Transcript Complements-Public - University of California, Berkeley

Information Complements, Substitutes
Strategic Product Design
Geoffrey Parker
Tulane University
[email protected]
Marshall Van Alstyne
University of Michigan
[email protected]
Sponsored by NSF Career Award #9876233
© 2002 Parker & Van Alstyne. All rights reserved.
Why should firms invest substantial sums in products they intend to
give away?
To whom do they really intend to give these products
anyway?
Can freebies be used strategically to protect turf, raise
barriers to entry, or foreclose markets for competitors?
How does a free good relate to bundling theory?
© 2002 Parker & Van Alstyne
Why do profit making firms like
... give away...
•
•
•
•
•
•
•
•
•
•
Adobe
RedHat
Microsoft
Fidelity
Wolfram
Bungie/ID
Intel
Kodak
Lexis / Nexis
Sun Microsystems
Acrobat Reader
Linux
Internet Explorer
Retirement Planner
Mathematica Reader
Game Level Editors
Video Morphing Software
Digital Camera Scripts
Law Student Access
Star Office
© 2002 Parker & Van Alstyne
Typically these are compound goods
Firm
Adobe
Content Editor
PDF Distiller*
Content
PDF Documents
Reader/Player
PDF Reader
Level Editor
Game Levels
Game Engine*
Compression*
Compressed Doc
Decompression
Microsoft
Sys Dvpr Toolkit
Applications
Windows OS*
Real Audio
Recorder/Host*
Sound File
Player
Bungie/ID
StuffIt
Companies choose different free goods markets and premium
goods markets. Here “*” indicates the premium good.
© 2002 Parker & Van Alstyne
Traditional Linear Supply Chain
parts
cars
Ford
Parts Supplier
$
sales & svc
Dealer
Consumer
$
$
Nontraditional Supply Network
level editor
ID
engine
$
Content
levels Provider
Consumer
reputation,
ego, $
distiller
Content
Provider
ego, $,
reputation
$
Adobe
pdf files
reader
Consumer
© 2002 Parker & Van Alstyne
Which Myth II level is original, this...
© 2002 Parker & Van Alstyne
...or this?
© 2002 Parker & Van Alstyne
Original Myth Game Level
© 2002 Parker & Van Alstyne
3rd Party Myth II Conversion (Civil War)
© 2002 Parker & Van Alstyne
3D Myth II Terrain Model
© 2002 Parker & Van Alstyne
To Model Complements
Market Two
Price
Price
Market One
p1
p2
q1
q2
Quantity
Q1
q1  Q1 
p1
V1
Quantity
Q2
q2  Q2 
p2
V2
Use simple linear demand functions
© 2002 Parker & Van Alstyne
To Model Complements
Market Two
Price
Price
Market One
p1
p2
q1
q2
Quantity
Q1
q1  Q1  e21q2 
p1
V1
Quantity
Q2
q2  Q2  e12 q1 
p2
V2
Add Katz & Shapiro network externality terms eij
Inter-network externality goes both directions
© 2002 Parker & Van Alstyne
An inter-network externality (or 2-sided network externality) is a
demand economy of scale that crosses coupled heterogeneous
markets.
Examples include:
• consumers & developers co-dependent on the same operating
system
• card-holders & merchants that accept the same credit card
• content consumers & creators (e.g. PDF, MP3 streaming video)
• players & game developers
For coupled networks, expect to see an intermediary try to
manage price pairs regardless of whether the intermediary is
independent or managed by one side of the network.
Parker & Van Alstyne
© 2002 Parker & Van Alstyne
Consider profits in two markets
Price
Market Two
(Acrobat Distiller)
Price
Market One
(Acrobat Reader)
p1
p2
q1
q2
Quantity
Quantity
Initially, there are profits to be made in both markets.
© 2002 Parker & Van Alstyne
Consider profits in two markets
Market Two
(Acrobat Distiller)
Price
Price
Market One
(Acrobat Reader)
p2
p1
q1
Quantity
q2
Quantity
Initially, there are profits to be made in both markets.
But subsidizing market one with a free good can
increase demand and profits in market two
more than the loss in market one.
© 2002 Parker & Van Alstyne
Choosing which markets to charge
Pdeveloper
Adobe
Pd0, Pc0
I
Magazine
Pd0, Pc0
Pconsumer
II
Pd0, Pc0
IV
III
ID
Region I -- Subsidize C,
charge D
Region II -- Charge C &
charge D
Region III -- Charge C,
subsidize D
Region IV – Subsidize both
(bad idea)
© 2002 Parker & Van Alstyne
So which market is subsidized?
