6/26/2014
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`Creative Business: Substitutes and complements
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`You are here: Home ∼ 2007 ∼ December ∼ 03 ∼ Creative Business: Substitutes and complements
`Creative Business: Substitutes and complements
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`Published by Suw on December 3, 2007
`
`As part of the Creative Business in the Digital Era project, I’m doing some thinking and
`learning about business models and microeconomics. This post is originally from the
`CBDE blog.
`
`After my post the other day about business model archetypes, I had a very interesting
`conversation with friend and ORG Advisory Council member, Kevin Marks, who pointed
`me in the direction of an article by Joel Spolsky – Strategy Letter V. In this post, Joel talks
`about the microeconomics he studied at university, stuff like “if you have a competitor who
`lowers their prices, the demand for your product will go down unless you match them.”
`The main body of his post discusses substitutes and complements, and for someone like
`me who has learnt about business the hard way (by doing it), it’s like a little light bulb
`illuminating.
`
`Like most creative people, I’ve never studied business, and for years I fell in to the same
`trap that I later saw many of the musicians I used to work with fall into: I didn’t want to
`learn about business because I didn’t think I needed to. All I wanted to do was write,
`maybe make a bit of music, but in any case, just do my own thing. Then my career took an
`unexpected turn, I started my own business, and I was on the lower slopes of the steepest
`learning curve of my life. Perhaps if I’d known about blogs like Joel’s in 2000, I would
`have had a better time of it! Anyway, I digress.
`
`A substitute is an item that can replace another item, so I can buy a PC from IBM or Dell,
`it doesn’t really matter – PCs are substitutable. A complement is an item that, you
`guessed it, complements another item, so if I buy an iPod, then there are a range of
`accessories that act as complements, such as iPod socks or remote controls or armband
`iPod holders for the keen jogger. Joel talks a lot about complements and focuses mainly on
`the computer industry.
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`http://charman-anderson.com/2007/12/03/creative-business-substitutes-and-complements/
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`Creative Business: Substitutes and complements
`A complement is a product that you usually buy together with another product. Gas
`and cars are complements. Computer hardware is a classic complement of
`computer operating systems. And babysitters are a complement of dinner at fine
`restaurants. In a small town, when the local five star restaurant has a two-for-one
`Valentine’s day special, the local babysitters double their rates. (Actually, the nine-
`year-olds get roped into early service.)
`
`How does this apply to, say, the music industry? Well, let’s say that you are in a band.
`Your main product is music, which you sell in the form of a CD. The complements to your
`CD are things like gig tickets, tour programs, T-shirts, DVDs. People buy these other
`products together with your CD, and are very unlikely to buy them if they aren’t also
`interested in buying your CD.
`
`Joel then goes on to say:
`
`All else being equal, demand for a product increases when the prices of its
`complements decrease.
`
`Let me repeat that because you might have dozed off, and it’s important. Demand
`for a product increases when the prices of its complements decrease. For example, if
`flights to Miami become cheaper, demand for hotel rooms in Miami goes up —
`because more people are flying to Miami and need a room. When computers
`become cheaper, more people buy them, and they all need operating systems, so
`demand for operating systems goes up, which means the price of operating systems
`can go up.
`
`OK, let’s just swap things about a bit. Your products are CDs, gig tickets, tour programs,
`T-shirt and DVDs. The complement to that is the music itself. (Note that we’re used to
`thinking the other way round, labelling the music as the product and the merchandise as
`the complement, because the music comes first and the merch has to come second. But
`when you view the saleable items as the products and the music as the complement, this
`all makes much more sense.) Demand for your products increases when the price of its
`complement – the music – decreases. If the price of your music is zero, i.e. you are giving
`it away for free online, economic theory has it that the demand for your products
`increases.
`
`Joel generally talks about companies that are producing complements to someone else’s
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`http://charman-anderson.com/2007/12/03/creative-business-substitutes-and-complements/
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`Creative Business: Substitutes and complements
`products, and discusses how important lowering the price of those complements is:
`
`Once again: demand for a product increases when the price of its complements
`decreases. In general, a company’s strategic interest is going to be to get the price
`of their complements as low as possible. The lowest theoretically sustainable price
`would be the “commodity price” — the price that arises when you have a bunch of
`competitors offering indistinguishable goods. So:
`
`Smart companies try to commoditize their products’ complements.
`
`If you can do this, demand for your product will increase and you will be able to
`charge more and make more.
