In nearly every industry, products are used by the buyer in conjunction with other complementary products. Computers are used with software packages and programmers, for example, and mobile homes are often used in mobile home parks—plots of land specially designed as permanent sites for mobile homes, complete with streets, electricity, and sewer hookups. Tennis equipment is used with tennis courts, and jet engines are used with spare parts.
The sales of complementary products are necessarily linked, so that their fortunes tend to rise and fall together. However, complementary products can have a strategic relationship to each other that goes far beyond related growth rates. One complementary product often aifects another’s market image and perceived quality, as well as the cost of using the other from the buyer’s viewpoint. Both of these effects are important to differentiation (Chapter 4). The relationship among complements can also affect the cost of supplying them (Chapter 3).
Where an industry’s product is used with complements, an important strategic issue arises: the extent to which a firm should offer the full range of complements or leave some to be provided by independent suppliers. Offering the range of complements provides an important competitive advantage in some industries, but represents an unnecessary and even risky distraction in others. Control over complements is a distinct issue from bundling, though the two issues are related. A firm that supplies complements may or may not choose to bundle, because the benefits of controlling complements can often be gained even if they are sold separately.
1. Competitive Advantages from Controlling Complements
A firm can potentially gain competitive advantage from controlling complements in one of several ways, depending on the firm’s strategy and industry structure. Broadly, the advantages stem from coordinating the value chains of a firm’s product and complements in order to gain interrelationships that are similar in character to those discussed in Chapter 9:
Improve Buyer Performance and Thus Differentiate. Complements often affect the performance of a product or the firm’s overall value to the buyer. Well-designed software can improve the performance of a personal computer, just as toner affects the copy quality of plain paper copiers. Similarly, a food concessionaire can significantly affect the buyer’s satisfaction with a racetrack. Gaining the performance benefit of controlling complements often requires bundling. A firm that controls a complement may thus be able to enhance differ- entiation.
A firm gains a competitive advantage in differentiation from controlling complements if competitors do not. Even if control over a complement is widespread in an industry, however, it can still be beneficial if it improves overall industry structure though no firm gains a competitive advantage.
Improve the Perception of Value. Complements frequently affect each other’s image or perceived quality. If mobile home parks look shoddy or are poorly designed, for example, this can adversely affect how buyers perceive mobile homes. Because of their association in the buyer’s mind, complements are frequently signaling criteria for each other.1 Controlling a complement can yield a competitive advantage in signaling even if a firm does not bundle. For example, Kodak’s strong position in film improves its perceived differentiation vis-a-vis other camera manufacturers that do not sell film, even though Kodak sells cameras and film separately.
Controlling complements to signal value may be beneficial to industry structure even if no one firm gains a competitive advantage from doing so. In the mobile home industry, for example, the overall image of mobile homes could be improved if all mobile home producers also developed high-quality mobile home parks. This would increase the demand for mobile home versus other forms of housing and benefit the entire industry. Control over complements by one firm may, in fact, have little impact on buyer perceptions unless a sufficient number of competitors also control the complement. In these cases a firm should actually work to encourage its competitors to enter the complementary industry along with it.
Optimal Pricing. The buyer’s purchase decision is frequently based on the total cost of a product and complements, rather than on the cost of the product alone. For example, buyers usually measure the cost of a condominium or automobile by the total monthly payment required (including principal and financing cost), rather than looking solely at the price of the condominium or automobile itself. Similarly, buyers may evaluate the cost of going to a movie in terms of the cost of the movie plus the cost of parking.2
Under these circumstances, prices must be set jointly to maximize profits, and this is difficult to do without controlling the complement. When setting the price of parking at a movie theater, one must recognize that lowering the cost of parking may increase the number of movie tickets sold, for example. I will discuss when such deliberate cross subsidization is the best strategy in the final section of this chapter.