Price
Developer Market
Price
Consumer Market
p1
p2
q1
q2
Quantity
Quantity
Consider which market creates more surplus.
© 2002 Parker & Van Alstyne
So which market is subsidized?
Developer Market
Price
Price
Consumer Market
p2
p1
q1
Quantity
q2
Quantity
Consider which market creates more surplus.
Subsidize the one that creates more surplus in the
cross market.
© 2002 Parker & Van Alstyne
So which market is subsidized?
Developer Market
Price
Price
Consumer Market
p1
q1
Quantity
p2
q2
Quantity
Consider which market creates more surplus.
Subsidize the one that creates more surplus in the
cross market.
© 2002 Parker & Van Alstyne
So which market is subsidized?
Developer Market
Price
Price
Consumer Market
p1
q1
Quantity
p2
q2
Quantity
Consider which market creates more surplus.
Subsidize the one that creates more surplus in the
cross market. Here >
so subsidize developers.
© 2002 Parker & Van Alstyne
Now introduce competition
Competitive Complement
Company A sells complementary products in markets {1, 2}. So e12AA> 0.
Company B sells a competing product in only market {1}.
Motivating Example: Netscape sells Navigator in mkt 1. Microsoft sells
Explorer in mkt 1 and Windows, PowerPoint, Word, or Excel in mkt 2.
Competitive Substitute
Company B offers an information good in mkt 1 that curtails consumption of
BA
A’s good in mkt 2, such that e12 < 0.
Motivating Example: By including Sun’s Java virtual machine in Navigator,
Netscape threatened to commoditize operating systems. Under “Write once,
Run anywhere,” Windows enjoys no advantage.
© 2002 Parker & Van Alstyne
Economics of Product Competition
Beer
Sugar Cereal
Sports Car
Democrat
Firm A
Wine
Healthy Cereal
Family Car
Republican
Firm B
Profit=P*Q
Firms can max Profit by either building
(1) market power  high P
(2) market share  high Q
© 2002 Parker & Van Alstyne
To Gain Market Power
P
Firm A
Q
Firm B
Differentiate your product
from the competitor
© 2002 Parker & Van Alstyne
To Gain Market Share
P
Firm A
Q
Firm B
Position between competitor and
largest block of consumers
© 2002 Parker & Van Alstyne
Competitive Complement
P
Q
P
Firm A
Q
Firm B
Product complementarity justifies seeking
market share because a price of zero
increases profits in the coupled market.
© 2002 Parker & Van Alstyne
Competitive Complement
P
Q
P
Firm A
Q
Firm B
Examples:
Competitor
MS Office
Netscape
MediaPlayer
Freebie
Complement
Star Office 
Explorer 
QuickTime 
Workstations/OS
MS Office/ActiveX
Macs
© 2002 Parker & Van Alstyne
To Model Substitutes
Competitor’s
Price
Price
Your product
p1
p2
q1
q2
Quantity
Quantity
Instead of complementarity that is positive…
Q1
q1  Q1 - e21q2 
p1
V1
Q2
q2  Q2 - e12 q1 
p2
V2
Design the cross product effect to be negative.
© 2002 Parker & Van Alstyne
To Model Substitutes
Competitor’s
Price
Price
Your product
p1
p2
q1
q2
Quantity
Quantity
Instead of complementarity that is positive…
Design the cross product effect to be negative.
© 2002 Parker & Van Alstyne
Competitive Substitute
P
P
Q
Q
P
P
Q
Firm A
Q
Firm B
Product substitutability justifies seeking
market share because a price of zero
decreases competitive interference on
another product.
© 2002 Parker & Van Alstyne
Competitive Substitute
P
P
Q
Q
P
P
Q
Firm A
Q
Firm B
Examples:
Competitor1
MediaServer
MS Windows
E-Bay buyer
Competitor2
MediaPlayer
Sys. Dvpr Toolkit
E-Bay Seller
Freebie
Complement

RealAudio
 Sys. Dvpr Toolkit
Yahoo auction seller
RealServer
Mac OS
Yahoo buyer
© 2002 Parker & Van Alstyne
Strategic Outcome
• The product design results are almost identical. Firm B
chooses P1  0 - the market with competition- in order to
create a free goods barrier to entry.
