Sunday, March 21, 2021

"Laws of Tech: Commoditize Your Complement"

Corporate strategy beyond the gauzy, soft-focus Harvard Business Review stuff.

From Gwern:

A classic pattern in technology economics, identified by Joel Spolsky, is layers of the stack attempting to become monopolies while turning other layers into perfectly-competitive markets which are commoditized, in order to harvest most of the consumer surplus; discussion and examples.

Joel Spolsky in 2002 identified a major pattern in technology business & economics: the pattern of “commoditizing your complement”, an alternative to vertical integration, where companies seek to secure a chokepoint or quasi-monopoly in products composed of many necessary & sufficient layers by dominating one layer while fostering so much competition in another layer above or below its layer that no competing monopolist can emerge, prices are driven down to marginal costs elsewhere in the stack, total price drops & increases demand, and the majority of the consumer surplus of the final product can be diverted to the quasi-monopolist. A classic example is the commodification of PC hardware by the Microsoft OS monopoly, to the detriment of IBM & benefit of MS.

This pattern explains many otherwise odd or apparently self-sabotaging ventures by large tech companies into apparently irrelevant fields, such as the high rate of releasing open-source contributions by many Internet companies or the intrusion of advertising companies into smartphone manufacturing & web browser development & statistical software & fiber-optic networks & municipal WiFi & radio spectrum auctions & DNS (Google): they are pre-emptive attempts to commodify another company elsewhere in the stack, or defenses against it being done to them.

Ex-MS product manager 20021 “Strategy Letter V: The Economics of Open Source” (Slashdot⁠; HN) discusses a pattern he saw in technology companies, software, and Microsoft in particular. While he does not cite, it’s likely he was influenced by & Google economist best-selling 1999 technology economics book, Information Rules: A Strategic Guide to the Network Economy⁠, which discusses the idea extensively⁠. Definition: make yourself a monopoly by growing the markets around you. I excerpt the definition & examples below (emphasis in original, most links added):

Every product in the marketplace has and ⁠. A substitute is another product you might buy if the first product is too expensive. Chicken is a substitute for beef. If you’re a chicken farmer and the price of beef goes up, the people will want more chicken, and you will sell more.

A complement is a product that you usually buy together with another product. Gas and cars are complements. Computer hardware is a classic complement of computer operating systems. And babysitters are a complement of dinner at fine restaurants. In a small town, when the local five star restaurant has a two-for-one Valentine’s day special, the local babysitters double their rates. (Actually, the nine-year-olds get roped into early service.)

All else being equal, demand for a product increases when the prices of its complements decrease.

…In general, a company’s strategic interest is going to be to get the price of their complements as low as possible. The lowest theoretically sustainable price would be the “commodity price”—the price that arises when you have a bunch of competitors offering indistinguishable goods. So:

Smart companies try to commoditize their products’ complements.

If you can do this, demand for your product will increase and you will be able to charge more and make more.

When ⁠, they used off-the-shelf parts instead of custom parts, and they carefully documented the interfaces between the parts in the (revolutionary) IBM-PC Technical Reference Manual2⁠. Why? So that other manufacturers could join the party. As long as you match the interface, you can be used in PCs. IBM’s goal was to commoditize the add-in market, which is a complement of the PC market, and they did this quite successfully. Within a short time scrillions of companies sprung up offering memory cards, hard drives, graphics cards, printers, etc. Cheap add-ins meant more demand for PCs.

When IBM licensed the operating system from Microsoft, Microsoft was very careful not to sell an exclusive license. This made it possible for Microsoft to license the same thing to and the other hundreds of OEMs who had legally cloned the IBM PC using IBM’s own documentation. Microsoft’s goal was to commoditize the PC market. Very soon the PC itself was basically a commodity, with ever decreasing prices, consistently increasing power, and fierce margins that make it extremely hard to make a profit. The low prices, of course, increase demand. Increased demand for PCs meant increased demand for their complement, ⁠. All else being equal, the greater the demand for a product, the more money it makes for you. And that’s why Bill Gates can buy Sweden and you can’t.....