As with differentiation, the benefits of controlling a complement for pricing do not require that the firm sell the product and complements as a bundle, or even that the firm have a market share in the complement that is comparable to its share of the base product. Even with a relatively small position in the complement, a firm can influence pricing in the complementary industry by initiating pricing moves that competitors are forced (or inclined) to follow. By lowering its own parking prices, for example, a movie theater firm may be able to force down prices at other parking garages in the area to some extent. Thus a position in the complement gives the firm a leverage point with which to influence the development of the complement’s industry, and its position in the complement need only be big enough to allow exercising such leverage.
Reduce Marketing and Selling Cost. Control over complements can lead to economies in marketing, because the demands for a product and for complements are related. Advertising and other marketing investments for one complement often boost demand for the other, and complements may be susceptible to shared marketing or selling. Similarly, an installed base in one product can lower the cost of marketing complements. In video games, for example, an installed base of machines helps the firm sell game cartridges. The economies are sometimes large enough so that a firm not controlling complements is unable to reach the threshold spending on marketing needed to be effective.
A firm gains a cost advantage in marketing if it is one of relatively few firms that controls a complement. Widespread control over complements can benefit the industry as a whole, however, if it raises marketing expenditures and boosts overall industry demand relative to substitute products. Widespread control over complements may also help overcome the “free rider” problem, where firms selling one complement piggyback on the marketing investments of firms selling others. Even if a firm’s decision to control a complement is quickly imitated by competitors, such a move will still be beneficial to the industry as a whole.
Sharing Other Activities. Controlling a complement may allow a firm to share other activities in the value chain besides marketing and sales. The same logistical system may be employed to deliver a product and complements, for example, or the same order entry system. Opportunities for sharing will often be present because of the fact that complements are sold to the same buyers. The circumstances under which sharing value activities leads to a competitive advantage are discussed in Chapter 9.
Raise Mobility Barriers. Where controlling a complement leads to one or more of the competitive advantages described above, it may also increase overall entry/mobility barriers into the industry if entry barriers into the complementary product are significant. For example, a real estate developer that could own a bank (and get preferential access to financing) would significantly increase the sustainability of its competitive advantage because the barriers to entry into banking are significant for most real estate developers. Today real estate devel- opers are legally prohibited from owning banks, though deregulation may change this in the future.
The benefits of controlling a complement are not mutually exclusive, and any or all can be present in an industry. For example, the food concession can not only affect the buyer’s satisfaction with the racetrack, but prices should be set jointly on concessions and admission. Depending on the characteristics of buyers, low admission prices may well raise the number of patrons who will buy high priced hot dogs. Control over both the racetrack and the food concession can lead at the same time to economies in marketing. The sustainability of the competitive advantage from controlling a complement depends on the presence of some barriers to entering the complementary good. Without them, competitors can readily replicate the advantage through entering the complementary industry themselves.
The benefits of controlling a complement can sometimes be achieved through coalitions with other firms without the need for actual ownership. For example, a firm and the supplier of a complement can agree to coordinate prices, or agree to pool their marketing budgets. The problem with such arrangements is the difficulty of reaching a stable agreement. As long as firms supplying complements are independent, each will be tempted to free-ride on the other, and to set prices and strategies to maximize its profits rather than the joint profits of both. Nevertheless, the possibilities of using coalitions to achieve the benefits of controlling complements must always be explored. If the possibility exists it may be the most cost-effective option for a firm (or for the firm’s competitors). Sometimes equity investments or other forms of quasi-integration between a firm and the supplier of a complementary product can overcome the difficulties of coordinating behavior.
2. Problems of Controlling Complements
Against the benefits of controlling complements must be weighed some potential problems. The first is that the structural attractiveness of a complementary industry may be low, and its profitability significantly lower than in the base industry. Though control of the complement may improve profitability in the base industry, this must be weighed against the profitability of the complement relative to alternative uses for the funds. The tradeoff does not always favor control of the complement.
