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Wednesday, January 4, 2023

What is the difference between complements and substitutes?

Business success is determined by several factors, including talent, leadership, and strategy. While many leaders can exert control over their organizations' internal operations, there is often little they can do to ensure that the economy, political landscape, and competition act and react in their favor.

As a result, preparation is critical in business. The right business strategy can quickly make an impact, whether through complements or substitutes.

If you're curious about how business strategy can help you and your company adapt, here's a primer on what complements and substitutes are, how they can benefit your organization, and why you should incorporate them into your business model.

In business, what is a complementary good or service?

A complement is a product or service that increases the willingness to pay (WTP) of a customer for another product or service. Customers with printers, for example, are willing to pay more for ink because a printer is useless without ink cartridges. Another example is razor blades, which are required for razors to function properly. These products are considered complementary because they rely on one another to serve customers.

When used correctly, compliments can be extremely beneficial and encourage companies to create businesses outside of their core industries. However, the exclusivity decision is especially important for emerging industries and product categories.

Consider the electric car company Tesla, which is used as an example in business strategy. While constructing electric car charging stations across the country, Tesla faced a critical decision: should the stations charge all-electric vehicles or only those manufactured by Tesla? The latter was chosen by the company. By developing an exclusive service for Tesla owners, the company not only increased the WTP for its product but also slowed the adoption of battery-powered vehicles.

This example raises an important question for all strategists: Should you make two products mutually exclusive in order to maximize sales, or should you allow competitors to sell complementary alternatives to your core product in order to increase functionality for customers and elevate the entire industry?

Complements for Specific Industries
Industry-specific complements raise a customer's willingness to pay for specific products and services within an industry. Using them is an effective strategy for businesses looking to expand their market reach. "A rising tide lifts all boats," writes HBS Professor Felix Oberholzer-Gee in Business Strategy.

For example, if a company developed a simple syrup that eliminated the calories in any alcoholic drink to which it was added, the alcohol industry would likely see an increase in health-conscious customers. As a result, sales of simple syrup would rise. In this case, the syrup is a non-proprietary, industry-level complement, which is the most effective at generating industry-wide impact.

Complements for Your Business
If you want to gain market share, you must keep compliments confidential. Company-specific complements increase the WTP of your company's goods and provide you with a competitive advantage in your industry.

For example, if a vodka company created the aforementioned simple syrup to only work with its products, sales of both vodka and syrup would increase. As a result, its competitors' market shares would fall.

Complements for Specific Industries
Industry-specific complements raise a customer's willingness to pay for specific products and services within an industry. Using them is an effective strategy for businesses looking to expand their market reach. "A rising tide lifts all boats," writes HBS Professor Felix Oberholzer-Gee in Business Strategy.

For example, if a company developed a simple syrup that eliminated the calories in any alcoholic drink to which it was added, the alcohol industry would likely see an increase in health-conscious customers. As a result, sales of simple syrup would rise. In this case, the syrup is a non-proprietary, industry-level complement, which is the most effective at generating industry-wide impact.

Complements for Your Business
If you want to gain market share, you must keep compliments confidential. Company-specific complements increase the WTP of your company's goods and provide you with a competitive advantage in your industry.

For example, if a vodka company created the aforementioned simple syrup to only work with its products, sales of both vodka and syrup would increase. As a result, its competitors' market shares would fall.

In business, what is a substitute good or service?
A substitute has the opposite effect of a complement; it is a product or service that reduces a customer's WTP for the product or service of another company. Technology is a common example because it is a low-cost substitute for human labor.

Substitutes, on the other hand, are not negative "competitive replacements." Substitutes, in other words, are not used to replace a failing product or service. Instead, they increase a company's value by lowering its willingness to sell (WTS) its core products. When new technologies emerge, it can be difficult to distinguish between complements and substitutes, regardless of the value they can provide your business.

The relationship between paper products and personal computers is one example given in Business Strategy (PCs). Many people predicted in the 1980s that PCs would make most offices paperless. Nonetheless, until the early 2000s, paper consumption in the United States nearly doubled. This rise was caused by PCs making printing easier while also being more prone to crashes during their early years on the market.

PCs were initially considered complementary to printers and paper products rather than a replacement. However, after the early 2000s, office paper product consumption fell significantly. As a younger generation entered the workforce, they became more comfortable with using digital-only products, which resulted in computers becoming a substitute. This is not an isolated case but rather a common pattern in the implementation of substitutes in business.

"Product relationships aren't set in stone; they evolve with customer preferences and technology," Oberholzer-Gee writes in Business Strategy. "Strategists frequently expect substitutes to arrive much sooner than they do, failing to recognize that relationships between products and services can change over time."



How to Select the Right Business Strategy
It can be difficult to decide whether to use a complement or a substitute. It is critical to select a value-based strategy that ensures long-term success.

"There are only two ways to create value: increase WTP or decrease WTS," writes Oberholzer-Gee in Business Strategy. "Complements and substitutes assist us in doing so."

To aid in decision-making, begin by understanding your customers' journeys. Consider the following questions:

What else do your customers look for during the discovery stage?
During the consideration phase, which competitors are they evaluating?
What prompted their additional purchases if they are returning customers?
Starting with these questions can help you determine which strategy best fits your company's goals and customer preferences.

While substitutes can be extremely effective at lowering WTS, complements, despite their difficulty in locating, are far more common in most industries. This is because complements are inextricably linked to a company's core products. The most intriguing aspect of complements is that when they become cheaper, they raise customers' WTP for your core products.

For example, if the price of coffee pods falls, more people will be willing to buy a coffee machine because they believe the price of the pods will fall in the future. As a result, the coffee machine is a wise investment. This type of dynamic relationship between core products and their complements allows you to face fewer competitive pressures by strategically positioning your offerings for success.

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