Complementors in the Digital Economy
Why is Intel going into video-conferencing and FedEx creating a Web site for commerce? Why are Oracle, Netscape, and Sun investing in the $100 million Java fund? What is it that adds value to these investments?
While it's not clear how Java will pay off directly, it is a good example of the fluid nature of value and the complexity of economic calculations in the new economy. What's going on is that investments in one product make another product more valuable. If videoconerencing takes off, that will give people the excuse they need to upgrade to Intel's Pentium Pro chip. When anyone buys something on FedEx's virtual mail Web site, that's one more package to be shipped.
The growth of Java applications will fuel the demand for Oracle database programs, Sun servers, and Netscape browsers. And, on a more abstract level, Oracle's investment in Java helps to expand the uses and value of computing in business and in everyday life. Why should this matter to Oracle, beyond, say, the value of fulfilling a responsibility as a good corporate citizen? Because all players in the digital economy have a shared interest in making the networked economy take off.
If this doesn't sound much like conventional economics, that's because it isn't. It seems that we need a new theory to help us to operate in the new reality. Fortunately, a new theory exists - the foundations of which were laid by one of the creators of the Information Age.
A New Game
John von Neumann-mathematician, genius, polymath-died in 1957, well before he could see the emergence of the post-industrial world he helped create. His contribution to the design of the modern computer architecture is well-known. But his genius is evident in other new structures, too. Von Neumann did some of the early work on self-reproducing systems-one of the hot topics in today's complexity theory. He was also the co-inventor, along with economist Oskar Morgenstern, of game theory, a way of thinking about how people interact with one another. Until recently, game theory remained an abtruse branch of applied mathematics. But von Neumann's game theory is now coming into its own, as a powerful way to describe the new economy.
Conventional economics takes the structure of markets as fixed. People are thought of as simple stimulus-response machines. Sellers and buyers assume that products and prices are fixed, and they optimize production and consumption accordingly. Conventional economics has its place in describing the operation of established, mature markets, but it doesn't capture people's creativity in finding new ways of interacting with one another.
In game theory, nothing is fixed. The economy is dynamic and evolving. The players create new markets and take on multiple roles. They innovate. No one takes products or prices as given. If this sounds like the free-form and rapidly transforming market-place, that's why game theory may be the kernel of a new economics for the Information Age. It can more adequately account for the dynamic nature of the value of the digital product, as well as for the increased complexity of economic calculations.
Complementors
The game theory perspective allows for more complicated relationships. There are multiple players, each with multiple roles. There are the conventional players-customers, suppliers, and competitors. To this group, we add a new category:complementors.
A complementor is someone whose products make your products more valuable or whose products are made more valuable by yours. Thus Digital's 64-bit alpha chip increases the value of many Oracle applications, and Oracle applications are the driving force behind the need for this chip's speed.
A complementor is the opposite of a competitor. Why not just call a complementor an ally or a partner? Because partner is a more general term. Partners include customers, suppliers, and complementors. Moreover, there's some natural tension in the complementor relationship. Although a complementor's products make yours more valuable, you want them to be available at a low price. The cheaper they are, the more pie that's left for you. For example, the more phone companies charge for ISDN lines, the less that's left over for Internet service providers.
It's often possible for someone to be a competitor and a complementor at the same time. Conventional wisdom would have it that the recent success of Intel's ProShare desktop videophone is bad news for its competitor, PictureTel. It's true that buying a ProShare system may take you out of the videophone market. But the compatibility between the two systems also creates a larger market. Now there's someone else to video call, more ISDN lines, a development of videoconference etiquette, more demand for this type of interaction. The market for videoconferencing won't really take off until there's a critical mass of people in the game.
The Wrong Way to Play
There are two sides to complementors. They can produce something that makes your product much more valuable. Or, you can be the one producing something that makes their products much more valuable.
Despite all the rhetoric about the new forms of economic cooperation in the new economy, it is all too easy to confuse a complementor with a competitor, and to fight against one's complementor, quite counter-productively. When the VCR dragged Hollywood studios into a new game, the studios saw this as a competitive threat, imagining that people wouldn't go out to movies as often. They fought to get a tax levied on blank cassettes, taking the battle all the way to the Supreme Court. Good thing they lost. VCRs created the market for movie rentals-now a $12 billion business-and have effectively tripled the potential revenue sources for Hollywood.
Why would one of America's most successful industries make such a tremendous blunder in understanding its own market? The answer may be that if you don't understand the concept of complementors, then you're likely to treat all entities as competitors-even when they're not.
. . . And the Right Way
For an example of the right way, take the Oracle Alliance's Cooperative Applications Initiative (CAI). Oracle teams with its complementors-leading third-party software providers-to make available to customers an extensive selection of software that can be integrated with Oracle applications. In this way, Oracle creates new markets for software in businesses that include packaged goods, government, higher education, energy, pharmaceuticals, and environmental, health, and safety. The CAI enables customers to pick and choose from leading solutions, and mix and match applications from Oracle's complementors that integrate with Oracle Applications. This allows customers to create a complete, customized solution that meets industry, business, and technology requirements. Of course, what's good for the customer is good for Oracle and its complementors too.
We don't want to leave you with the impression that complementors are the whole game, or that complementors are more important than customers, suppliers, or competitors. They're not. But they are as important, just not as well understood. Understanding the role of complementors is a critical component in building the digital economy.
By Adam Brandenburger and Barry Nalebuff. Adam is a professor at Harvard Business School, Barry is a professor at Yale School of Management.