Saturday, January 14, 2006

Economics 101 Revisited: Complements and Substitutes

A while back, Joel Spolsky wrote a very insightful article on the topic of economic complements and substitutes. He mentioned open source as a complement to hardware. It is interesting to see that many people still believe in the "cult" of open source, rather than look at the economics of it (see comments here). I thought it may be very insightful to look at five recent (and past) developments from the lens of complements and substitutes. Just to refresh, smart companies commoditize their complements so that they can sell more of their product.

1. Microsoft vs. Netscape, and now Google
All of us know how Microsoft waged, and won a war against Netscape. PC hardware was the major complement to Microsoft's software, and Microsoft was in control of this situation with hardware vendors competing against each other, while Microsoft enjoyed its monopoly. Enter Internet and Netscape browser. Suddenly here was a new complementary product (browser) to Microsoft Windows which was being monopolized by Netscape, thus threatening MS. No wonder MS made IE free (commoditized the web browser) in order to protect itself.

The situation is the same with Google today. Google search is a product complementary to MS Windows and Office. Had there been no major player controlling the search market, it was fine for MS. Google enjoying monopoly in this complementary market is a threat to MS, as is Microsoft's monopoly in PC Operating System threat to hardware manufacturers' profitability. No wonder DEC was swallowed by Compaq, Compaq by HP, and IBM sold off PC business to Levono. No one was able to sustain profits in a market where a major complement was fully monopolized.

2. iPod success story
I remember reading somewhere a quote from Sony's top management which ran like this: "The genius of Steve Jobs is not to create iPod, but to combine it with iTunes." Sony already had a similar product in shape, but were not able to commercialize it. iPod and iTunes are complements. Jobs has commoditized iTunes. If someone has the reference to the quote, please let me know.

3. SAP and Big Consulting Firms
The success of any ERP product depends on complementary Consulting Firms. SAP depends on the big five consultancies for capturing marketshare and delivering successfully, at the same time it is not able to commoditize these complementary consulting firms. No wonder SAP talks that "best of breed is dead" and one should not go for expensive ERP implementations that involve lots of consulting bandwidth. One can argue that SAP Netweaver is trying to "commoditize" consulting effort by making it more and more easier to integrate all the pieces together, taking away the higher margins consultants charge.

4. Google Pack
One strategy to make more sales is to bundle complements with your products. Thus a CD player may come bundled with 10 movie CDs, or a cellphone bundled with free talk time. Amidst all the noise, another angle to view Google Pack is that it is bundling all the complementary products which are anyways free. Just makes it easier for Google to make more Adword hits when people use its search toolbar while they get hold of all the complementary software in one place (the Google Pack).

5. Oracle ERP and Database
Oracle's CEO recently announced that it will certify its Fusion platform with other Middleware like JBOSS and IBM Websphere. It was also announced that it may certify other databases too with Fusion. Middleware and Databases are complementary products to ERP. It is economic sense to commoditize them if you want to sell more Fusion (or SAP's Netweaver for that matter).

Another angle to this thinking is substitutes. You can deal with substitutes by enhancing your value chain, or making switching costs high. More on that later, if people show interest.

1 comment:

jagdish said...

Will that increase no of jobs in oracle