Seeking Closure: Competition in Complementary Markets

A firm with a product that competes in a market that has a complementary product (in a different market) must consider the interdependence between the complementary products as well as the competition within markets. If the firm participates in both markets, the balancing act becomes even more challenging. This paper provides insights about strategies in this latter setting. When should the firm seek to keep its products closed to competitor’s complementary products, and when would the firm would be better off by accepting a common standard? To address these questions, we employ standard game theoretic analysis to a simple spatial model that captures aspects of both inter-market externalities and intra-market competition. We find that if a firm participates in both markets and chooses a closed standard, it achieves lower profits compared to an open standard, but greater market share. Surprisingly, we find that customers are better off when standards are kept proprietary. Consider Apple Computer’s sales of iPod players and iTunes music. The iPod competes in the market for MP3 players, and iTunes competes in the complementary market for downloadable songs. The demand for the MP3 players (hardware) and for the music available for the players (software) each influence demand for the other. By adhering to a proprietary technological standard, Apple attempts to reinforce such crossmarket externalities between its own product offerings – to the chagrin of its competitors.