Control over complementary products of the firm

In nearly every industry, products are used by the buyer in con­ junction 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, complemen­ tary products  can have   a strategic   relationship  to   each   other  that goes far beyond related growth  rates. One complementary  product often affects   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 im portant to differentiation (Chapter 4). The relation­ ship among complements can also affect the cost of supplying them (Chapter 3).

Where an industry’s product is used with complements, an impor­ tant  strategic issue arises:   the   extent  to   which   a   firm   should   offer the full range of complements or leave some to be provided by indepen­ dent suppliers. Offering the range of complements  provides an impor­ tant competitive advantage in some industries, but  represents an unnecessary and even risky distraction in others. Control over comple­ ments 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 control­ ling 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.   Comple­ ments often affect the performance of a product or the firm’s overall value to the buyer. Well-designed software can improve  the perfor­ mance 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 perfor­ mance 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 con­ trolling 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 o f 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 advan­ tage 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 indus­ try 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 comple­ mentary 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 recog­ nize 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 chap­ ter.

As with differentiation, the benefits of controlling  a complement for pricing do not require that  the firm sell the product and comple­ ments 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 market­ ing complements. In video games, for example, an installed base of machines helps the firm sell game cartridges. The  economies are some­ times 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. W idespread control over comple­ ments can benefit the industry as a whole, however, if it raises market­ ing 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 com­ plement 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.      W here controlling  a complement leads to one or more of the competitive advantages described above, it may also increase overall entry/m obility barriers into the industry i f 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 exclu­ sive, 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  admis­ sion. 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 indepen­ dent, 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 comple­ mentary  product  can overcome  the difficulties of coordinating behavior.3

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 signifi­ cantly lower than in the base industry. Though control of the comple­ ment may improve profitability in the base industry,  this must be weighed against the profitability of the complement relative to alterna­ tive 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  require­ ments for which a firm is ill-equipped and  a firm may have little competitive advantage in the complementary industry. Thus any bene­ fits 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 manag­ ing 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 indus­ try 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, RC A ’s need to have an in-house service organization  was much  greater  than  later when independent service shops had mastered color set repair  tech­ niques. 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 complemen­ tary industry to bolster its overall differentiation. Staying in a comple­ ment 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 fragmen­ tation of the complementary  industry  may   also   lead   to   inefficiency of complementary products suppliers, and to under-investment in mar­ keting.

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 facili­ ties, and transportation  may have a compelling  advantage  over one who only operates the hotel. W hat  is necessary is for a firm to ask itself periodically whether there are benefits to controlling each comple­ ment. For some complements the benefits will persist or even increase, while for others a timely exit may be justified.

4. Identifying Strategically Im portant  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 identifica­ tion 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 im portant  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 com­ monly 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 struc­ture. A complement will not be im portant 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 exam­ ple, but light bulbs do not have a meaningful impact on the differentia­ tion of a lamp or on the cost of m arketing it. Since widespread control over complements can be a significant benefit for industry structure, however, some complements are im portant  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.

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