2015-01-26 - Complementors are a 6th Force in Porter’s Five-Forces Model

Professor Barry Nalebuff

Complementors are a 6^th Force in Porter’s Five-Forces Model

Barry Nalebuff, Milton Steinbach Professor of Management at Yale University, enlightens us. A prolific expert on game theory, Professor Nalebuff has written extensively on its application to strategy. He offers a fresh perspective on the field by emphasizing the role and value of cooperating as well as competing. An active consultant, Professor Nalebuff has advised executives at American Express, GE, McKinsey, Google and the NBA.

In 1998, Professor Nalebuff founded Honest Tea with Seth Goldman, one of his former MBA students at Yale. In 2011, they sold their company, now recording sales of $70 million to Coca Cola.

1. Can you give a recent example or case study of a firm or industry that clearly illustrates the value-net concept?

The value net is a richer view of all of the different players in the game. We have the traditional vertical view of money flowing from the customer to the firm, and from them to suppliers. We understand from the horizontal view the roles of competitors, but what is often left out is the role of complementors. They are the symmetric role to competitors. Whereas a competitor reduces the value of your products, a complementor increases their value. In fact, a better name for competitor would be substitutor.

Substitutes and complements can also exist on the supply side. Harvard and Yale are not only competing for customers. They are also competing for faculty on the supply side. A faculty member who goes to teach at Harvard does not teach at Yale. At the same time, the two universities’ faculty members can be complements, for example, when a Harvard professor writes a case study a Yale professor uses.

Turning to an example from the business world, Tata Motors recently introduced the Tata Nano, the first car for less than $2,000. Creating a car that costs this little was something of an engineering miracle. Used cars and motorcycles would be substitutes for the Nano, but Tata failed to consider these complements when they planned the auto’s introduction. In particular, the customer most likely to purchase a Nano was also likely to be trading in a motor cycle. But Tata dealers did not have any facilities or capability to accept trade-in motorcycles.

Furthermore, Tata had not thought about car loans. First-time car buyers who had previously been riding motorcycles typically did not have a credit rating. The issue was not that they had a bad one – they just did not have one at all! Because Tata was not initially prepared to provide car loans, many of their prospective customers were unable to purchase a Nano. Tata eventually corrected both problems. The company made motorcycle trade ins possible and provided car loans for the unbanked, but their failure to consider complements initially had put them in a bad position at the launch.

I believe the case of Japan is different, but in the United States, Walmart has overtaken Toys R Us to become the largest toy retailer. Whereas Toys R Us is destination shopping (in the US), Walmart is a store where people shop all the time. Therefore, Walmart has better complements. While you are already in the store shopping for other merchandise, you can purchase a birthday present conveniently rather than making a special trip to Toys R Us.

To my understanding, Toys R Us is not destination shopping in Japan. Rather, the stores are integrated into shopping malls or near other stores. Therefore, Toys R Us has been more successful in Japan. Similarly, in the U.S., Toys R Us will have to open more stores in venues like Time Square, where people already are, or add complementary products and services such as children’s haircuts, or the option to hold a birthday party on Aisle 6. In other words, Toys R Us must create other reasons for people to visit their stores.

Gas stations suffer a similar problem related to complements. You may have the world’s best gasoline, but if you don’t have a convenience store, you are going to lose to a competitor that does. You thought you were in the gasoline business, but you have to be in the convenience store business, too.

Michael Porter does not really see complements as a sixth force (in his Five-Forces Model). He continues to argue that complements are simply value enhancers. As such, complements are nice to have, but not a distinct force. I counter that they have to be a force by definition: The opposite of literally anything that you could say about substitutes applies to complements. Furthermore, you need to be concerned about the structure of the complements industry. If you are Microsoft, you care whether or not Intel has a monopoly. If they do, they have the same ability to take industry profits as you do. Therefore, Microsoft supports AMD. Similarly, because Intel is concerned about Microsoft’s monopoly, the former supports Linux. The fact that the industry structure of the complements threatens their capability to garner profits shows why complements are a sixth force in industry.

 

2. Your dynamic, Co-opetition model contrasts with Porter’s static, zero-sum Five-Forces Model. To what extent are the models compatible?

