11 Sep 2008Working Paper Summaries

Competing Complements

by Ramon Casadesus-Masanell, Barry Nalebuff and David B. Yoffie

Over the last two decades, an increasing number of industries have evolved from vertical integration to more horizontal structures where firms design and manufacture components that are later assembled by third parties for the final customer. In these horizontal industries, firms may be "complementors," rather than customers, suppliers, or competitors. Classic examples of complementors include Intel and Microsoft. Similar complementor relationships arise in industries such as communications, consumer electronics, automobiles, and health care. In these industries, complementor analysis may be as important as competitor analysis. The authors of this paper introduce competition into one side of complementor analysis, and suggest implications for managers, public policy, and the development of theory. Key concepts include:

For managers, one way to persuade complementors to behave in ways beneficial to you is by promoting competition in their "spaces." However, if the competition that you can induce is mild, you are better off dealing with monopolist complements.
From a public policy viewpoint, mild competition within complements might be preferable to intense competition. Moreover, duopolistic competition between complements might generate more total surplus than a triopoly.
From a theoretical viewpoint, this paper is a first step toward a general theory of competition between and within complements. The paper adds to the literature on co-opetition initiated by Brandenburger and Nalebuff (1996).

Author Abstract

In Cournot's model of complements, the producers of A and B are both monopolists. This paper extends Cournot's model to allow for competition between complements on one side of the market. Consider two complements, A and B, where the A + B bundle is valuable only when purchased together. Good A is supplied by a monopolist (e.g., Microsoft) and there is competition in the B goods from vertically differentiated suppliers (e.g., Intel and AMD). In this simple game, there may not be a pure-strategy equilibria. In the standard case where marginal costs are weakly positive, there is no pure strategy where the lower quality B firm obtains positive market share. We also consider the case where A has negative marginal costs, as would arise when A can expect to make upgrade sales to an installed base. When profits from the installed base are sufficiently large, a pure strategy equilibrium exists with two B firms active in the market. Although there is competition in the complement market, the monopoly Firm A may earn lower profits in this environment. Consequently, A may prefer to accept lower future profits in order to interact with a monopolist complement in B.