Monday, June 17, 2002

Joel on Micro Microeconomics is a beautiful thing, and I go to Chicago, so I really get to appreciate it in all its glory. I'm glad Joel has picked up some micro and applied it to the software biz, but let's take his thinking a little further.

Two goods are "complementary" if demand for them rises and falls in tandem. For example, if the demand for right shoes goes up, demand for left shoes will inevitably go up as well. Joel is right in saying OS and hardware are complements, so if the cost of one falls through the floor (boosting demand), the demand for the other will rise as well even though it's still at the old (high) price. Therefore, all companies want to commoditize away the complementary good and become "left shoe monopolists".

Or do they? Economics is about trade-offs, and commoditizing away complements has the bad effect of removes their incentive to invest in boosting demand. They may slide down the demand curve, but they lose the ability to shift the demand curve out. Integrated complements can jointly coordinate and invest in activities that increase demand for the product as a whole. Coca-Cola, which makes concentrate, gives its bottlers local monopolies so they properly invest in downstream retail relationships. Content companies invest in cable companies to promote local advertising for premium programs. McDonalds operates transient franchises on motor ways to make sure they're well run. DeBeers doesn't believe jewelry retail can do much to increase demand for diamonds, so forms appraisal agencies to commoditize them away. Apple coordinates hardware and software to introduce innovations like USB. Microsoft insists OS and middleware/applications must be integrated so it can offer the best computing experience. The list goes on.

Firms need to figure out whether they're best served by commodity complements (that move down the demand curve) or integrated complements (that can shift the demand curve out) and then do that. The entire computer industry except Microsoft wants desperately to commoditize operating systems so it can get back to innovating, and GNU/Linux is their best bet.


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