I would say our models are complements, not substitutes. I add a sixth force, something that is missing. Customers and suppliers are completely symmetric; they are the opposite face of the same relationship. I would say the same is true for substitutes and complements. As explained in my book, with the exception of the German language, which has a word for everything, no other language has a word for the firms that supply complementary products and services, that is complementors,  I will bet you have a single word for competitor in Japanese. But you do not have a single word meaning complementor, a situation suggesting that this relationship has not been well understood. While complements are not more important than competitors, complements are equally important. The fact that we do not have a word for complements indicates the concept is not well understood. We have a word for every other relationship in the Five-Forces Model: We have a word for the customer and the supplier; words for competitor and for rivalry, too. But we do not have a word for complementor.

 

3. Value nets seem to be transient in nature. In this respect, they appear similar to the notion of transient competitive advantage proposed by Rita McGrath. On the other hand, you seem to hold the opinion that competitive advantages must be sustainable, or at least, sustained. Are value nets also sustainable, or are they transient? Are there conditions where the value net is likely to be transient and other conditions under which it is likely to be sustainable?

I do not think saying, “Value nets are sustainable or transient,” is correct use of terminology. The value net is a map. You can assert that competitive advantage is sustainable. I have little more to add about the competitor side of sustainable advantage because that area has been well mined by Porter, McGrath, and many others. However, we can talk about the sustainability of a complementor advantage. If someone else comes into a market like Curves following your initial entry with another brand like Pepper or Eggplant similar to Curves, your advantage in the market could decline. On the other hand, when others introduce complements, they can help your products as well. As a result, your complementary advantage remains; it does not go away.

If others start making car loans to the unbanked, this complement helps Tata Motors sell more Nanos. In fact, helping the customer acquire such complements more easily and cheaply is an important goal. I distinguish what I refer to as proprietary complements from industry-wide ones. If Tata Motors has no competitors selling Nano substitutes, who furnishes the car loans does not matter. If the banks provide them, fine. On the other hand, if other companies are selling Nano substitutes, but your loans are proprietary, in other words, you only provide them for Nano purchases, these complements lose value when rivals offer their own, proprietary complements. For this reason, you want the complements to your product to be better than those of other companies. In this sense, you can have a transient, complement advantage. Both the creation and existence of complements will help you, not harm you, as the market for complements to your product develops.

 

4. In the current internet age, where change is rapid, do you feel the concept of arena is more suitable than industry as the unit of analysis for strategy? From the standpoint of your theory on value nets, which seems more appropriate?

If you think about Tesla Motors’ latest move, they are building a battery factory because the greatest obstacle to the electric car is battery technology. It needs to be improved. This technology also happens to be a complement that may be too expensive for any one player to provide by itself. For this reason, we see a lot of alliance formation. Better battery technology will help the entire industry, not just a single firm. It’s also a missing, key complement.

In the case of Google, their approach to the self-driving car seems to be to develop maps that are incredibly detailed. Not the type of simple map you would view on your laptop, but one that maps details from curb heights to potholes. Google’s database would be an example of a proprietary complement. If you want to use a self-driving car, you will need the detailed data they have on roads.

I believe Google recently purchased Boston Dynamics, one of the most advanced robotics companies in the world. The company has developed remarkable, four-legged robots that can travel off-road terrain.

Why would Google acquire such a company? The technology will allow them to map terrain that is not on roads. You can imagine that Google will want to collect data on the inside of buildings like shopping malls at some point, for example. Google is really good at collecting and organizing data. The self-driving car not only relies on data, but once the car is fully functional, will be good at collecting data, too. It can drive up and down streets taking all sorts of photographs with Google Street View.

The invention of the Google car has removed a complement—the driver. But it has also resulted in the need for another key complement that is currently missing: insurance. We have yet to figure out how to insure a driverless car. Regulations are another missing complement that will have to evolve to accommodate the introduction of driverless autos. You can manufacture the world’s best self-driving car, but until you get the insurance complement right, you will not be able to use the car. Once the insurance industry creates this complement, it becomes permanent; it is not a transient entity that goes away.

On the other hand, whether or not another company is able to manufacture a self-driving car depends on how the company plans to do so. If they plan to use Google’s database, they will have to pay Google a licensing fee. In this case, Google’s advantage remains. In contrast, if another company creates an alternative technology, like having the car communicate with cars surrounding them, this company may compete with Google that does not rely on access to the data complement.

             

 

5. Numerous once-lauded Japanese companies including Sony, Panasonic, and Nintendo are now struggling in the market. From a value-net perspective, how would you assess the source of their current competitive difficulties? How can these companies apply the principles of your theory to develop more successful strategies?

