in locations and personnel.

The appropriate choice between adaptation and harvesting depends on how costly it is to convert the firms existing assets to alternative uses. And, as we discuss below, organizational inertia has often led firms to continue investing in their existing asset base well beyond the point where such investments are economically justified. Much of the literature on cannibalizationavoidance refers to R&D. Arrow (1962) was the first to lay out the theoretical argument that an incumbent monopolist is less likely to innovate than a new entrant, since innovation destroys rents on the firms existing products.

More recent theoretical studies along these lines include Reinganum (1983) and Ghemawat (1986a). Bresnahan (1985) argues that Xerox exhibited such behavior following the expiration of its patentenforced monopoly-Xerox lagged in certain types of innovations and was sluggish to cut l 3 For first-movers, sunk costs are a two-edged sword: they lock the firm into a particular course of action but also provide commitment value that can help deter entry. First-mover Advantages prices on account of its large flee

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