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Information Complements, Substitutes, and Strategic Product Design

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  • Geoffrey G. Parker
  • Marshall W. Van Alstyne

Abstract

Competitive maneuvering in the information economy has raised a pressing question: how can firms raise profits by giving away products for free? This paper provides a possible answer and articulates a strategy space for information product design. Free strategic complements can raise a firm's own profits while free strategic substitutes can lower profits for competitors. We introduce a formal model of cross-market externalities based in textbook economics -- a mix of Katz & Shapiro network effects, price discrimination, and product differention -- that leads to novel strategies such as an eagerness to enter into Bertrand price competition. This combination helps to explain many recent firm strategies such as those of Microsoft, Netscape (AOL), Sun, Adobe, and ID. We also introduce the concept of a ''content-creator'' who adds value for end-consumers but may not be paid directly. Similar to the case of product dumping, this research implies that both firms and policy makers need to consider complex market interactions to grasp information product design and profit maximization. The model presented here argues for three simple and intuitive results. First, a firm can rationally invest in a product it intends to give away into perpetuity even in the absence of competition. The reason is that increased demand in a complementary goods market more than covers the cost of investment in the free goods market. Second, we identify distinct markets for content-providers and end-consumers and show that either can be a candidate for the free good. The decision on which market to charge rests on the relative elasticities as governed by their network externality effects. If the externality effect is sufficiently great, the market with the higher elasticity is the market to subsidize with the free good. It is also possible to charge both markets but to keep one price artificially low. Importantly, the modeling contribution is distinct from tying in the sense that consumers need never purchase both goods -- unlike razors and blades, the products are stand-alone goods. It also differs from multi-market price discrimination in the sense that the firm may extract no consumer surplus from one of the two market segments, implying that this market would have previously gone un-served. Third, a firm can use strategic product design to penetrate a market that becomes competitive post-entry. The threat of entry is credible even in cases where it never recovers its sunk costs directly. The model therefore helps to explain several interesting market behaviors such as free goods, upgrade paths, split versioning, and strategic information substitutes.

Suggested Citation

  • Geoffrey G. Parker & Marshall W. Van Alstyne, 2000. "Information Complements, Substitutes, and Strategic Product Design," William Davidson Institute Working Papers Series 299, William Davidson Institute at the University of Michigan.
  • Handle: RePEc:wdi:papers:2000-299
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    Cited by:

    1. Cheng, Hsing Kenneth & Tang, Qian Candy, 2010. "Free trial or no free trial: Optimal software product design with network effects," European Journal of Operational Research, Elsevier, vol. 205(2), pages 437-447, September.
    2. Diaw, K. & Pouyet, J., 2004. "Competition, Incomplete Discrimination and Versioning," Discussion Paper 2004-69, Tilburg University, Center for Economic Research.
    3. Joshua S. Gans & Stephen P. King & Julian Wright, 2005. "Wireless Communications," Monash Economics Working Papers archive-45, Monash University, Department of Economics.
    4. Jean-Charles Rochet & Jean Tirole, 2003. "Platform Competition in Two-Sided Markets," Journal of the European Economic Association, MIT Press, vol. 1(4), pages 990-1029, June.
    5. Yue, Xiaohang & Mukhopadhyay, Samar K. & Zhu, Xiaowei, 2006. "A Bertrand model of pricing of complementary goods under information asymmetry," Journal of Business Research, Elsevier, vol. 59(10-11), pages 1182-1192, October.
    6. Niedermayer, Andreas, 2015. "Does a Platform Monopolist Want Competition?," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 523, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    7. Kai Reimers & Xunhua Guo & Mingzhi Li, 2019. "Beyond markets, hierarchies, and hybrids: an institutional perspective on IT-enabled two-sided markets," Electronic Markets, Springer;IIM University of St. Gallen, vol. 29(2), pages 287-305, June.
    8. Andras Niedermayer, 2006. "Does a Platform Monopolist Want Competition?," Diskussionsschriften dp0604, Universitaet Bern, Departement Volkswirtschaft.
    9. Xing Wan & Javier Cenamor & Geoffrey Parker & Marshall Van Alstyne, 2017. "Unraveling Platform Strategies: A Review from an Organizational Ambidexterity Perspective," Sustainability, MDPI, vol. 9(5), pages 1-18, May.
    10. Armstrong, Mark, 2002. "Competition in two-sided markets (2002 version)," MPRA Paper 42863, University Library of Munich, Germany.
    11. Shin-yi Wu & Pei-yu Chen, 2008. "Versioning and Piracy Control for Digital Information Goods," Operations Research, INFORMS, vol. 56(1), pages 157-172, February.
    12. Vladimir Mazalov & Elena Konovalchikova, 2020. "Hotelling’s Duopoly in a Two-Sided Platform Market on the Plane," Mathematics, MDPI, vol. 8(6), pages 1-16, May.
    13. Hemant K. Bhargava & Vidyanand Choudhary, 2004. "Economics of an Information Intermediary with Aggregation Benefits," Information Systems Research, INFORMS, vol. 15(1), pages 22-36, March.

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