• The reason, however, is different. For complementary
goods, Firm B sells more. For substitute goods, Firm B
stems losses.
“Microsoft would not have given IE away …, nor would it have
taken on the high cost of enlisting firms in its campaign to
maximize IE’s usage share and limit Navigator’s, had it not been
focused on protecting the applications barrier [to its operating
system]”
Judge Thomas Penfield Jackson
Findings of Fact, 11-5-99
© 2002 Parker & Van Alstyne
Are consumers worse off under monopoly?
Price
Market Two
(Acrobat Distiller)
Price
Market One
(Acrobat Reader)
p1
p2
q1
q2
Quantity
Quantity
Consumer surplus is the gold right triangle.
© 2002 Parker & Van Alstyne
Are consumers worse off under monopoly?
Market Two
(Acrobat Distiller)
Price
Price
Market One
(Acrobat Reader)
p2
p1
q1
Quantity
q2
Quantity
Consumer surplus is the gold right triangle.
At least one market is strictly better off (generally both)
And the sum is always greater across both markets.
© 2002 Parker & Van Alstyne
The effect of bundling
p1
V1
r1V2
q1
Let r1[0,1] be the amount that Mkt 1 values the Mkt 2 good.
Find Mkt 1 demand for the Mkt 2 good scaled by r1.
Convolve both curves to find Mkt 1 demand for both goods.
© 2002 Parker & Van Alstyne
To Bundle or not to Bundle
1
b>u
0.8
 Bundle
0.6
rj
0.4
0.2
Region
b<u
0.2
Equal
 UnBundle
0.4
0.6
0.8
1
rc
© 2002 Parker & Van Alstyne
Further Applications
Temporal Complements -- Markets 1 & 2 represent the same good in time, e12 
0, e21 = 0. Lexis gives law students free access then charges law firms.
Upgrades -- Markets 1 & 2 represent novice and professional versions , e12  0,
e21 = 0. Firms like Ventana give their simulators free to students and charge
$1200 for the full-featured version.
Temporal Substitutes -- Markets 1 & 2 are current and future complements while 1
is a substitute for a competitor’s future good. Although Microsoft introduced IE
after Netscape introduced Navigator, it could potentially have introduced IE in
anticipation of competition.
Tangible Complements -- Market 1 is a tangible good e12 = 0, market 2 an
information good with high network externality e21  0. Firms like Kodak and
Intel give away camera scripts and video morphing software because friends
and family share scripts and video eats CPU cycles.
Advertising -- Markets 1 & 2 represent consumer & ad buyers, eca  0, eac < 0.
Qualcomm gives away Eudora in sponsored mode.
© 2002 Parker & Van Alstyne
Product Category
Mkt 1 Product
Intermediary
Mkt 2 Product
Portable Documents
Document reader*
Adobe
Document Writer
Credit Cards
Consumer credit*
Issuing bank
Merchant Processing
Operating Systems
Complementary Applications
Microsoft, Apple, Sun
Systems Developer Toolkits*
Plug-Ins
Applications Software
Microsoft, Adobe
Systems Developer Toolkits*
Ladies’ Nights
Men’s Admission
Bars, Restaurants
Women’s Admission*
TV Format
Color UHF, VHF, HDTV*
Sony, Phillips, RCA
Broadcast Equipment
Advertisements
Content*
Magazines, TV, Radio
Advertisers
Computer games
Game Engine/ Player
Games Publishers
Level Editors*
Auctions
Buyers*
E-bay, Christie’s, Sotheby’s
Sellers
Streaming Audio/Video
Content*
RealPlayer, Microsoft, Apple
Servers
* Indicates which market is discounted, free or subsidized.
Source: Parker & Van Alstyne 2002
© 2002 Parker & Van Alstyne
Contributions
• Uses standard economics models of tangible goods to
explain information goods
• Different from tying and price discrimination
• Articulates space of products and tipping conditions for
which markets are charged
• Indicates how strategic product design can be used to
expand demand or close markets
• Explains when to bundle and when to unbundle
© 2002 Parker & Van Alstyne
“Information Complements,
Substitutes & Strategic Product Design”
and
“Unbundling in the Presence of
Internetwork Externalities”
Parker & Van Alstyne
URL: ggparker.net/gparker/papers/InfoComplements.html
© 2002 Parker & Van Alstyne