So, hi everybody and great to have you here. We're still talking about strategy for complements but, first let's briefly recap from the last lecture. So, we figured out in the previous lecture that it may make sense to produce both complementary products A and B. And why does it make sense? It makes sense because you can internalize the positive effects, and we call them externalities, that complements have on each other. And therefore if you produce these complements yourself then there's a couple of things you can do. You can cross-subsidize across these products. You can bundle these products together Or you can use complements to increase lock-in to your system. And we'll discuss these in turn. Let's first look at cross-subsidization. The general idea is, I think, fairly simple. So you have product A that's sold at a small margin or even at a loss, to increase sales of product B, which you sell at high margins. This has the obvious advantage that you can increase your profits through intelligent pricing. Now, in particular, your pricing decision for each of the products takes into account the effect that it has on the other product's demand, right? So, we know from the previous session that there is negative cross price elasticity, which means that if you decrease your price for one product then the demand for the complement is going to go up, okay? And cross subsidization takes that into account. There's a risk, however, there's several risks. First of all consumers may not end up buying product B at all. So you may only be interested in the base product and you're not interested in the complement. Then, you only take advantage of the low price for product A, but the high margin product B you're never going to buy. Second, consumers may buy product B but from another manufacturer. In which case, you again take advantage of the fact that product A is cheap, but you're never going to make back or the firm is never going to make back the low margins they made for product A, because product B is going to be sold by another firm as well. Let's have a look at some examples. Thinking of razors and razor blades. So looking at razors and razor blades, you can see these guys are often sold very cheaply or with a couple of extra blades or even given away for free. On the other hand, every time you buy blades, you can expect to pay a fairly high price. So that means that the razors typically come at a fairly low margin and the razor blades come at a much higher margin, okay? And they're produced by the same firm. Another example would be mobile phones and operator contracts. You will typically get a subsidized handset, a subsidized phone if you sign up for a long contract. This is typically because your mobile phone operators will expect to make back some of the subsidies they gave out for the mobile handset through the lifetime of the contract. Printers and cartridges. Printers are fairly cheap now especially if you compare them to cartridges which are fairly expensive. And again here, getting someone to lock in to a printer system then means that he's going to have to buy the cartridge in turn, so in the future. So here, cross subsidies work in the sense that you get someone into buying a system and then he will continue buying complementary products for that system. Bundling is a second strategy referring to complements that are produced by the same firm. And the idea is that the firm simply sells product A and complement B combined as a package, which has the advantage that you have little or no competition in market A because you are selling something extra on top of product A. You decreased competition in the market for B, because whenever you have someone interested in complement B he's also got product A as well, which again works in complementary ways. The risk here is that there may be buyers of A only or B only, so they are only interested in the base product or only interested in the complementary product. And you lose those, if you sell them a bundle. Also once bundling becomes standard, consumers will demand it, and probably also the firm will find it difficult to think of the advantages of unbundling. Okay, so thinking about how to sell products separately and how to differentiate, how to set the right prices and so on, are things that may get lost in the process of continuing to bundle the product all the time. So, what are examples of bundles? So one example would be a game console and games. If you look at this here, this is a Wii bundle. And in this bundle you get a game, that's Mario Kart, you get the Wii console itself, you get a controller and you even get a steering wheel on top of that. So, that means that you don't just get the base product, but you get a whole bundle of different products, all wrapped up in one big carton. Okay, in one big package. So that would be a classical example of a bundle. What are other examples? Operating system and web browser. So you cannot get a web browser, or you typically get an operating system that also has a web browser installed in it. So that again is a bundle. You typically, when you book a flight you also automatically book baggage handling. So you have a free allowance of two pieces of hand luggage or one suitcase and so on. So that's something you don't pay extra for, but you also cannot go out of it, so you cannot opt out. So, you have to pay that extra price, so that implied extra price for baggage handling, okay? So, second strategy for producing both complements would be to bundle them in one. Finally, how can we use complements to increase lock in? And the idea is again quite simple, users will typically have switching costs when they switch from A to a substitute. And that switching cost is higher, the more complements they've bought, okay? So, that's quite an interesting phenomenon and we'll see a couple of examples very soon. But, the idea is simply that if you get someone to buy lots and lots of complements, then it's going to make it very difficult for that person to switch from the base product A to any other product. And the advantage of course here is that you have higher switching cost, which then implies a higher value of the customer to the firm. Quite simply, if a customer will find it difficult to switch to another product, you can charge him higher prices. And what would be examples of that? Microsoft Office and Microsoft Windows. If someone's using a lot of Microsoft Windows products then it's going to be difficult for him to switch to a different system of Windows or of operating system. Games and video consoles. If you have lots and lots of different games for a particular video console, you're likely to persist with that standard of the console. So, let me sum up now from the last two videos. We've looked at strategies, at generic strategies, of how to deal with complementary products. And the first strategy, the first set of strategies we looked at, was supporting complements. So this was referring to other companies producing complementary products and you simply made it easier for them to produce complements for your base product. The second was a bit stronger, which was producing complements yourself. And that of course has pros and cons. You might be overstretching yourself. You might be doing something you're not actually very good at but at the same time you can control the, the whole system of complementary products and you can price say intelligently and so on. So when producing complements it's particularly interesting to think of the strategies of initializing cross subsidies, so pricing in an intelligent way, bundling complementary products together and increasing lock in. So, but for now, since you're an expert in strategies for complements I'm sure you will now have an easy time with the following quiz. I'll see you after this, and then we'll talk about how complements can help achieve cooperation among firms. Thanks very much and I'll see you soon.