One of the greatest challenges such Japanese firms face stems from the fact that many of their products have become too good. First, we transitioned from black-and-white to colors television sets, then from color to high-definition televisions and 60-inch screens. All were noticeable improvements people were willing to pay for. But in much the same way I will not pay for a car that accelerates from 0 to 60 mph in three seconds because I cannot utilize this technology, people no longer want to “upgrade” their televisions. I do not feel the need to upgrade my television to the latest 3-D or 4K technology. I do not need a larger screen, either. A bigger one would not fit on my wall!

The same thinking applies to personal computers. I do not need a supercomputer on my desktop. Most of the time, my computer waits for me! The most important features of current laptops are weight and battery life, not processing speed or screen size. Recognition of this fact has led to a lot of work on battery development. I now have three different laptops—one in my office, another at home. Some are three and four years old, but still work perfectly well. They are a little larger, so I do not always want to lug them around, but when you think about it, I do word processing, make PowerPoint presentations, and use spreadsheets. For these tasks, my current laptops are perfectly adequate. Speed would become an issue only if were to start doing video editing. For now, I care primarily about the portability of my laptops and the life of their batteries.

For Japanese companies, I think this technology issue is the real challenge. We have reached the point where the sustaining innovation is no longer valued by consumers. As Clay Christiansen would put it, Japanese companies continue to manufacture products that exceed customer desires. The customers are unwilling to pay for the new product features. As a result, Japanese firms’ sustainable improvements are no longer providing value for these companies. To resolve this dilemma, they have to create fundamentally new, disruptive innovations, which is a great challenge. If you are an entrenched player, the challenge is especially monumental.

If you think back to Apple’s iPod, I believe the key was the fact that their product was a complement to stolen music. At the time, all sorts of music sharing sites like Napster allowed people to amass giant libraries of stolen music essentially for free. But there was no good away of carrying all those tunes around with you, organizing them, or playing them, either. Furthermore, the music was all digital, so you had to work with a Walkman.

Apple saw the opportunity to offer a complement allowing you to fully enjoy this music. Now, the iTunes store makes buying music easy, but at the time, stealing music was easier than purchasing it. Today, people are no longer purchasing music at all. Instead, consumers are joining music-subscription services like Spotify, Pandora, and Beats. People no longer want to own any music at all because they can now play whatever they want whenever they want. They no longer need a large, digital-storage device, just connectivity.

Turning from iPads to cameras, the phone has essentially become a substitute for them. You could make the world’s best lenses like Sony, whose Alpha (α) camera line is amazing. But the best camera you have is the one you are currently carrying. Your cell-phone camera is not as good as your fancy Sony one, but because you have it in your pocket, it wins. Before you know it, cell phones are going to offer image stabilization and zoom lenses. As these technologies develop, Sony’s plight will only worsen. More generally, I do not have any good news for my friends at Sony, Panasonic and other once-leading Japanese firms.

 

6. In a talk on Honest Tea, you give an interesting twist to the tale of the Princess and the Pea, suggesting that aspiring entrepreneurs focus their attention on the peas—products that do not fully satisfy or other irritating situations—as sources of opportunity. What peas in the U.S. or world markets have drawn your attention recently? What makes these opportunities attractive to you?

In this children’s story, a princess is lying on eight mattresses stacked on top of one another with a pea underneath the lowest mattress. She cannot sleep because this pea is bothering her. In one view of the story, this is how you know she is a princess. Only a princess would be bothered by such a small annoyance. Yet another view is, “Princess, get a life! Don’t let this tiny pea annoy you.” Most parents take this view with their kids. But in my view, if you seek out these annoyances, the peas we have learned to tolerate, they may turn out to be great business ideas. With Honest Tea, the pea was my frustration with existing beverage options: They were either boring like water; liquid candy like sodas; or dangerous diet products. Interestingly, such is not the case in Japan, where you have weak tea: unsweetened or very lightly sweetened canned iced tea. Before Honest Tea, no similar product existed in the United States.

What we currently do not have is an alcoholic beverage for people who do not want to become drunk. For this reason, I recently started another beverage company to make a very low-alcohol drink. It’s called KomBrewCha, which is a take off of Kombucha, fermented tea. The motto of the company is, “Get tickled, not pickled.” It’s a product you can enjoy when you want a slight buzz that also allows you to return to work, go exercise, drive. With KomBrewCha, you can socialize without going to excess. .