`
`In the music industry the separation between product and complement is more perceived
`than real – whilst the record company controls the complement – music – the rights
`required to create products is often licensed out to third parties, such as merchandising
`specialists, who have to conform to the record company’s terms. From what Joel’s saying,
`it would be in the interests of the third parties, e.g. the merchandising companies, to lower
`the price of the music to increase demand for their product – the more people can access
`the music of MyWonderfulBand, the more fans there are, the more demand for T-shirts.
`In practice, though, that’s impossible as the merchandising companies have no leverage to
`achieve such a goal.
`
`But if the same people – the band – are in control of both products and complements, they
`can create an end-to-end business model that sees them giving away the product and
`earning off its complements. I’d argue that people like Ani DiFranco have been doing this
`for years, encouraging people to make copies of her music and then selling merchandise
`and touring frequently. For a musician, this is a self-reinforcing feedback loop. The more
`you tour, the more merchandise you sell, the more you bring your music to the attention of
`people who may want to buy tickets for your next gig or buy a T-shirt or CD. By taking the
`risk of commoditising your music, you can potentially drive up the demand for the
`complements substantially, if you can get over the icky feeling of commoditising the very
`thing you feel most passionate about.
`
`This ties in nicely with Tim O’Reilly’s view that:
`
`Obscurity is a far greater threat to authors and creative artists than piracy.
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`http://charman-anderson.com/2007/12/03/creative-business-substitutes-and-complements/
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`Creative Business: Substitutes and complements
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`So how about the other creative industries? Well, in the publishing industry, the product is
`the book contents, the complement the book itself, so giving away ebooks should drive
`demand for paper books. Authors don’t seem to do much in the way of merchandising –
`perhaps that should change, especially with services like Spreadshirt or Cafepress. Films
`are rather the same – the moving image is the product, the DVD the complement.
`Photography – the image is the product, the print or the book the complement…
`
`Now, I did warn you that I am thinking out loud here, and I see a problem with all this, and
`it has to do with substitutes. Remember, a complement is “a product that you usually buy
`together with another product”. But for many of the products that come out of the creative
`industries, the physical incarnation is not a complement to the digital version of the
`creative work, but a substitute. Joel defines a substitute like this:
`
`A substitute is another product you might buy if the first product is too expensive.
`Chicken is a substitute for beef. If you’re a chicken farmer and the price of beef goes
`up, the people will want more chicken, and you will sell more.
`
`If the digital creative work is a substitute for the physical instantiation of the work, the
`whole complement theory falls over. Computers and operating systems are complements
`of each other because one without the other is sort of pointless – you want the one if you
`have the other. But with no CD, my MP3 is still listenable; with no DVD, my MPEG is still
`watchable; with no print, my JPG is still viewable. This is why the RIAA and its ilk have
`being getting so much in a tizz about the downloading of unauthorised files – they see the
`digital as directly substitutable for the physical. And if something is substitutable, it can’t
`be complementary. Can it?
`
`This is, I think, where the lines get a little fuzzy. Technically, an MP3 is a perfect
`substitute for a CD – you can do pretty much everything with an MP3 that you can do
`with a CD. (Indeed, the chance are you’ll turn your CD into MP3s as soon as you get it).
`But I’m not sure that its substitutability is so perfect and I wonder if, as more people
`experience total music data loss when their MP3 player or computer hard drive craps out,
`its perceived substitutability will actually decline. It took the loss of 40gb of digital music
`carefully collected over years and years for me to learn that backing up my music is really
`important. As the MP3 player market matures, we will see more people loose data when
`their devices perish or when they try to swap between silo’d devices that do not play
`nicely together, e.g. trying to play proprietary format music on a non-compatible device.
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`http://charman-anderson.com/2007/12/03/creative-business-substitutes-and-complements/
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`Creative Business: Substitutes and complements
`At that point, substitutability will decline slightly and complementariness will increase
`slightly, although it will be individual context that will define whether a given MP3/CD is a
`complement or a substitute.
`
`It is an irony that the industry that has been so worried about substitutability also has
`some of the best complements to it’s main creative output. Bands aren’t reliant on just CDs
`for income: gigs and merchandise play a significant part in the successful band’s income,
`and it’s possible to imagine that percentage could increase as income from CDs decreases.
`Other creative industries, though, are going to need to find some complements, and
`quickly. The digitisation of creative works is neither slowing down nor going away; and the
`commoditisation of those works is both inevitable and uncontrollable, driven as it is by the
`consumer rather than the rights owners. The only way to deal with the commoditisation of
`your past cash cow is to sell complements to it.
`
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`Article written by Suw
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