A second problem with controlling complements is that the com- plementary industry may involve very different managerial requirements for which a firm is ill-equipped and a firm may have little competitive advantage in the complementary industry. Thus any benefits from controlling a complement must be weighed against the risk that the firm will fail or only achieve a weak competitive position. The lack of skills in the complementary industry cannot be completely overcome by acquiring a complementary product supplier and managing it as a free-standing entity, because close coordination between complements is required to achieve most of the benefits.
3. Control over Complements and Industry Evolution
The value of controlling complements may well shift as an industry evolves. The need to control complements to improve their quality or image may be greatest early in the evolution of the complementary industry, because of uneven quality or the presence of fly-by-night firms.4 In the early years of color TV, for example, RCA’s need to have an in-house service organization was much greater than later when independent service shops had mastered color set repair techniques. As a complementary industry matures, it may become desirable to exit or harvest a firm’s position in the complementary industry. Independent suppliers may be able to do an adequate job, and the firm may no longer be able to offer anything unique in the complementary industry to bolster its overall differentiation. Staying in a complement too long when there are capable outside suppliers can actually erode differentiation rather than enhance it.
The pricing advantages of controlling a complement also may erode as the complementary industry matures. In the emerging phase, prices of complements are more likely to be higher than would be desirable because suppliers are skimming or inefficient. Early fragmentation of the complementary industry may also lead to inefficiency of complementary products suppliers, and to under-investment in marketing.
While there is a tendency for the need to control complements to decline with industry maturity, this is by no means a universal pattern. The advantages of controlling complements for marketing costs and other shared activities often persist, for example. A resort that owns not only a hotel but also the golf course, other sports facilities, and transportation may have a compelling advantage over one who only operates the hotel. What is necessary is for a firm to ask itself periodically whether there are benefits to controlling each complement. For some complements the benefits will persist or even increase, while for others a timely exit may be justified.
4. Identifying Strategically Important Complements
In view of the potential importance of complements both to a firm’s competitive position and to industry structure, a firm must be aware of what products are complements to its product. The identification of complements is sometimes subtle, and often complements can be uncovered that are not generally perceived as such. Most industries will have a rather long list of products that are complementary to some degree. Table 12-1 gives an illustrative (and partial) list of prod-ucts that are at least somewhat complementary to residential home building.
Given the potentially numerous complements in many industries such as home building, it is necessary to distinguish those complements that are strategically important from those that are not. It is clear that a house builder such as U.S. Home will gain little competitive advantage from competing in all the industries listed in Table 12-1, though it may well gain an advantage from competing in some of them.
Strategically important complements have two characteristics: (1) they are or could be associated with each other by the buyer, and (2) they have a significant impact on each other’s competitive position. Some association of a complement and a firm’s product by the buyer is implied in most of the potential competitive advantages of controlling a complement. The association among complements leads the buyer to connect their images, measure their performance collectively rather than individually, or measure their cost as a group. This association is also what underlies joint marketing or sales.
The strategic relationship among complements is thus in large part a function of buyer perceptions. A firm can rank complements based on how strong the association with its product is or could be. Houses and financing are commonly associated by buyers, for example, while houses and grass seed are rarely associated though their demand is undeniably related. Similarly, movies and parking costs are commonly associated, while the cost of driving to the movie is rarely associated with the cost of the movie. If products are in fact connected but not presently associated by buyers, a firm may be able to gain competitive advantage by educating buyers to make the association. A sophisticated knowledge of buyer purchasing behavior is necessary to uncover actual or potential buyer associations among complements.
The second test of the strategic significance of a complement is the effect of controlling it on competitive advantage or industry struc-ture. A complement will not be important for a firm to control unless it has a material effect on overall cost or differentiation of the group of related products. Light bulbs are complements to lamps, for example, but light bulbs do not have a meaningful impact on the differentiation of a lamp or on the cost of marketing it. Since widespread control over complements can be a significant benefit for industry structure, however, some complements are important to control even if they cannot be turned into a competitive advantage.
Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.