Strategic Management of Complementary Goods

Understanding Complementary Goods

Definition: Products A and B are considered complements if the utility of the combination is greater than the sum of their individual utilities: U(A+B) > U(A) + U(B).

Symmetry: A is a complement to B if and only if B is a complement to A (A ↔ B).

Equivalent Definition: If A is a complement to B, then the demand for A decreases as the price of B increases: ∂Da / ∂pb < 0.

Surprising Complementary Effects

Idea: Substitute goods can also exhibit complementary effects. Example: A price cut for Store A makes a shopping mall more attractive, which subsequently increases sales for Store B.

Classification of Complements

• Contribution of A alone to total utility: va = u(A) / u(A+B)
• Contribution of B alone to total utility: vb = u(B) / u(A+B)
• Complementary part of utility: vab = u(A+B) - va - vb

There is strong complementarity if vab is large. Product A is more dependent on B than B is on A if va < vb.

Strategic Management of Complements

Controlling the Complement

Idea: Decide whether to sell complements oneself or allow third parties to sell them.

• Pros: Product A might function better with B than with a third-party version (B′); cost advantages in marketing, sales, and potentially production.
• Cons: The market for B might be unattractive; B might require competencies that Firm F lacks; prospective customers might be deterred by Firm F's dominant position.

Cross-Subsidization Strategies

Idea: Sell one complementary good at a low price to increase the sales of the other. This is implemented through intelligent pricing and cross-subsidies. Product A is sold at small margins to spur the sale of Product B, which carries high margins.

Prerequisites for Cross-Subsidies

• High demand elasticity for A
• Low demand elasticity for B
• Strong complementarity between A and B

Risks of Cross-Subsidies

• Consumers might not buy the high-margin product at all.
• The product might be bought from another supplier.
• The product might be substituted or produced by the consumers themselves.

Product Bundling

Idea: Firm F sells Product A and its complement B only as a combined package.

• Advantages: If there is little or no competition for A, competition in the market for B decreases; cost advantages in marketing; provision of complex composite products.
• Risks: Potential buyers of only A or only B are lost; the bundling becomes a market standard.

Customer Lock-in Mechanisms

Idea: Increase customer switching costs to ensure they remain loyal to the firm's standards.

Mechanism: The more complements to Product A that a customer buys from Firm F, the higher the switching costs become. This implies a higher lifetime value of the customer to the firm.